Every company wants more accurate sales forecasts; you purchase what you need, when you need, and most importantly, you don’t buy too much or too little. The more accurate your sales team’s forecasts are, the less of an impact your carrying costs of inventory will have on your company's bottom line. Unfortunately, we all know that sales projections can’t possibly attain 100% against actual sales. There is guaranteed to be a deviation. However, it’s more about the pursuit of perfection, than actually ever attaining that 100%. Each time your accuracy increases, your costs of inventory decrease. So, how can you improve your sales forecast accuracy?
Improved Accuracy Equals Lower Inventory Costs
Before venturing into some of these strategies, it’s perhaps best to understand the importance behind continually raising the bar on your sales team’s performance. In essence, consider this a key performance indicator for your sales team, one that forces them to have stronger cohesion with their internal and external customers. Your inventory costs are mainly broken down into two main cost drivers, 1) the costs to hold inventory without sales and 2) the costs of lost sales because of low inventory.
When you hold inventory for too long without sales, your company incurs additional costs related to inventory financing, obsolescence, damage, pilferage and inventory counting, in addition to other miscellaneous costs. When you don’t have inventory, and miss a sale as a result, your company loses gross profit. One measures the costs of holding inventory without sufficient sales, while the other measures the costs of lost business because inventory wasn’t available to sell. The following video explains these two main cost drivers.
The video above is from the post: Inventory Carrying Costs vs. Lost Sales: Both Destroy Your Bottom Line
Finding that middle ground is extremely difficult, but it’s much easier when your sales team is doing its part to provide more pertinent sales projections. Therefore, here are some simple tips to use to improve how your sales team provides your company with future sales volumes.
1) Month-to-Month & Quarter-to-Quarter Fluctuations
Your salespeople must be able to account for any month-to-month, or quarter-to-quarter, fluctuations by account. This forces them to know their customer’s business, inside and out. They must be able to account for their customer’s customers. In this case, they should be able to tell when a given account will have an increase or decrease in demand. This information could come from historical trends, different business cycles, or seasonality. However, it must be focused solely on that individual account. Why? Simply put, your market is made up of several different customer segments. Most move when the market moves, but others may have market niches that move against the general trends in your industry. Understanding who these customers are is essential.
2) Seasonality and Historical Trends
Your company must account for the impacts of seasonality and dips in its business cycles. It’s a guarantee that you’ll come across busier and slower times of the year, but if your salespeople don’t catch it, then it’s guaranteed to either lead to high holding costs, or lost sales.
Monthly Comparison: Start by graphing your month-to-month sales over a given year. Next, compare those results to previous years. You are looking for those monthly business cycles that you may have missed. Performing a year-over-year comparison will allow you to isolate those portions of your business cycle that you may have missed.
Quarterly Comparison: It’s also important to perform a quarter-to-quarter comparison of sales volumes. Why? Well, looking at the graph of the sales volumes, it’s obvious that the company’s slowest periods are during its second quarter (April, May and June) before it starts to pick up gradually in the third quarter and takes off in the fourth. However, there’s another dip between the fourth quarter and the first quarter of every New Year. This is highlighted in BLUE (in excel table) and shows a 26% decline from Q4 2010 to Q1 2011, and 24% from Q4 2011 to Q1 2012. It’s the beginning of another year and it’s not uncommon to be slow getting off the mark. Doing a quarterly comparison of actual sales volumes will allow you to cross-reference these volumes against your monthly comparisons.
3) Using PERT: Project Evaluation and Review Technique
PERT is the foundation for Gantt Charts and is an essential tool used by project and product managers. It relies upon using three variables in order to determine the most likely outcome. Now, PERT is far more involved than what we are reviewing here. However, the basic rules apply: Assign a value to these three variables and then use the formula to come up with the most likely outcome. In terms of sales forecasts, we want your salespeople to ask themselves; A) What is the best scenario in terms of sales? B) What is the most likely scenario in terms of sales, and C) What is the worst case scenario in terms of sales.
Theses three questions, the PERT calculation, and a video, are provided below. You can use this by customer account, by territory or by product line. When you think about a salesperson coming up with a projection on sales, these are the likely questions they’ll ask themselves.
- Best Case Scenario = A
- Most Likely Scenario = B
- Worst Case Scenario = C
- PERT Calculation = {1(A) + 4(B) + 1(C)} / 6
4) Tracking Performance: Sales Forecasts vs. Actual Sales, Absolute Error & Forecast Accuracy
You must also do a comparison of projected versus actual sales. This comparison is often referred to as the “Absolute Error,” but it is nothing other than accounting for the difference between what was projected as sales volumes, and what was actually sold. For instance, let’s assume your sales forecast was for 150 units in a given month, but only 130 were sold. The absolute error would be 20 units and the forecast accuracy would involve taking the 130 and dividing it by 150, which would give you 87% as a forecast accuracy.
- Sales Forecast: 150 units
- Actual Sales: 130 units
- Absolute Error: 20 units
- Forecast Accuracy: 130 / 150 or 87%
5) Safety Stock Review: Account for Finished Good Lead Times
It’s essential that your company is not only aware of its month-to-month, and quarter-to-quarter, business cycles, but that its inventory is planned to adjust to these ups and downs. Remember, lost sales is a direct cost of inventory. If your company encounters a stock out, its inventory costs will rise as it tries in vain to rush raw materials, or finished goods, into your warehouse.
Your safety stock must account for any seasonality adjustments. For instance, any inventory needed for the fourth quarter increase in customer demand, must be planned for during the third quarter – especially if the lead times are something as high as 6 to 8 weeks. Granted, this likely goes without saying, but I am amazed at the number of times companies are caught with inventory stock outs simply because they failed to account for having to adjust their safety stock thresholds for their busier times of the year.
The graph above is taken from the post: Determining Safety Stock & its Impact on Inventory Holding Costs
No sales forecast is ever guaranteed to be 100% accurate. There are guaranteed to be fluctuations between what was projected and what was actually sold. That aforementioned example of the absolute error would imply that the company itself is left holding 20 units. This could be viewed as the cost of having been off the mark. The company will likely hold these 20 units longer than it wants to and will have extra inventory holding costs as a result. However, if your company ensures multiple customers for your most common components, then these types of minor deviations are more than manageable. Remember, it's the pursuit of perfection that matters. Focus on that and the rest should follow.
To read more about this topic, please see:
Comments