10.5 Forecasting
Budgeting is a quantified expectation for what a business wants to achieve, and a forecast is an estimate of what will be achieved (Accounting Tools, 2023).
Forecasting is the process of making predictions of the future based on past and present data. This is most commonly by analysis of trends. Prediction is a similar, but more general term. Both might refer to formal statistical methods employing time series, cross-sectional or longitudinal data, or alternatively to less formal judgmental methods.
Sales forecasting can involve either formal or informal techniques or a combination of both. Formal sales forecasting techniques often involve the use of statistical tools. For example, to predict sales for the coming period, management may use economic indicators (or variables) such as the gross national product (GNP) or gross national personal income, and other variables such as population growth, per capita income, new construction, and population migration. To use economic indicators to forecast sales, a relationship must exist between the indicators (called independent variables) and the sales that are being forecast (called the dependent variable). Then management can use statistical techniques to predict sales based on the economic indicators.
Management often supplements formal techniques with informal sales forecasting techniques such as intuition or judgment. In some instances, management modifies sales projections using formal techniques based on other changes in the environment. Examples include the effect on sales of any changes in the expected level of advertising expenditures, the entry of new competitors, and/or the addition or elimination of products or sales territories. In other instances, companies do not use any formal techniques. Instead, sales managers and salespersons estimate how much they can sell. Managers then add up the estimates to arrive at total estimated sales for the period.
Usually, the sales manager is responsible for the sales budget and prepares it in units and then in dollars by multiplying the units by their selling price. The sales budget in units is the basis of the remaining budgets that support the operating budget. Many will contribute to the sales budget including: product managers, sales leaders, sales representatives, marketing managers, business partners and external consultants.
Example: GelSoft
To illustrate this step, assume that GelSoft makes gel-filled seats for bicycles. Management forecasts sales for the first quarter at 40,000 units. Sales are projected to increase by 5% each quarter, reflecting higher demand as a result of increased marketing. The selling price for each seat is set at $34 and is not scheduled to be increased during the budget period (year). GelSoft’s sales budget would be prepared by showing the sales units for each quarter multiplied by the budgeted sales price to get the sales in dollars.
Table 10.5.1 GelSoft's Sales Budget
Q1 |
Q2 |
Q3 |
Q4 |
Total |
|
|---|---|---|---|---|---|
| Sales in units | 40,000 | 42,000 | 44,100 | 46,305 | 172,405 |
| Budgeted Price | $34 | $34 | $34 | $34 | |
| Sales | $1,360,000 | $1,428,000 | $1,499,400 | $1,574,370 | $5,861,770 |
To calculate the number of units for each quarter, we must add the increase in additional units to the current units. For example, Q2’s units are equal to Q1 + an additional 5%.
To simplify we can add [latex]5\%[/latex] to [latex]1[/latex] to create the multiplier [latex]1.05[/latex]
Multiply the first quarter sales by [latex]1.05[/latex]: [latex]40\text{,}000\times 1.05=42\text{,}000[/latex]
Another way to do this is to take [latex]5\%[/latex] of [latex]40\text{,}000[/latex], which is [latex]2\text{,}000[/latex], and add it to the base of [latex]40\text{,}000[/latex].
Continue to do this for each quarter, using the prior quarter as the base.
Table 10.5.2 GelSoft's Projected Sales for Each Quarter
Quarter |
Projected Increase |
Multiplier |
Units (rounded) |
|---|---|---|---|
| Q1 | 40,000 | ||
| Q2 | 5% | 1.05 | 42,000 |
| Q3 | 5% | 1.05 | 44,100 |
| Q4 | 5% | 1.05 | 46,305 |
| Total Projected Sales | 172,405 |
Having accurate sales figures is the key to the entire budgeting process. If this budget is inaccurate, it rolls downhill and the rest of the budgets will be off as well. In big companies, there might be mathematical models and statistics involved in figuring out these numbers. Don’t worry. We won’t be doing that in this course, but knowing the importance of this information is the key.
This budget will affect the variable portions of the selling and administrative budgets and will also feed into the production budget. The production budget is needed to figure out direct materials, direct labour and manufacturing overhead budgets. Once these are all done, then comes the finished goods inventory budget.
Here is a short review of how to create a sales budget:
“Sales Budgets” from Managerial Accounting by Lumen Learning is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.
