Sales forecasting is a crucial skill set for any start-up’s arsenal. In this week’s post, we examine the processes and assumptions behind forecasting.
Sales forecasting, or the projection of achievable sales revenue, is often an intricate and multi-staged process. For larger and more established companies, forecasting is based on statistical methods that rely heavily on historical data. For start-ups, particularly at the pre-revenue stage, forecasts must rely on a combination of assumptions and metadata. A bottom-up forecasting approach, the subject of this post, is often most beneficial for pre-revenue start-ups. While the resulting forecasts might not be entirely accurate, they will achieve their intended purpose – allow the start-up to plan with regards to liquidity and capacity planning. Noting that at these early stages liquidly is most crucial for the survival of any start-up.
Defining the Sales Funnel
Good forecasting begins with a good sales strategy. Since sales account for both a company’s revenues and allow it to cover it’s needed costs, the bottom-up approach begins with the sales funnel – a method of measuring and categorizing sales opportunities to build a revenue model.
The sales funnel is intended to mirror the customer’s buying process by describing the various stages of a sales opportunity. While these stages can be customized by each business based on its customers’ unique behaviors, the table below outlines common stages of the sales funnel and at it’s end when cash transacts, only then is that a validation & proof of concept.
|Suspect||Potential customer that is a reasonably good fit||No buying signals or interactions|
|Lead||Potential customer that contacted business or was referred by 3rd party||Limited interaction
No verification of real interest
|Prospect||Verified real interest/need||Interested in meeting to pursue purchase|
|Qualified||Verified services are a fit, budget is available, and customer has decision-making power||One or more in-depth conversations have taken place|
|Developed||Confirms readiness to buy||Request for a formal proposal with deadline|
|Committed||Accepted offer||Agreed to proposal or placed an order|
|Transacted||Received order and invoice||Payment|
How Long Till I Close The Deal?
Now that you’ve laid out the stages of the sales funnel, it is important to determine how much time each stage will take. This can differ greatly from one business to another, and requires an examination of time considerations in both the sales cycle and the buying process, always taking into account possible delays that may occur. The following considerations have a significant effect on the length of the sales cycle:
|Buying Process||Sales Cycle|
With these considerations in mind, there is one final bit of information needed – the conversion rate. A ratio describing the probability that a sale will move from one stage to the other, the conversion rate is crucial in not only assigning a timeline to your sales processes but determining their quality as well.
Assumptions are Your Friend!
It’s now time to go against the age-old warning against making assumptions and do just that! Reasonable assumptions are crucial in determining how long the sales cycle is expected to take, and mitigate the risk of underestimating the time required to close a deal – the latter which could have devastating effects on your forecasting and financial planning. That said, it is advisable to estimate a best-case, realistic-case and worst-case scenario when defining the lifespan of the sales funnel. For example, a buying process that takes five months is followed by a couple of months for delivery and invoicing. This means the business can expect to have the cash in hand seven or eight months after beginning the sales process. This is the best-case scenario. For financial planning purposes, particularly for a start-up bootstrapping or seeking external funding, a worst-case and seemingly exaggerated scenario should best be considered to ensure one begins with enough cash to allow them go through the cycle at it’s worst. In this case, it might be wise to consider a maximum time period of 18 months.
By understanding the stages of the sales funnel, noting the time considerations associated with the buying process and the sales cycle, and calculating the conversion rate, start-ups are well-positioned to conduct effective financial planning. Determining revenue and required budget is key to sales forecasting and by extension, effective financial planning.