Sales forecasting: Definition and methodologies
Sales forecasting is an essential business exercise.
Whether you run a small business, a startup, or a global corporation like Bluehost or Hostgator, having accurate sales forecasts gives you the ability to make smarter, better-informed decisions about important matters that affect cash flow, including goal setting, budgeting, and hiring, among many others.
In this article, we take a look at the sales forecasting definition, as well as 5 sales forecasting methodologies that you can choose from.
Sales Forecasting Definition
Sales forecasting is simply the estimation of future sales revenue. It is done by predicting how many sales a sales unit (a company, team, or individual salesperson) can make in the coming week, month, quarter, or year.
The sales forecast is often based on historical data, industry averages, and the current status of the sales pipeline.
So, for instance, a small business owner like this one could base his sales forecast for the coming year on the previous year’s sales, while a mid-sized business like this one that sells plagiarism detection software might consider basing its forecast on industry averages.
As with the weather forecast, the sales forecast is to be used as a plan that salespeople can work from, as opposed to a firm prediction of future revenue.
Why is Sales Forecasting Important?
Although there are a lot of tools businesses can leverage for growth, sales forecasting remains among the most important things that can impact the decisions you make for your business.
Imagine you’re a Sales Manager or VP of Sales of a company like this one which sells inflatable stand up paddleboards, and you find yourself pondering over questions such as:
- "How much is our revenue target this year?"
- "How many leads are we going to need to hit our revenue target in this quarter?"
- "Will we need to hire more salespeople to meet our sales goals for the year?"
- "How much revenue is this new product going to bring in to the company?"
Sales forecasting is one way to get an answer to these and other important questions.
It gives you a clearer picture of how many sales your company can expect to make, and how much new revenue you stand to generate in any given period.
With these insights, you can then take the necessary steps to propel your business toward continuous growth.
Remember, making money in any business comes down to one thing: Sales.
Sales are the lifeline of any business, and it's clear that accurate sales forecasting is among the best ways to help business leaders make informed decisions to ensure continued growth.
Factors that Affect Your Sales Forecast
One of the major factors that can affect your sales forecast is data. Good sales forecasting requires good data.
This is a challenge that many new businesses face, as they don't have a lot of data pertaining to their own sales process. This means that they may have to base their sales forecasting on industry trends and even educated guesses, in some cases.
Established companies, on the other hand, can employ their historical data in helping them model future performance.
Here are other factors that might affect your sales forecasting and should be taken into consideration when creating your forecast:
- Budget allocation
- Marketing spend
- Economic conditions
- Customer satisfaction
- Political conditions
- Even weather
You must take all these factors into account in order to ensure an accurate sales forecast and to help you understand any shortcomings of the forecasting method you choose.
Top Sales Forecasting Methodologies (and examples)
There are several sales forecasting methods you can use to predict your future sales, some more accurate than others.
Many businesses employ two or more forecasting techniques in order to create a range of sales forecasts. This gives them both the best-case and worst-case scenarios.
Listed below are a few of the most popular sales forecasting methods that will help you predict your future revenue more accurately.
1. Relying on Your Sales Team’s Opinions
This is among the most commonly used ways to create a sales forecast. The theory behind it is simple. Just ask for your sales rep’s judgment on how much a deal might be worth when it closes.
So, for instance, a business such as this one that sells mannequins might ask each of its sales reps how much they expect to make in sales over the next week, month, quarter, etc.
Then, all they’d have to do is add all the totals together, and then extrapolate them for a further one or two years, and they would have just created a sales forecast.
Photo credit: MannequinMall
A lot of businesses rely on this method for estimating future sales because the sales reps have the best visibility with regard to what's coming up. However, this method is not recommended as it clearly has some flaws.
For one thing, salespeople tend to greatly overestimate sales forecasts, and different salespeople often arrive at vastly different estimates.
Also, this method has no repeatable process that will allow you to generate a consistent sales forecast.
2. Reviewing Historical Data
This is yet another simple approach for creating a sales forecast. Looking at past data involves examining a record of your past performance under similar conditions to determine how you will likely perform in the present, as well as in the future.
Say, for instance, your business has grown at a rate of 10% per year in the last five years. Around the same time last year, you managed to close $25,000 of new business.
Employing this model, it would be quite reasonable for you to estimate $27,500 in sales revenue for this month.
This method might be particularly useful for a business like this one which sells sexy outfits for valentines. Reviewing their historical data will allow them to get a clear picture of the annually repetitive demand fluctuation around Valentine’s day.
Photo credit: 3wishes
Although this method is a bit more accurate than relying on your sales team’s opinions, it still doesn't tell you about everything else that is happening in the world.
The 2019 coronavirus outbreak is a good example of how the approach of using historical data can fall apart.
For many businesses, it didn't matter how many units they sold in the third quarter of 2019, with the rise of remote work in 2020, and with millions staying at home, and experiencing burn-out, those businesses just weren't going to sell as much.
This business, which sells Falsa blankets is an example of just such a business that is likely to have been seriously impacted by the global pandemic.
Photo credit: Orizaba Original
Of course, a company like this one focused on IT security risk assessment would have managed to weather the storm brought on by the global pandemic a lot easier than other businesses.
However, they would still have to take into consideration other factors that might affect their sales forecast when using this method, such as the number of salespeople in the company, how the company’s competitors are performing, and so on.
3. Using Deal Stages
Although it’s simple, this method is still a little more sophisticated than the previous two. When using deal stages for forecasting, you assign a probability of a deal closing in each stage of your sales process.
You can then multiply that probability by the size of the opportunity to come up with an estimate of the sales revenue to expect.
So, for instance, if you were selling training webinar software packages for large corporations, you might assign 2% if you receive a reply to your initial cold email.
The bottom line is, the further the prospect is down the pipeline, the higher the odds of closing the deal, as shown in the example below:
Photo credit: Klenty Blog
This software company, which offers an Amazon repricing tool, might use a similar method for their sales forecasting, with the initial call being awarded 2% and the product demo 45%, and so on.
This is a popular method that has been proven to work better than the previous two methods mentioned here, but it's still not without its drawbacks.
One of the main disadvantages of using deal stages for sales forecasting is that it doesn’t take into account the passage of time.
For instance, if you have run a design resources demo for two different prospects, but one of them happened three weeks ago and the other this morning, the probability of the deal closing obviously isn't the same for both opportunities.
4. Length of Sales Cycle Forecasting
Sales cycle forecasting is an alternate forecasting method that helps to provide a more accurate picture than using deal stages.
When assessing the strength of a particular pipeline, this method takes into account the age of the sales opportunity, as opposed to the probability.
Sales cycle forecasting compares the length of time a deal has been in the pipeline to the length of time it normally takes to close a deal. In other words, it uses data on how long it typically takes for a lead to be converted into a paying customer.
So, for example, if you have a WordPress affiliate business with an average sales cycle of about two weeks, and it’s been a week since the client first opted into your email list, then the probability that the deal will close is about 50%.
Using the length of the sales cycle for forecasting sales is an effective technique because it's totally objective.
Your forecast is not dependent on subjective factors such as your salesperson's “gut feelings” or “intuitions”.
Another advantage of sales cycle forecasting is that you can apply it to a lot of sales cycles (depending, of course, on the source). For instance, a cold email outreach prospect might take three months where a referral client might take three weeks.
If you run a large business like Wix or Shopify which deals with different sales cycles (or different products), it means that you will have to create separate sales cycles to get a more accurate prediction of how likely the deals are to come off.
This method requires accurate data, which makes it extremely valuable to companies that religiously track everything about how and when a prospect enters the sales pipeline.
The good news is that it's easy to log all the data easily and correctly with the right CRM without requiring the sales reps to enter loads of data.
5. Multivariable Analysis Forecasting
Last on our list of sales forecasting methodologies is a combination of all the above-mentioned methods. You can use a custom forecast model that includes multiple variables, including:
- Individual Rep Scoring
- Past Data Review
- Opportunity Stage Probability
- Sales Cycle Length
By incorporating different sectors from the other forecasting techniques, this type of multivariate analysis allows you to create the most sophisticated and accurate sales forecast.
Consider an example where two reps who sell capsule filling machines work on the same account.
The first rep is working on a deal worth $10,000 and has just completed the demo. The opportunity stage forecasting predicts a win rate of 60% for the completed demo stage. Therefore, the sales forecast for this particular deal is $6,000.
The second rep works the smaller deal of $4,000, and he is in an earlier stage of the sales process. However, this rep’s win rate is around 80%, which makes the forecast for his deal $3,200.
So, the total sales forecast for that account would be $6,000 + $3,200 = $9,200.
This example is a simplified version of using multivariable analysis forecasting, but it's important to note that forecasts based on this model are highly complex and require advanced analytics solutions, which makes them impractical for startups and small businesses.
This sales forecasting method also requires clean data, which means sales reps need to track the deal activities and progress, otherwise you'll end up with inaccurate results, regardless of the software you use.
Which One is Right For You?
If you are not sure which sales forecasting method is the best one for your organization, you're not alone.
CSO Insights reports that over 60% of forecasted deals never close.
Photo credit: Clari
The data also shows that over 25% of managers in sales are unhappy with the accuracy of their sales forecasts.
Whether you sell online or in the physical world, it's possible to try out several different methods before settling on one technique for forecasting sales in your business.
Or, you may start out with one method, but soon outgrow it.
What's important here is to remember that you have to look at your business in terms of where you are today, and where you want to go in the future. This will help you decide on which sales forecast method is right for you.
Also, there are some platforms like Close that take the guesswork out of sales forecasting and help you set yourself up for success using effective data-driven techniques.
Of course, we may be a little biased, and although there are many online marketing tools you can choose from, we do believe Close.com is the best option if you want better insights into your current and future sales.
And to help you get started creating your sales forecast, here are 23 Sales Forecast Templates that you can choose from.
Over to you. Did this article explain everything you need to know about the sales forecasting definition and methodologies?
Burkhard Berger is the founder of awesomex™. You can follow him on his journey from 0 to 100,000 monthly visitors on awesomex.com. His articles include some of the best growth hacking strategies and digital scaling tactics that he has learned from his own successes and failures.