Unit-2

National Institute of Technology Kurukshetra

A
presentation
on

unit-2

Sales Forecasting
 Meaning of Sales Forecasting:
• Any forecast can be termed as an indicator of what is likely to
happen in a specified future time frame in a particular field.
Therefore, the sales forecast indicates as to how much of a
particular product is likely to be sold in a specified future period
in a specified market at speci­fied price.
• Accurate sales forecasting is essential for a business house to
enable it to produce the re­quired quantity at the right time.
Further, it makes the arrangement in advance for raw mate­rials,
equipment’s, labour etc. Some firms manufacture on the order
basis, but in general, firm produces the material in advance to
meet the future demand.
Importance of Sales Forecasting
• It helps to determine production volumes considering
availability of facilities, like equipment, capital, manpower,
space etc.
• It forms a basis of sales budget, production budget natural
budget etc.
• It helps in taking decision about the plant expansion and
changes in production mix or should it divert its resource
for manufacturing other products.
• It helps in deciding policies.
• It facilitates in deciding the extent of advertising etc.
Importance of Sales Forecasting (continued)……

• The sales forecast is a commitment on the part of the sales department,

and it must be achieved during the given period.
• Sales forecast helps in preparing production and purchasing schedules.
• Accurate sales forecasting is a very good aid for the purpose of
decision making.
• It helps in guiding marketing, production and other business activities
for achieving these targets.
 Types of Sales Forecasting

1. Short-term forecasting: This type of forecasting can be defined

when it covers a period of three months, six months or one year.
Generally, the last one is most preferred.

2. Long-term forecasting: The forecasting that covers a period of 5,

10 and even 20 years.
Purpose of Short-Term Forecasting:

• To adopt suitable production policy so that the problem of

overproduction and short supply of raw material, machines
etc. can be avoided.
• To reduce the cost of raw materials, machinery etc. To have
proper control of inventory.
• To set the sales targets.
• To have proper controls.
• To arrange the financial requirements in advance to meet
the demand.
Purpose of Long-Term Forecasting

• To plan for the new unit of production or expansion of

existing unit to meet the demand.
• To plan the long-term financial requirements.
• To train the personnel so that man-power requirement can
be met in future.
Methods Used for Sales Forecasting
• Collective Opinion or Sales Force Polling
• Economic Indicators
• Time Series Analysis – data relating to past demand can be
used to predict future demand; past data may include
trend, seasonal, and/or cyclical components.
• Moving average method
• Weighted moving average method
• Exponential smoothing method
Elements of a Good Sales Forecasting:

• Accuracy

• Simplicity

• Economy

• Availability
Collective Opinion method

• In this method forecasting depends upon the salesman’s estimation

for their respective areas, because the sales-man are closest to the
customers, hence can estimate more properly about the consumers’
reaction about the product and their future requirements.
• All the esti­mates of salesmen are consolidated to know the total
estimate of the sales. This final estimate then goes through severs
checking to avoid undue imagination which is done many times by the
salesmen.
• The revised estimates are then again examined in the light of factors
like expected change in design, change in prices, advertisements,
competition, purchasing power of local people, employment, population
etc
Collective Opinion method (continued)……
Advantages:
• 1. This method is simple and requires no statistical technique.
• 2. The forecasts are based on the knowledge of salesmen, who are
directly responsible for the sales.
• 3. In practice, this method is much useful in the case of new
products.
Disadvantages:
• 1. This method is useful only for short-term forecasting, i.e.
maximum for one year.
• 2. As the forecasting is dependent upon the salesmen’s estimation
and if sales quotas are fixed then they, in general under-estimate
the forecast.
• 3. As Salesmen have no knowledge about the economic changes, the
Economic Indicators:
• In this method the forecasting is dependent upon certain economic
indicators, which are generally published by Central Statistical
Organization under the national income estimates.
Some of these indicators are:
• Personal income for the demand of consumers’ goods.
• Agricultural income for the demand of agricultural inputs, implements
etc.
• Construction contracts sanctioned for demand of building materials.
• Registration of automobiles for the demand of accessories, petrol’s
etc.
This method has some limitations, likewise.
1. Appropriate economic indicator is difficult to find out.
2. For newer products, no past data are available.
 Time Series Analysis

Time series forecasting models try to predict the future based on past
data.
-Sales figures collected for the last twelve weeks can be used to
predict the demand in the thirteenth week.
Forecasting can be done for short-term (under three months), medium-
term (three months to two years), and long-term (more than two
years).
Time Series Analysis (Continued).....

Choosing a forecasting model depends on:

• Time horizon to forecast
• Data availability
• Accuracy required
• Size of forecasting period
• Availability of qualified personnel
• Degree of flexibility (response time to change in demand) of the
organization
Linear Regression Analysis
Regression can be defined as a functional relationship
between two or more correlated variables. The relationship
is usually developed from observed data.
Linear regression refers to the special class of regression
where the relationship between variables forms a straight
line.
Y = a + bX
X= Independent variable, Y= Dependent variable,
a= Y-axis intercept, b= Slope
Simple Moving Average

It is used when demand for a product is neither growing or

declining rapidly.
Forecast for the next period is the average of the past n periods.
The longer the moving average period, the greater the random
elements are smoothed.
-But, if there is a trend in the data, the moving average has the
adverse characteristic of lagging the trend.
Data availability and storing is crucial in using moving average
method.
Weighted Moving Average

A weighted moving average allows any weights to be placed on each

data, providing, of course, that the sum of all weights equals 1.

Ft= w1 At-1+ w2 At-2+ w3 At-3+…………+ wn At-n

Choosing Weights:
-Experience and trial and error are the simplest ways.
-Most recent past values might get the highest weight.
-If the data has seasonal influence, weights should be established
accordingly.
Exponential Smoothing Technique
• Most recent occurrences are more indicative of the future than those in the
more distant past.
• In exponential smoothing, each increment in the past is decreased by (1-α),
where α is the smoothing constant.
Advantages:
-Exponential models are surprisingly accurate.
-Formulating an exponential model is relatively easy.
-The user can understand how the model works.
-Little computation is required to use the model.
-Computer storage requirements are small because of the limited use of
historical data.
-Test for accuracy as to how well the model is performing are easy to compute.
 Exponential Smoothing Technique
(Continued)
Three pieces of data are needed: most recent forecast, actual demand that
occurred for that forecast, and a smoothing constant (α).
Ft = Ft-1 + α(At-1 – Ft-1)
α determines the level of smoothing and the speed of reaction to differences
between forecast and actual performance.
α is determined both by the nature of the product and by the management sense
of what constitutes a good response.
-For a standard item with relatively stable demand, reaction rate will be small.
-If the product is experiencing growth, the reaction rate will be higher .
Break even analysis
A break-even analysis is a financial tool which helps you to
determine at what stage your company, or a new service or a
product, will be profitable. In other words, it’s a financial
calculation for determining the number of products or services a
company should sell to cover its costs (particularly fixed costs).
Break-even is a situation where you are neither making money nor
losing money, but all your costs have been covered.
Break-even analysis is useful in studying the relation between the
variable cost, fixed cost and revenue. Generally, a company with
low fixed costs will have a low break-even point of sale. For an
example, a company has a fixed cost of Rs.0 (zero) will
automatically have broken even upon the first sale of its product.
Components of Break Even Analysis
Fixed costs

Fixed costs are also called as the overhead cost. These overhead costs occur
after the decision to start an economic activity is taken and these costs are
directly related to the level of production, but not the quantity of
production. Fixed costs include (but are not limited to) interest, taxes,
salaries, rent, depreciation costs, labour costs, energy costs etc. These costs
are fixed no matter how much you sell.

Variable costs

Variable costs are costs that will increase or decrease in direct relation to
the production volume. These cost include cost of raw material, packaging
cost, fuel and other costs that are directly related to the production.
Contribution Margin
Break-even analysis also deals with the contribution margin
of a product. The excess between the selling price and total
variable costs is known as contribution margin. For an
example, if the price of a product is Rs.100, total variable
costs are Rs. 60 per product and fixed cost is Rs. 25 per
product, the contribution margin of the product is Rs. 40
(Rs. 100 – Rs. 60). This Rs. 40 represents the revenue
collected to cover the fixed costs. In the calculation of the
contribution margin, fixed costs are not considered.
Margin of Safety:
The excess of actual or budgeted sales over the break-even
sales is known as the margin of safety. It is the difference
between actual sales minus the sales at break-even point. It
represents the amount by which sales revenue can fall
before a loss is incurred.
As at break-even point there is no profit no loss, sales
beyond the break-even point represent margin of safety
because any sales above the break-even point will give some
profit.
Thus,
Margin of Safety = Total Sales – Sales at Break-Even Point.
Breakeven analysis is useful for the
following reasons
• It helps to determine remaining/unused capacity of the
concern once the breakeven is reached. This will help to show
the maximum profit on a particular product/service that can
be generated.
• It helps to determine the impact on profit on changing to
automation from manual (a fixed cost replaces a variable cost).
• It helps to determine the change in profits if the price of a
product is altered.
• It helps to determine the amount of losses that could be
sustained if there is a sales downturn.
Break Even Point:
The break-even point may be defined as that point of sales volume
at which total revenue is equal to total cost. It is a point of no
profit, no loss. A business is said to break-even when its total sales
are equal to its total costs. The break-even point refers to that
level of output which evenly breaks the costs and revenues and
hence the name.
At this point, contribution, i.e., sales minus marginal cost, equals the
fixed costs and hence this point is often called as ‘Critical Point’ or
‘Equilibrium Point’ or ‘Balancing Point’ or no profit, no loss. If
production/sales is increased beyond this level, there shall be
profit to the organisation and if it is decrease from this level,
there shall be loss to the organisation.
Computation of the Break-Even Point
The break-even point can be computed by the following
methods:
(i) The Algebraic Formula Method
(ii) Graphic or Chart Method.
Algebraic Formula Method for Computing the Break-Even Point:
The break-even point can be computed in terms of:
(a) Units of sales volume.
(b) Budget total or in terms of money value.
(c) As a percentage of estimated capacity.
(a) Break-Even Point in Units

Fixed cost
B.E.P=
(selling price per unit- Variable cost per unit)
or
B.E.P = Fixed cost/ contribution Per unit

F+ aQ =bQ
Q=F/(b-a)
(c) Break-even Point as a percentage of estimated
capacity:
Break-even point can also be computed as a percentage of
the estimated sales or capacity by dividing the break-even
sales by the capacity sales. For example, if a firm has an
estimated capacity of 1,00,000 units of products and its
break-even point is reached at 50,000 units, then the break-
even point is at 50% of capacity (1,00,000/50,000).
If information as to total contribution at full capacity is
available, the break-even point as a percentage of estimated
capacity can be found as under:
B.E.P (as % age of capacity) = Fixed Cost/Total Contribution
Break even chart