Step 1 Forecasting Sales

A major problem in budgeting is forecasting sales, for many factors affecting sales are outside the firm's control, for example, the behaviour of the firm's competitors and the future economic climate.

The importance of an accurate sales forecast cannot be over-emphasized. If the sales forecast is too optimistic, the firm may be induced to expand its capital expenditure programme and incur costs which may not be recoverable at a later date. In the meantime, the production target may be set too high, resulting in the pile-up of inventory of finished goods, which in itself has important financial consequences. Moreover, an optimistic sales forecast may disguise a deteriorating sales position, so that the necessary economies are not made which would produce a satisfactory profit. If, on the other hand, the sales forecast is pessimistic, the firm will miss the opportunity of larger current profit and may be misled as to its future prospects. The firm may, as a result, not undertake the necessary capital expenditure which would place it in a good position to exploit the market.

The sales forecast is the initial step in preparing the sales budget. It consists not only of analysing the market for the firm's products, but includes forecasting the levels of sales at different prices. Hence, the study of the firm's pricing policy is an integral aspect of sales forecasting. Once the sales forecast is completed, the sales budget may be derived from the target sales established both as regards price and sales volume.

There are various methods of forecasting sales, for example:

(a) The sales force composite method. This method places responsibility upon individual salesmen for developing their own sales forecast. The advantage of this method is that if participative budgeting is to be encouraged, the sales staff should assist in the preparation of the sales forecast.

(b) The analysis of market and industry factors. This method recognizes the importance of factors not within the knowledge of the sales force, such as forecasts of the gross national product, personal incomes, employment and price levels etc. The salesmen's estimates are modified by the information so obtained.

(c) Statistical analysis of fluctuations through time. Sales are generally affected by four basic factors: growth trends, business cycle fluctuations, seasonal fluctuations and irregular variations in demand. A time series analysis of sales is a statistical method of separating and analysing the historical evidence of the behaviour of sales to identify these several effects and their impact on sales. The results of this analysis are applied to the sales forecast, and are means of testing the quality of the forecast.

(d) Mathematical techniques for sales forecasting. Of recent years, mathematical techniques have been applied to the study of the relationship between economic trends and a firm's sales pattern through time, to arrive at a projection of future sales. These techniques usually involve the use of computers. One such technique is known as exponential smoothing, which is really a prediction of future sales based on current and historical sales data, weighted so as to give a greater importance to the latest incoming information.

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Read on: The Organization of Budgeting

The budgeting process itself requires careful organization. In large firms, this process is often in the hands of a budget committee which acts through the budget officer whose function it is to co-ordinate and control the budgeting process for the whole organization. Departmental budget estimates are requested from divisional managers, who in their turn collate this information from estimates submitted to them by their own departmental managers. Hence, budget estimates are based on information which flows upwards through the organization to the budget committee. The budget committee is responsible... see: The Organization of Budgeting