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The Sales Forecast

The key to the accuracy of most cash budgets is the sales forecast. This forecast can be based on an internal analysis, an external one, or both. With an internal approach, sales representatives are asked to project sales for the forthcoming period. The product sales managers screen these estimates and consolidate them into sales estimates for product lines. The estimates for the various product lines are then combined into an overall sales estimate for the firm. The basic problem with an internal approach is that it can be too myopic. Often, significant trends in the economy and in the industry are overlooked.

For this reason, many companies use an external analysis as well. With an external approach, economic analysts make forecasts of the economy and of industry sales for several years to come. They may use regression analysis to estimate the association between industry sales and the economy in general. After these basic predictions of business conditions and industry sales, the next step is to estimate market share by individual products, prices that are likely to prevail, and the expected reception of new products. Usually, these estimates are made in conjunction with marketing managers, even though the ultimate responsibility should lie with the economic forecasting department. From this information, an external sales forecast can be prepared.

When the internal sales forecast differs from the external one, as it is likely to do, a compromise must be reached. Past experience will show which of the two forecasts is likely to be more accurate. In general, the external forecast should serve as a foundation for the final sales forecast, often modified by the internal forecast. A final sales forecast based on both internal and external analyses is usually more accurate than either an internal or an external forecast by itself. The final sales forecast should be based on prospective demand, not modified initially by internal constraints, such as physical capacity. The decision to remove these constraints will depend on the forecast. The value of accurate sales forecasts cannot be overestimated because most of the other forecasts, in some measure, are based on expected sales.