Sales Projections and the Budgeting Process
Sales projections help answer the question of how you earn a reasonable level of profit. Of course, the answer is complicated if competitors are selling the same product or service, because it suggests you may have to lower prices to stay competitive. If you want to cut prices to attract business, you need to plan your costs so your profit level remains reasonable.
Another possibility is to improve the design of your products and not change prices. If you do that, you add the cost of design to product costs. But increased sales without cutting prices may offset the cost of design.
Good planning is useful, and poor planning leads to projections (of profit, sales, and company growth) that aren’t useful. If you base decisions on inaccurate projections, you’re likely to use assets in ways that won’t maximize your profits. Simply put, you end up spending time and money on the wrong activities.
Coming up with accurate sales projections often begins with market research. Suppose you’re selling running shoes in the United States, and you discover that 10 million people buy running shoes each year in the U.S. On average, they spend $80 for a pair. Fortunately, you’ve priced your shoes at $78, so you’re right around the average.
Next, you estimate that your firm can capture 10 percent of the U.S. running-shoe market. That means a total sales volume of 10 percent of a 10 million-unit market, or 1 million units sold in a year. At $78 a pair, you project your sales to be $78 million.
Finally, you consider whether the market is growing or shrinking. If the running-shoe market is growing at 10 percent per year, you could reasonably increase your sales projection by 10 percent each year, also. Of course, market growth is impacted by the overall economy and the specific industry (sporting goods, in this case).
Competitors may also impact your growth. You’d need to project all these contingencies before coming up with a reasonable sales forecast.
The sales growth rate drives decisions about spending, employee hiring, and cash planning. If you’re selling 30 percent more, you can plan to increase your spending and hire employees to manufacture 30 percent more of your product. You also probably can expect a 30 percent increase in cash inflow as a result of growth.
But wait! If a more careful review indicates 10 percent growth, your 30 percent projection creates some problems for you. You increased your spending and hiring assuming the 30 percent level, but the sales and cash inflows will only come in at 10 percent. Put simply, you’re planning on spending 20 percent too much. Whether you’re building homes or selling running shoes, the numbers still apply.