Salespeople are the headlights of every business. They have an insider’s perspective of their customers and prospects. They are the first to know about what customers plan to buy in the future.
Unfortunately, many companies are struggling to translate their salespeople’s predictions into a reliable financial plan. Just last week I spoke with the CEO of a company that employs more than 50 salespeople, and he said, “Salespeople are eternal optimists, and when I see their forecasts, I automatically cut them in half.” When I asked him, “How many times has your reduced number been accurate?” he said, “Never.”
My next question was, “How far off are your projections every month?” He said, “Our best guess usually brings us within 10 percent.”
Now let’s do the math so we can determine the financial impact of this forecasting error. If a company has $50 million in revenues, a 10 percent over-forecast represents $5 million. The big question is, what’s the true cost of this error?
First: The company has to carry an additional $5 million worth of product in its inventory. That’s $5 million in cash flow that the company could invest in other opportunities. The company could put the $5 million into tax-free bonds and earn $500,000 on that money per year.
Second: The company has to finance that inventory. At a 6 percent interest rate, the cost is $300,000.
Third: Producing the excess inventory is likely to inflate the company’s payroll by 10 percent, which translates to about $500,000 in additional payroll expenses. In this case, the financial waste of a 10 percent over-forecast translates into $1.3 million, which means that for every percentage point by which the company’s sales forecasting is improved, the company could save $130,000 a year.
Let’s say the forecasting error goes in the other direction. What are the costs of under-forecasting?
First, if there isn’t enough inventory, the order may be lost. Let’s say 50 percent of the company’s customers cancel their orders. That would be a $2.5 million loss in revenues.
Second, if the order is delayed, there is increased pressure to accelerate production, which often means overtime plus express shipping costs.
Third, if customers receive their orders late, customer satisfaction will drop.
Get forecasting right
World-class companies can’t afford to make big forecasting errors. They create a culture of measurement in which sales and marketing managers work in synch to achieve their goals. I recently spoke to the VP of sales of a software company, and he showed me how his 300-person sales team follows a documented sales process that gives the CEO a monthly forecast that’s 98 percent accurate. The VP of sales shared more reasons for pushing up forecasting accuracy.
He said that higher forecasting accuracy allows him to catch market changes earlier. You can respond faster with special promotions when the market slows down, or you can step up sales quickly if the market goes up. His comment: “Speed drives ROI.”
While many organizations are stuck tracking forecasting with spreadsheets, world-class companies use purposefully built, sales-forecasting software, such as Salesforce.com, that’s integrated with their CRM solution. These solutions both capture the data and provide exceptional analytics to drive better insight and accurate action.
As the economy moves into the recovery phase, now is the time to invest in better sales-forecasting tools that will eliminate expensive errors and give your company the flexibility to respond quickly to market changes. Run your company based on science, not on hunches, so you can cut costs and maximize productivity.
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