After all, we could ask why forecasting the activity for the next sales cycle is so critical to companies. Why spending so much energy, trying to foresee the general level of activity, spending time trying to figure out mix effect and macro trends, identifying the drivers of the activity, when this time could be used to develop new product or sell them.
What's the point of all of this forecasting process? Why don't you read first our ultimate content page on sales forecasting?
Here are a few reasons to convince you if not already, why making a forecast is key, when running a business or driving a line of revenue in every company.
Making a forecast is key to ensure financial stability
Estimate break-even point
Let's start with some easy and management high-level theory.
A key component of a company is the determination of its break-even point.
The break-even point is the minimal turnover a company needs to generate, in order to cover all its fixed costs. This is for the theory, now, what does that mean. Every year, a company needs to assume a given amount of fixed costs. Fixed costs don't vary with the level of activity of the company, at least not medium term.
These fixed costs could be:
- Paying the employees wages every month
- Affording software licenses to run the company
- Paying the lease of the premises
- spending on commercial ads
These are obvious fixed costs - and most of them are easy to forecast. It means that at the beginning of the fiscal year, most of fixed costs a company will need to deal with are already known.
Every sales will generate some turnover. This turnover however, will need to factor in variable costs. Variable costs depent on the volume of production. Eg- to produce a pen, each pen is integrating a certain amount of plastic and ink. So the total amount of pens produced will directly impact variable costs.
Forecasting the activity will help to understand if the general level of activity (topline, meaning the turnover) will be high enough to help absorbing the fixed costs. In other words, how much one need to generate in turnover every month before starting making any profit. Are the forecasted sales and general level of activity high enough?
CFOs need forecasts
The target number decided for each month will help ensuring that the actuals are inline - and that the company is achieving the right direction. Any deviation to the forecast might endanger the likelyhood to make a profit - or to reach a given market share. Hence why CFOs are so obsessed by deviations between the plan (target) and the actuals observed. Any understood deviation needs to be course-corrected.
As you would imagine, low margin businesses are spending even more time fine-tuning their forecast since they just can't affort misforecasting.
For this first reason, getting a good forecast is mandatory in every business.
Targets and forecast are good to align the teams
One goal to achieve
Having a common goal to achieve is good for the teams motivations, especially when this goal has been clearly communicated and understood. It helps teams alignement, create a sense of responsibility.
No wonder why supermarket chains - and more generally all retailers - clearly assign daily targets to their shop managers and department managers. It helps create accountability and sense of urgence to reach the goal. This is how you drive performance among the team.
These targets broken down at an employee level als help determining the amount of bonus and variable wage an employee will be entitled too, while having their final annual review process.
Build a data-driven company
When top executives pay really attention to forecast and actuals performance, this inspires. Senior management are models for employees. If executives look carefully at the forecast, value numbers, this will contribute to build a data-driven company.
Understanding deviation against plan will trigger several analysis. Employees will understand clearly what they need to achieve.
Building the forecast will require everyone's help. Information are gathered, consolidated, throughout the company. Sales forecasts are definitely a key component of data-driven companies.
A good forecast helps driving investors' trust. Especially when goals have been met.
Commit, then deliver.
Let's imagine for a second that you're investor. You could invest $1M in 2 companies.
How would you chose to which company you will lend your money - assuming both companies will have the same level of ROI ?
You might want to lend this amount of money to the company which built the most trust among the financial community; meaning the company which always delivered on what they promised to investors in the past.
When you forecast a end of the year financial number, the narrower the range of financial projection is (lower guidance and upper guidance) the better - even more if the company proved to meet expectations during previous quarters / years. It shows to investors that the company is in control of its business, commit and delivers.
Having an accurate forecast is critical for all these reasons. You will not be 100% accurate, but using as many tools available on the market is key to get to a forecast fast and speed up the fine-tuning. So let's be in touch!