By Mike Williams and Erik Owen

If you’ve stopped trying to fix the bad guesses about future sales, then you must be resigned to the amount of money it’s costing you. It’s just the way it is, “The Cost Of Doing Business.” Of course we beg to differ, and convincing you starts with putting a number on the losses. You’ve probably never estimated it, because you’re afraid to look. But you need to know the answer.

Sure, the answer is, like everything else, “It depends on your business.” No help there. But here’s how to calculate it and what you need to take into consideration. Take what applies to you, and leave the rest (like your favorite Salad Bar):

Inventory Costs. Applies to: Retail, Restaurant, Manufacturing, Distribution, Tradesmen, some others

If the forecast was even a little closer to actual, you could carry less inventory. In some businesses this means Raw Material or Goods Available For Sale, in some you can add Finished Goods Inventory.

If you’re preparing to cost this excess inventory based on the rent for the space it consumes, plus costs to keep the inventory climate-controlled, insured, and secure, STOP. Will a closer sales forecast save you these costs? Not unless you plan to move into a smaller space or are somehow able to rid yourself of the excess square footage (rent it out, move out of it, sell it off). Don’t count these costs, since you’re going to incur them no matter what. Here’s what does count:

• Interest on the cash you had to put up to buy the inventory – how much could you pay off toward lines of credit, loans etc. if you didn’t need this inventory? What interest expense will this save?
• The amount of shrinkage, spoilage, obsolescence, etc. that old inventory suffers. HUGE in retail: If you don’t sell it today, who will want it tomorrow? Will it be out of date, out of style, replaced by version 2.0 as it gathers dust in your showroom/stockroom/warehouse?  Manufacturers, are you sure your customer will keep sending you orders for the same product forever, or someday will you have raw material that you use to make. . . nothing?

Value the second point this way: How much inventory, ready to sell, do you have on hand right now? If it’s lower than normal add a little; drop it a little if today’s number is abnormally high. This is what you will someday have to just eat. Your customer for that inventory goes out of business (TWO of Mike’s went under in the same week once – that was fun), the competition makes your inventory obsolete, fashions change, the menu needs to be changed, you get the idea.

Labor Costs. Applies to: Us All

Okay, there are some exceptions out there, service businesses with no physical products and all personnel on commission-only. Fine. The rest of us can pull back on staff if we know sales will decline, and can staff-up to the right level as they increase. Most companies, though no one likes to, can cut back overtime, put staff on reduced hours, let some positions vanish to attrition, or let people go. These days it’s fairly easy to do hiring, and 1099 labor (completely variable) can be used in many cases, consult your labor attorney and make sure it’s legal for you. In all these cases, an improved forecast lets you capture these savings or control these costs, putting that money back in your pocket.

Lost Sales Due To Cannibalization Fear. Applies to: Retail, Wholesale, Restaurant, Manufacturing, Tradesmen

What on earth does that mean? Tell me if you would do the same: Mike had a client who had a great new product ready to go. It had advantages that the market wanted. But they had an entire warehouse full of the old product, and they knew that no one would want it once the new product was launched. So they played chicken with the marketplace. “How long can we keep getting sales of the old product, without our competitors leap-frogging us? Can we get the warehouse emptied out and then launch?” They are smart people, they knew this was a bad decision, but who wants to admit they’re going to take a bath on the money already spent to make the old product? I know this is difficult to hang a number on, but clearly if you don’t tighten the forecast, this will be you someday.

We’ve already accounted for the amount of inventory you’re going to get soaked on, but what about lost sales? Will a new product improve sales? Of course it will, or you wouldn’t be bothering with it. Maybe it will only prevent sales from declining, which you perceive will happen if you stick with the old product. You’ve probably already done work to estimate how the new product will help sales. Take that dollar amount of improved sales, multiply by the gross margin you earn on the new product, and flush that money down the toilet. That’s what the bad decision described above is costing you. And you’re making the bad decision because you never tried to improve your sales forecasting.

Lost Sales Due to Lack of Accountability and Measurement.  Applies to all

When you don’t forecast sales, you fail to create the measuring stick used to objectively measure and drive your sales force.  When you don’t have an objective measuring stick, it’s far more challenging to hold the sales force accountable for the numbers.  This is about discipline and measurement.

How do you measure the cost?  It is the additional gross margin dollars you would have gotten if you had set the bar higher and held the sales team to their goal.

By the way, sales forecasting also gives you a tool to better compensate your sales team, further connecting performance to pay and driving more results.

Have we convinced you that forecasting is valuable?  We would welcome your comments and discussion.

Oak Hill Business Partners’ Growth Management Services will work with your management team to devise and execute an overall strategy for growing your organization.  Whether it’s a refined marketing strategy or improved communications with your target audience, we have the expertise to support you so you can focus more effort on your core expertise.   For more information, Contact Us today.

Mike Williams is a Partner with Oak Hill Business Partners specializing in sales and operations.  He has more than 20 years of experience working with businesses in many different industries.  His background includes sales, sales management, operations, and entrepreneurship.

Erik Owen is the President of Oak Hill Business Partners and has over 20 years of professional experience working with startups to Fortune 100 listed public companies.  His background covers finance and accounting, administration, general management, and entrepreneurship.