Ag 470F-1

Sales Forecasting AG 470-H

Unit Objective After completing this unit, the student should understand the importance of sales forecasting in agricultural sales. and be able to use methods and techniques presented in the unit to perform sales forecasting. Specific Objectives and Competencies 1. List three factors affecting prices. 2. Appl formulas used in pricing merchandise !. "istinguish bet#een categories of operating e$penses for a business. 4. "efine forecasting profits. %. List #h forecasting profits is essential to business success. &. "escribe a pro forma profit and loss statement. 7. 'omplete a profit and loss statement. (. List options to be considered if a loss is forecasted. ). "iscuss brea*-e+en anal sis. 10. 'alculate brea*-e+en point in terms of sales dollars. 11. 'alculate brea*-e+en point in units to be sold.

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Ag 4 7 0 - H Sa l e s Fo r e c a s t i n g

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Sa l e s Fo r e c a s t i n g Ag 4 7 0 - H Unit Obje c t i v e After completing this unit, students should be familiar #ith #h sales forecasts are important and some methods of performing sales forecasts. S p e c i f i c O b j e c t i v e s a n d Co m p e t e n c i e s After completing this unit, students should be able to, 1. "iscuss the reasons for de+eloping a sales forecast. 2. "escribe se+eral different sales forecasting methods. 3. "efine #hat cash flo# statements, and pro forma profit and loss statements are. 4. "iscuss #hat a brea*-e+en anal sis is and perform one using a sales forecast.

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Ag 4 7 0 - H Q estions !is c s s i o n fo r

1. -hat is a sales forecast and #h is a sales forecast useful. 2. "escribe se+eral different sales forecasting methods, and discuss the pros and cons of these methods. !. -hat is a cash budget and #h is it important. 4. -hat are pro forma financial statements and #h are the important. %. "iscuss #hat a brea*-e+en anal sis is and perform one using a sales forecast.

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"e a c # e r S#e e t

An s $ e r

Answers to Questions for Discussion 1. -hat is a sales forecast and #h is a sales forecast useful. A sales forecast in+ol+es estimating sales in dollars and ph sical units as accuratel as possible for a specific period of time. /here is a little bit of science and a little bit of art in sales forecasting 0 anticipating #hat bu ers are li*el to do under a gi+en set of conditions. 1oor forecasting can lead to o+erl large in+entories or lost sales due to being out of stoc*. A sales forecast is useful because nearl e+er management decision includes a critical assumption about sales +olume. All production schedules are built around pro2ected demand. 3a#-material purchases are based on e$pected sales. /he human resources function of hiring and firing is greatl influenced b anticipated sales. 'ash needs are based on sales forecasts. 'apital in+estment in buildings and equipment are determined b sales pro2ections. /he fact is that a great ma2orit of the decisions that management ma*es as #ell as the entire planning process rests squarel on forecasted sales. 2. "escribe se+eral different sales forecasting methods, and discuss the pros and cons of these methods. 4n general, companies often use a three-stage procedure to arri+e at a sales forecast. First, the ma*e an environmental forecast, follo#ed b an industry forecast, and ending #ith a company sales forecast. /he en+ironmental forecast calls for pro2ecting inflation, unemplo ment, interest rates, consumer spending and sa+ing, business in+estment, go+ernment e$penditures, net e$ports, and other en+ironmental or econom #ide e+ents important to the compan . Next, this forecast is then used along #ith other indicators to forecast industr sales. Finally, the compan then prepares its sales forecast b assuming it #ill capture a certain mar*et share. All forecasts are built on one of three information bases, #hat people sa , #hat people do, or #hat people ha+e done. /he first basis 0 what people say - in+ol+es sur+e ing the opinions of bu ers or those close to them, such as salespeople or outside e$perts. 4nformation is gathered using three methods, sur+e s of bu er intentions, composites of salesforce opinions, and e$pert opinion. 5uilding a forecast on what people do in+ol+es another method, that of putting the product into a test mar*et to assess bu er response. /he final basis 0 what people have done 0 in+ol+es anal 6ing records of past bu ing beha+ior or using time-series anal sis or statistical demand anal sis.

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Answers to Questions for Discussion Survey of buyers intentions: 7ne #a to forecast #hat bu ers #ill do is to as* them directl . /his can be implemented through some sort of sur+e . 8ur+e s are especiall +aluable if the bu ers ha+e clearl formed intentions, #ill carr them out, and can describe them to an inter+ie#er or in a #ritten sur+e . 9ere is an e$ample of the t pe of questions as*ed, and this is called a purchase probability scale,
"o ou intend to bu an automobile #ithin the ne$t si$ months. .00 :o chance .10 .20 8light chance .!0 .40 Fair chance .%0 .&0 ;ood chance .70 .(0 8trong chance .)0 1.00 For certain

A sur+e of bu ers< intentions is costl to implement both from a financial and time standpoint. 9o#e+er, it does pro+ide +er focused consumer information. Composite of Salesforce Opinion: -hen bu er inter+ie#ing is impractical, a compan ma base its sales forecasts on information pro+ided b its salesforce. A compan #ill t picall as* its salesforce to estimate sales, b product, for their indi+idual territories. /hen it can add up these indi+idual estimates to arri+e at an o+erall sales forecast. Fe# companies #ill use their salesforce<s estimates #ithout ma*ing some ad2ustments. 8alespeople are often biased obser+ers. /he ma be naturall pessimistic or optimistic, the ma go to one e$treme or another because of recent sales setbac*s or successes, the ma not ha+e the time to prepare careful estimates, or the ma not consider it #orth#hile. 8alespeople ma ha+e better insight into de+eloping trends than does an other group in a compan . 4n addition, after participating in the forecasting process, salespeople ma ha+e greater confidence in their quotas and more incenti+e to achie+e them. A composite of salesforce opinion can generall be implemented quic*l #ith a relati+el lo# financial in+estment. Expert Opinion: 'ompanies can also obtain forecasts b turning to e$perts. =$perts include dealers, distributors, suppliers, mar*eting consultants and trade associations. >an companies bu economic and industr forecasts from #ell-*no#n firms such as "ata 3esources, -harton =conometric and 'hase =conometric. Forecasting specialists such as these are often in a better position than a compan is to prepare economic forecasts because the ha+e more data a+ailable and more forecasting e$pertise. 7ccasionall , companies put together a special group of e$perts to ma*e a particular *ind of forecast. /he e$perts ma be as*ed to e$change +ie#s and come up #ith a group estimate ?group discussion method@. 7r, the ma be as*ed to suppl their estimates indi+iduall , after #hich an anal st combines them into a single estimate ?pooling of indi+idual estimates@. 7r the ma suppl indi+idual estimates and assumptions that are Answers to Questions for Discussion re+ie#ed b an anal st, re+ised and follo#ed b further rounds of estimation ?"elphi method@.

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4n terms of both time and cost, using the e$pert opinion method of forecasting sales probabl falls in-bet#een the sur+e of bu ers< intentions and the composite of salesforce opinion methods of estimating sales. est!"ar#et "et$o%: -here consumers do not plan their purchases carefull , or are inconsistent in carr ing out their intentions, or #here e$perts are not good guessers, a compan ma #ant to conduct a direct test mar*et. A direct test mar*et is especiall useful in forecasting sales of a ne# product or of an established product in a ne# distribution channel or territor . /est mar*eting lets the mar*eter get e$perience #ith mar*eting the product, find potential problems, and learn #here more information is needed before going to the great e$pense of full introduction. /he basic purpose of test mar*eting is to test the product itself in real mar*et situations. /est mar*eting also allo#s the compan to test its entire mar*eting program for the product 0 its positioning strateg , ad+ertising, distribution, pricing, branding and pac*aging and budget le+els. /est mar*eting is a relati+el e$pensi+e method of forecasting sales, primaril because it is e$pensi+e to actuall tool up to ma*e, deli+er, ad+ertise and sell the product in the test mar*et. Add to this the fact that the compan is not et en2o ing the economies of scale that come about from ma*ing large +olumes of a product, and test mar*eting is quite costl . 9o#e+er, the flip side to this is that it does gi+e the compan a good feel for #hat the mar*et might demand #ith a full roll-out of the product. ime!Series Analysis: >an firms base their forecasts on past sales, assuming that the cause of past sales can be unco+ered through statistical anal sis. /he causal relations can then be used to predict future sales. A time series anal sis of a product<s past sales can be separated into four ma2or components. /he first component is trend. /rend is the long-term, underl ing pattern of gro#th or decline in sales resulting from basic changes in population, capital formation and technolog . /he second part is cycle, #hich captures the medium-term, #a+eli*e mo+ement of sales resulting from changes in general economic and competiti+e acti+it . /he third component is season, #hich refers to a consistent pattern of sales mo+ements #ithin the ear and describes an recurrent hourl , #ee*l , monthl or quarterl sales pattern. /he fourth factor is erratic e+ents, #hich includes fads, stri*es, sno#storms, earthqua*es, riots, fires and other erratic disturbances. /hese components are b definition unpredictable and should be remo+ed from past data to see the more normal beha+ior of sales. Answers to Questions for Discussion /ime series anal sis can be done for a reduced cost if competent personnel are housed inhouse. >ar*et research companies can also pro+ide this t pe of ser+ice on a contract basis at an increased cost. &ea%in' (n%icators: >an companies tr to forecast their sales b finding one or more leading indicators 0 other gauges that change in the same direction but in ad+ance of compan

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sales. For e$ample, a plumbing suppl compan might find that its sales lag the housing starts indicator b about four months. Statistical Deman% Analysis: /ime series anal sis treats past and future sales as a function of time rather than as a function of an real demand factors. 5ut man real factors affect the sales of an product. 8tatistical demand anal sis is a set of statistical procedures used to disco+er the most important factors affecting sales and their relati+e influences. /he factors most commonl anal 6ed are prices, income, population and promotion ?ma be measured b ad+ertising dollars@. 8tatistical demand anal sis consists of e$pressing sales ?A for quantit @ as a dependent +ariable and tr ing to e$plain sales as a function ?f@ of a number of independent demand +ariables B1, B2, . . . , Bn ?such as price, income, population, etc.@. /hat is, A C f ?B1, B2, . . . , Bn@ Dsing a technique called multiple regression anal sis, +arious equation forms can be statisticall fitted to the data in the search for the best predicting factors and equations. Li*e the time series anal sis discussed abo+e, statistical demand anal sis has similar costs. !. -hat is a cash budget and #h is it important. A cash budget ?sometimes called a cash flo#@ is a pro2ection of the firm<s cash needs and income in a future time setting. 4t is based on the sales forecast, and allo#s the manager to estimate the cash funds needed to ta*e ad+antage of cash discounts, to finance seasonal demands, to de+elop a sound borro#ing program, to e$pand, and to ma*e plans for debt ser+icing. 4. -hat are pro forma financial statements and #h are the important. A pro forma financial statement ?either an income statement or a balance sheet@, is a pro)ection of the best estimates of #hat the business #ill loo* li*e in an upcoming period, using the sales forecast. 4t pro+ides a loo* into the future of the business and helps the manager 2udge #hat the financial needs of the business #ill be during and at the end of the operating period. /he most important figure in the preparation of these pro forma statements is estimated sales from the sales forecast. 7perating e$penses are then Answers to Questions for Discussion estimated from this pro2ected sales figure to de+elop the pro2ected profit and loss ?income@ statement. Dsing the pro forma income statement, the manager can de+elop a pro forma balance sheet, #hich #ill gi+e a picture of the firm<s pro2ected assets, liabilities and o#ner<s equit . %. "iscuss #hat a brea*-e+en anal sis is and perform one using a sales forecast A brea*-e+en anal sis determines the brea*-e+en point, #hich is the point at #hich income generated from sales 2ust equals the total costs incurred from those sales. 5rea*-e+en anal sis

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?sometimes called +olume-cost anal sis@ sho#s the le+el of business necessar to brea*-e+en and to earn a specific amount of profit under +arious cost and price assumptions. 5rea*-e+en anal sis can sho# the impact of changes in selling price on the +olume of business necessar to reach a certain profit le+el. 4t can also specificall re+eal ho# anticipated changes in e$penses #ill affect profit le+els. 4t can be useful in e+aluating +arious mar*eting strategies, such as ad+ertising and promotion e$penditures, indi+idual product pricing, and the amount of product +olume a ne# piece of equipment must produce to ma*e it pa . /he basis for brea*-e+en anal sis is the separation of costs into t#o categories, fixe% and variable. Fi$ed costs are those that do not +ar #ith the +olume of business. Eariable costs are those costs that change directl #ith the +olume of sales. =$amples of fi$ed costs #ould be, costs for land, buildings and equipment ?fi$ed assets@, and administrati+e salaries among others. =$amples of +ariable costs #ould be cost of goods sold ?ra# material costs@, hourl labor, and bad debt loss. /hus to perform brea*-e+en anal sis, the follo#ing steps are follo#ed, 1. 4dentif fi$ed and +ariable costs. =$penses from the profit and loss statement should be classified as to #hether the are fi$ed or +ariable. For e$ample ?not an all-inclusi+e list@, 8alaries and #ages 0 mostl fi$ed if a plant runs #ith full time labor. "epreciation 0 fi$ed because it does not depend on sales. Dtilities 0 split bet#een fi$ed and +ariable 5ad-debt loss 0 +ariable, since it is tied closel to sales le+el. 8upplies 0 t picall +ariable, though it depends on the t pe of business. 4nterest e$pense 0 fi$ed, it +aries #ith the amount of mone borro#ed, not sales. 'ost of ;oods 8old 0 +ariable, and in fact it is the most perfect +ariable cost.

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Answers to Questions for Discussion 2. 8ummari6e fi$ed and +ariable costs. Fi$ed and +ariable costs should then be summari6ed. /otal dollar fi$ed costs are summed first. /hen +ariable costs per unit of sales are summed. !. 'alculate contribution to o+erhead ?'/7@. 'ontribution to o+erhead is the heart of brea*-e+en anal sis and man crucial management decisions. 4t sho#s the portion of each unit of sales that can be applied to#ard the fi$ed or o+erhead costs. =ach time a unit of product is sold, the +ariable costs must be co+ered first. An thing that remains ma*es a contribution to o+erhead. 'ontribution to o+erhead is thus calculated as 1-+ariable costs. 4. 'alculate brea*-e+en 5rea*-e+en can then be computed as,
BE = fixed cos t CTO

%. An e$ample ma be instructi+e. 8uppose that fi$ed costs for a firm are F(00,000. 'ost of goods sold and other +ariable costs amount to )0G of sales for the most recent period. 'ontribution to o+erhead ?'/7@ #ould then be 1 - .)0, or .10. Dsing this e$ample, the brea*-e+en point #ould be, 5= C F(00,000H.10 C F(,000,000 /hus brea*-e+en sales are F(,000,000. ;raphicall , the brea*-e+en point is sho#n belo#,

Grap ing !"#

Grap ing !"#

otal Fixe% Cost Sales ,olume

Costs * +evenues

Costs * +evenues

otal ,ariable Cost

otal Fixe% Cost Sales ,olume

Answers to Questions for Discussion

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Grap ing !"#

otal Cost otal ,ariable Cost

Grap ing !"#

otal +evenue otal Cost otal ,ariable Cost

Costs * +evenues

otal Fixe% Cost Sales ,olume

Costs * +evenues

otal Fixe% Cost Sales ,olume

Grap ing !"#

-rea# Even
otal +evenue otal Cost

.rofit

Costs * +evenues

&oss

otal ,ariable Cost

otal Fixe% Cost Sales ,olume

After fi$ed costs are co+ered, '/7 becomes contribution to profit ?'/1@. 9o#e+er, no profit is made until fi$ed costs are co+ered. 8o, ho# does this appl to sales forecasts. A sales forecast can be applied to determine the le+el of profitabilit a firm #ould ha+e under these predicted sales. For e$ample if the sales forecast for the firm in the abo+e e$ample predicts sales of F10,000,000, then profit can be calculated as follo#s, 8ales Forecast - 5rea*-e+en sales C 8ales abo+e brea*-e+en $ '/7 C 1ro2ected profit F10,000,000 -F (,000,000 F 2,000,000 $ .10 CF 200,000

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St d e n t Ac t i v i t i e s Class ,isitation: A'ribusiness sales office Eisit #ith a manager or salesperson from a local agribusiness such as an equipment, fertili6er or feed dealer. 9a+e the students prepare questions to as* such as, do ou prepare a sales forecast for our business 0 if not, #h notI ho# important is a sales forecast to our businessI #hat data sources do ou use for our sales forecastI do ou prepare a cash flo# budget or pro forma financial statementsI ho# accurate ha+e our sales forecasts beenI ha+e ou used brea*-e+en anal sis in our business before, and if so in #hat conte$t. Survey: 8ur+e local agricultural input suppl salespeople that represent #holesale manufacturers and distributors such as 1urina >ills, -a ne Feeds, :utrena, "o#-=lanco, >onsanto, 'iba, John "eere, 'ase-49, A;'7, etc., to determine ho# their companies de+elop sales forecasts. As* them #hether their firms utili6e composite of salesforce opinion techniques. 9a+e the students summari6e their findings. Collectin' Data: 9a+e the students pretend the are #or*ing for a compan that manufactures and sells potato har+esting equipment. 9a+e them gather data that the could utili6e in a statistical demand anal sis or a time series anal sis. For the time series anal sis, data on historical potato production in 4daho is probabl sufficient. A good source for this data is the annual Idaho Agricultural Statistics publication compiled b , 4daho Agricultural 8tatistics 8er+ice, 2224 7ld 1enitentiar 3oad, 1.7. 5o$ 1&)), 5oise, 4" (!701 ?20(@ !!4-1%07. For the statistical demand anal sis, information on competing crops such as #heat, barle , sugar beets, onions or alfalfa #ould li*el be useful ?again, source #ould be Idaho Agricultural Statistics@. 4n addition, information on consumption of potatoes might be included ?can be found in the annual Agricultural Statistics, published b the Dnited 8tates "epartment of Agriculture, and much of this data is also a+ailable on the #eb site for :A88 ?:ational Agricultural 8tatistics 8er+ice@ - http,HH###.usda.go+HnassH@.

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+eferences 3esources Dsed in "e+eloping Dnit 9 -oo#s: 5eierlein, J.;. and >.-. -ool+erton. ?1))1@ Agribusiness #erspective. ?1st ed.@ =ngle#ood 'liffs, :J, 1rentice-9all, 4nc. "o#ne , -.". and 8.1. =ric*son. ?1)(7@ Agribusiness :K, >c;ra#-9ill, 4nc. Lotler, 1. and ;. Armstrong. ?1))1@ #rinciples of 1rentice-9all, 4nc. (nternet +esources: -ebsite, 4nc. >aga6ine. "o *e #ord search on sales forecasts http,HH###.inc.comH -ebsite, Agricultural =conomics !)1 0 Agribusiness >anagement, Dni+ersit of 4daho. Lecture on 'hapter 1! discusses sales forecasts, lecture on 'hapter 10 discusses brea*e+en anal sis. 1art of case stud M2 is a brea*e+en anal sis. http,HH###.uidaho.eduHagHageconH!)1Hagec!)1.html -ebsite, :A88 ?:ational Agricultural 8tatistics 8er+ice@ http,HH###.usda.go+HnassH. ar!eting" The anagement

anagement. ?2nd ed.@ :e# Kor*,

ar!eting. ?%th ed.@ =ngle#ood 'liffs, :J,

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Ag 4 7 0 - H Sa l e s Fo r e c a s t i n g QU% & 1. -hat purpose does brea*-e+en anal sis ser+e. a. allo#s the firm to determine the le+el of costs incurred #ith ne# in+estments. b. allo#s the firm to determine the le+el of sales necessar to co+er the cost of a ne# in+estment. c. allo#s the firm to accuratel pro2ect mar*et share. d. brea*-e+en anal sis ser+es no purpose. e. a and c abo+e. f. none of the abo+e 2. -hen a compan ma*es an Nen+ironmental forecast,O it is, a. 1ro2ecting the mar*et share for its products. b. Forecasting total industr sales. c. 1ro2ecting inflation, unemplo ment, interest rates and other econom #ide e+ents. d. 1ro2ecting pollution rates, climate changes and other en+ironmental aspects that affect the compan . !. /est mar*eting is, a. An ine$pensi+e #a of forecasting sales. b. A #a to test the product in a real mar*et situation. c. A method of basing a sales forecast on past sales. d. Dsuall done using a composite opinion from the sales force.

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4.

8ales forecasts are built on one of three information bases, a. -hat people sa , #hat people do, and #hat people ha+e done. b. -hat people tal* about, #hat people listen to, and #hat education le+el people ha+e. c. /he compan <s cost records, the compan <s total emplo ment figures and the compan <s pro2ected re+enue. d. 9o# man competitors the firm has, a firm<s historical return on in+estment and the firm<s total assets.

%.

A purchase probabilit scale measures, a. the probabilit that a consumer #ill remember ad+ertisements for the compan <s product. b. the chance of a consumer recommending a compan <s product to a friend or relati+e. c. the probabilit that a consumer #ill purchase a compan <s product, usuall #ithin a gi+en time frame. d. the chance of a customer returning a good as defecti+e.

&. /he formula for calculating brea*-e+en is, a. BE = fixed cos t b. BE = c. BE = d. BE =

1 +ar iable cos ts CTO fixed cos t CTO
1 +ar iable cos ts fixed cos ts CTO

7. ;i+en the follo#ing data, calculate the brea*-e+en point for this firm, Fi$ed costs C F1,000,000

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'ost of goods sold and other +ariable costs a. F1,000,000 b. F7,&)2,!0( c. F(,21!,124 d. F1,14),42%

C (7G of sales

(. =$pert opinion, as a method of forecasting sales, a. falls in-bet#een the using a sur+e of bu er<s intentions and the composite of salesforce opinion methods of estimating sales in terms of both time and cost. b. tests the product itself in real mar*et situations. c. assumes that the cause of past sales can be unco+ered through statistical anal sis. d. utili6es e$perts b as*ing them to e$change +ie#s and come up #ith a group estimate. e. both a and d abo+e.

).

-hat is a cash budget. a. a budget prepared using credit sales and the probabilit of collection rates on these credit sales. b. a pro2ection of the firm<s cash needs and income in a future time setting, based on the sales forecast. c. a pro2ection of the firm<s customer credit policies in the future. d. a pro2ection of the firm<s cash discounts offered to customers #ho pa cash at the time of purchase.

10.

-hat are pro forma financial statements. a. Financial statements de+eloped b pros - such as an accountant. b. An income statement or balance sheet based upon a pro2ection of the best estimates of #hat the business #ill loo* li*e in an upcoming time period.

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c. An income statement or balance sheet based upon actual results from the prior time period. d. Are financial statements prepared using a special format, thus the name Npro forma.O

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Ag 4 7 0 - H Sa l e s Fo r e c a s t i n g QU% & A'S ( ) * S 1. b. 2. c. !. b. 4. a. %. c. &. c. 7. b. (. e. ). b. 10. b.