Chapter 5

Sales Forecasting and Budgeting

PowerPoint presentation prepared by Dr. Rajiv Mehta New Jersey Institute of Technology

Chapter Outline
Sales Forecasting and Its Relationship to Operational Planning Forecasting Approaches and Techniques Evaluating Forecasting Approaches Sales Budget Planning Preparing the Annual Sales Budget

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5|2

Learning Objectives
After reading this chapter, you should be able to do the following:
1. Relate sales forecasting to operational planning. 2. Use the most popular quantitative and qualitative sales forecasting tools. 3. Evaluate the various sales forecasting techniques. 4. Identify the purpose and benefits of sales budgets. 5. Prepare an annual sales budget.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5|3

Sales Forecasting and Its Relationship to Operational Planning

A sales forecast is a prediction of the future market potential for a specific product. It sets the sales expectations for a given time period and can indicate what types of products customers are likely to want.

Market potential is a quantitative

estimate, in either physical or monetary units, of the total sales for a product within a market.

Sales potential is the portion of

market potential that one among a set of competing firms can reasonably expect to obtain.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5|4

Reasons Why Forecasting Is Important

sales and marketing planning production scheduling cash flow projections financial planning capital investment procurement inventory management human resource planning (hiring salespeople) budgeting

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5|5

Impact of Erroneous Sales Forecasts

Functional area Production Inventory Finance Promotion Forecast Too high
excess output, unsold products overstock idle cash wasted expenditures

Too low
inadequate output to meet customer demand understocks cash shortage insufficient expenditures to cover the market

Distribution
Pricing Sales force

costly, insufficient to sell excess products

reductions to sell excess products too many salespeople, high selling costs

inadequate to reach market

price increases to allocate scarce products too few salespeople, market not covered

Customer relations
Profits

money wasted on unneeded activities, resulting in lower profits

lower unit profits since expenses are high

unsatisfactory due to out-ofstock products

lower total profits because market not covered
5|6

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

Sales and Operational Planning Process (S&OP)

Analyze sales records.

Develop a preliminary forecast.

Have managers review and adjust forecast.

Build a sales plan around the forecast.

Make adjustments to operating plans.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5|7

Characteristics of Successful S&OP Programs

Firms dont know how well theyre doing unless they measure outcomes. All managerial levels must support the S&OP process and the plans that result. Regular meetings are held. Metrics monitor progress and provide benchmarks.

1. People

5. Performance

Successful S&OP programs

2. Process

4. Strategy
Effective strategy should align supply and inventories with demand.

3. Technology

Market intelligence and decision support system are in place for reports that assist in planning. 5|8

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

Estimating Industrial Demand

Survey potential industrial customers to measure their purchase intentionsthe likelihood they will actually purchase a given product.

1. Standardized classification systems

Estimating industrial demand approaches

2. Buyer intentions

North American Industrial Classification System (NAICS) has replaced the original SIC.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5|9

Steps in Forecasting Sales Using the Breakdown Approach

1. Forecast general economic conditions. 2. Estimate the industrys total market potential for a product category. 3. Determine the share of this market the company currently holds and is likely to retain in view of competitive efforts. 4. Forecast sales potential of the product. 5. Use the sales forecast for operational planning and budgeting.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 10

Sales Forecasting Model: Breakdown Approach

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 11

Forecasting Approaches and Techniques

based on primary research

1. Breakdown approach

Forecasting approaches and techniques

2. Build-up approach

Forecast economic conditions, such as these: GNP consumer price index wholesale price index interest rates unemployment levels

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 12

Sales Forecasting Techniques

1. Nonquantitative methods

Sales forecasting techniques

2. Quantitative methods

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 13

Nonquantitative Forecasting Methods

Nave forecast assumes that the next periods sales will be the same as they were in the previous period.
Jury of executive opinion method asks key managers within the company for their best estimate of sales in a given planning horizon and combines the results to develop the forecast.

Sales force composite method is similar, but it asks the sales force for their best estimates of sales in the planning horizon.

1. Judgment methods

Nonquantitative forecasting methods

2. Counting methods

survey of customers buying intentions

test marketing

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 14

Quantitative Forecasting Methods

moving averages exponential smoothing Box-Jenkins trend analysis using ARIMA

1. Time-series methods

Quantitative forecasting methods

2. Causal or association methods

correlation-regression econometric model

Input-output models

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 15

Statistical Software for Sales Forecasting

To learn about SAS, the leader in business intelligence and predictive analytics software, go to
http://www.sas.com

To read about the firms in various industries that use SAS software to make better, faster, intelligent business decisions, go to
http://www.sas.com/software/index.html

To read white papers and success stories on sales forecasting and data management by solution, industry, and technology, go to
http://www.sas.com/apps/forms/index.jsp?id=wp&cid=3880 http://www.sas.com/success/index.html

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 16

Articles on Sales Forecasting

To sharpen your skills by reading interesting articles on sales forecasting purposes, techniques, and procedures, go to
http://www.inc.com/magazine/19971101/1353.html http://www.zeromillion.com/business/sales-marketing/salesforecasts.html http://www.salesvantage.com/article/view.php?w=628&The_Key _to_Accurate_Sales_Forecasting/

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 17

Articles on Sales Forecasting

For interesting articles on choosing the right sales forecasting method as well as becoming a forecasting savant, go to
http://www.salesvantage.com/article/list.php?c=15 http://www.salesvantage.com/article/view.php?w=724&Sharpen _Your_Competitive_Advantage_Using_Techniques_that_Makes _you_a_Forecasting_Savant/

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 18

Time-Series Methods
Using historical data to predict sales, forecasters look for the following: 1.Trends are movements in a time series as a result of
developments in population, technology, or capital formation.

2.Periodic movements are consistent patterns of sales

changes in a given period generally called seasonal variations.

3.Cyclical movements are wave-like movements of sales

that are longer in duration than a year, such as business recessions.

4.Erratic movements are one-time specific eventssuch

as wars, strikes, snowstorms, hurricanes, fires, and floods that are not predictable.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 19

Types of Time-Series Methods

1. Moving averages

Time-series methods

2. Exponential smoothing

Moving averages are forecasts developed using a moving average to predict future sales as a mathematical function of sales in recent time periods. As the forecasters add each new periods sales data to the average, they remove from the total the data from the oldest period.

3. ARIMA

An autoregressive integrated moving average (ARIMA) model is based on the moving average concept. The model incorporates information about trends by spotting patterns in the fluctuations in data.

Exponential smoothing is a type of moving average that represents the weighted sum of all past numbers in a time series, with the heaviest weight placed on the most recent data.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 20

Types of Causal or Association Methods

1. Correlationregression analysis Causal or association methods 2. Econometric models

Causal/association methods attempt to identify the factors affecting sales and to determine the nature of the relationship between them.

3. Input-output models

Econometric models are based on a series of regression equations.

Input-output models are complex systems showing the amount of input required from each industry for a specified output of another industry.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 21

Correlation-Regression Analysis
1. Correlation analysis

Correlationregression analysis

2. Simple regression analysis

A correlation analysis helps calculate the strength of the association between two variables. Correlations do not imply cause and effect.

3. Multiple regression analysis

Multiple regression analysis is a statistical approach to predicting a dependent variable, such as sales, using several independent variables, such as advertising expenditures and price simultaneously.

Simple regression analysis is a statistical approach to predicting a dependent variable such as sales, using one independent variable such as advertising expenditures.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 22

Criteria for Evaluating Forecasting Methods

1. Comprehensibility: Sales managers
must understand the basic methods of developing forecasts.

2. Accuracy: A forecasting method must

provide results that are sufficiently accurate for the purpose desired.

3. Timeliness: The forecasting method must

generate forecasts in time for managers to use them.

4. Quality and quantity of information:

In forecasting as in other areas, garbage input leads to garbage output (GIGO).

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 23

Criteria for Evaluating Forecasting Methods

5. Qualified personnel: Experts
can give opinions on qualitative techniques like the jury of executives opinions or the Delphi method.

6. Flexibility: Managers continually

monitor actual sales for any deviations from forecast that may indicate the need for revised sales forecasting tools.

7. Costs/benefits: The benefits

from forecasting must more than offset the costs of generating the sales forecast.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 24

Sales Budget Planning

A sales budget is a financial sales plan outlining how to allocate resources and selling efforts to achieve the sales forecast.
1. Planning function

Sales budget uses

2. Coordinating function

Budgeting is an operational planning process expressed in financial terms, which provides a guide for action toward achieving the organizations objectives.

3. Controlling function

The control function of a sales budget is to evaluate actual results against sales budget expectations.

Sales budgets must be closely integrated with budgets for other marketing functions.

Differences between them are known as budget variances.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 25

Benefits of Preparing the Annual Sales Budget

The following are benefits of preparing the annual sales budget: ensure a systematic approach to allocation resources develop the sales managers knowledge of profitable resource use create awareness of the necessity of coordinating selling efforts with other divisions of the company establish standards for measuring the performance of the sales organization obtain input from all areas of the company in the profit-planning process
Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 26

Budget Preparation Steps

Sales managers must provide early warning of budget overruns and ensure that sales revenue and cost ratios remain within reasonable budget limits. Common line items in sales budgets include these: salaries direct selling expenses commissions and bonuses promotional materials advertising All management levels must be fully informed about sales goals and objectives.

1. Review and analyze the situation 6. Implement the budget and provide periodic feedback 2. Communicate sales goals and objectives

Budget preparation steps

5. Prepare a budget presentation 4. Develop a preliminary allocation of resources Succinct, wellreasoned written and oral budget presentations can be used to ask for increased allocation of funds.

3. Identify specific market opportunities and problems

Assign resources to particular activities, customers, products, and territories.

Sales managers and salespeople should use budget resources to pursue specific market opportunities and deal with problems on a timely basis.

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 27

Statistical Software for Sales Budgeting

To read an interesting article about sales budgeting software, go to
http://www.ferret.com.au/articles/z1/view.asp?id=10128 5

To learn about a sales budgeting software go to

http://www.managingautomation.com/maonline/director y/product/Data_Perceptions_Prophecy_Sales_Forecast ing_and_Budgeting_Software_3604491

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 28

Articles on Sales Budgeting

To augment your understanding of the link between sales forecasting and budgeting, go to
http://www.allbusiness.com/accountingreporting/budget-budget-forecasting/977-1.html

To broaden your understanding of sales budgets in international operations, go to

http://findarticles.com/p/articles/mi_m0OOL/is_2_5/ ai_n6118710/pg_5

Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 29

Ethical Situation: What Would You Do?

Discussion Question
As one of the newer district sales managers for a fast-growing technology company, youve asked your salespeople to give you three sales forecasts in their territories for the coming year: (a) optimistic, (b) pessimistic, and (c) most likely. After totaling their three different sales forecasts, you realize that the optimistic forecast will increase sales by nearly 20% in your district, the pessimistic forecast by 10%, and the most likely by about 15%. Your national sales manager has asked each district sales manager to give her their most likely sales forecast for the coming year, so she can assign sales quotas. Your thoughts are that its probably best to give her the most pessimistic sales forecast because this should help ensure that she assigns your district a quota that you should easily achieve. If you can exceed your assigned district sales quota by a substantial amount, youll probably get a large bonus, and you may even be named district sales manager of the year for your company. You know that your companys production schedules are based on the annual sales forecasts, but you plan to be very aggressive early in the year in ordering products to make sure you get more than your share for your salespeople before possible inventory shortages come later. You dont see any personal down side to this strategy.
Copyright Houghton Mifflin Harcourt Publishing Company. All rights reserved.

5 | 30