Best guess, hype or wishful thinking?

  • 2001-01-18
  • Paul E. Adams
Bad sales forecasts are bad for business. I just read a business plan about a promising start-up. Too promising. The product description and customer identification were well thought out, the sequencing of promotional activities and the sales campaign was methodical, the proposed income statement looked creditable, and the list of executives and potential customers was impressive. At first glance not wanting to miss out Ð I was ready to write a check.

But after spotting the sales projections Ð wow! The first year $1.75 million, the second year $6.35 million and the third, an astounding $19.59 million. Not a bad growth rate, from zero to 20 million in three years. Sounds exciting, does it not? Or is it a red flag?

When I found no comments or details explaining these projections, I put my checkbook away. The red flag was at full mast, as I am familiar with entrepreneurs, who trying to attract money wave magic wands and engage in puffery. Some believe their own fantasies, and some think they are Merlin able to create miracles. In either case, unrealistic projections lead to financial wreckage.

Although the sales forecast is one of the most important calculations in any business plan, the maze of the plan's financial detail can so overshadow it that we just assume it is accurate. Successful entrepreneurs know that the sales forecast is the basis of the estimated cash flow and money management. They know red-ink flows from missed forecasts. And they are well aware, if their company's common stock is traded, that the market is unforgiving of crystal ball error. Remember the recent dot-com meltdown?

I suggest if you are thinking of joining or investing in a new business with a glowing business plan then check that rosy sales projection. Without backup data, be cautious; sales hype rarely reflect the truth. If you are starting a business, can you justify your forecast or has fantasy colored your outlook? Perhaps your desire to succeed can be so strong that wishful thinking can creep into your plans without you being aware of it.

If you have ample historical sales data, reasonable forecasts are easy; even by eyeballing the figures with intuition and knowledge of the market can result in a creditable projection. The problem is new products or companies with no sales history are difficult to predict. As accurate as the numbers may appear, it is still a guess. And guesses are based on judgment Ð good and bad.

A sales forecast is just that, a forecast, a prediction with a possibility of error. Every business, every new product or project has a break-even point Ð a minimum sales volume that is necessary to generate enough income to cover the expenses and product cost. If the forecast is above your break-even, you have a margin of safety. If the forecast is equal to it you may be headed for trouble with no room for error. I suggest that before you offer your time or money, you compare the sales forecast to that all-important break-even sales or income level. It will give you a yardstick of risk.

You may be comfortable with statistics or any of the number crunching methods of sales forecasting, but you should always be uncomfortable with sales estimates that are "too" optimistic. The lesson of this column is that you should always question sales projections and never assume they are accurate.

Remember, the calculations of the business plan Ð expenses, profit margins and cash flow Ð are based on someone's crystal ball talents. If you are looking at a "too good to be true" forecast, ask about the "marvelous" marketing strategy that is going to create the miracle. If you cannot find comments or descriptions substantiating it, save your money and label it fantasy!