Outline the main factors that influence sales.

The sales figure of any business is made up of three variables namely sales volume, sales price and sales mix. These variables are influenced by a number of factors that should be taken into account when forecasting sales.

Factors influencing sales

In practice, sales forecasts can be developed in a number of ways such as:

• To aggregate projections made by the sales force on the basis of their assumptions of the market and changes in market conditions. On one hand this can be quite a subjective approach, however a good sales team should know its market well and should anticipate any significant changes that could affect sales.
• Using market research techniques would be particularly appropriate when considering the launch of a new product.
• Large businesses sometimes develop economic models to predict sales. These models would incorporate a number of the variables identified above and take into account the relationship between them and their effect on sales.

Why is the sales forecast of critical importance to the preparation of projected financial statements?

When preparing projected financial statements, the forecast of sales is the initial task or starting point. A reliable sales forecast is essential as many items such as cost of goods sold, other variable costs, stock levels, fixed assets and capital requirements will be significantly influenced and determined by the level of sales forecast.

Outline the main ways in which a business can forecast its operating costs.

To accurately estimate future costs, it is important to understand cost behaviour patterns and how some costs are affected by fluctuating sales activity levels. Costs may be classified into the following categories:

• Fixed costs. These are costs which are not expected to vary with sales. For example if sales increase by 10 per cent, fixed costs would remain fixed and not increase in proportion to sales. Examples are rent, rates, depreciation, salaries and insurance. From a forecasting perspective, the level of sales activity forecast will not significantly influence these costs unless the sales forecast is beyond the relevant range of sales activity for these costs. Thus the main factors that influence fixed costs are inflation, legal agreements, economic outlook and national wage agreements, as labour costs are a major element of the fixed costs of any business.
• Variable costs . These are costs that are expected to vary with sales. Thus if sales increase by 10 per cent, these costs are expected to increase proportionately. Examples would include cost of sales, sales commissions and part-time labour. In reality, although these costs should increase as sales increase, it may not be strictly proportionate because factors such supplier’s prices, commissions and part-time labour rates may vary.
• Semi-variable costs. These have both a fixed and a variable element and so may vary partially with sales. Such costs may be identified by examining the past records of the business. For example light and heat costs could be classified as a semi-variable cost as a certain amount of light and heat will be incurred irrespective of the level of sales. However if sales increase significantly, then more rooms will be used requiring extra power. Semi-variable costs can be broken down into their separate fixed and variable components (through the use of the high-low method, scatter-graph approach and statistical techniques such as regression analysis covered in chapter 2). By doing this, one can establish the total variable and total fixed costs of a business.

The analysis of costs into fixed and variable components is vitally important when forecasting future costs. Variable costs will increase in relation to sales whereas fixed costs may only increase with the rate of inflation (unless there is evidence to the contrary such as a new leasing agreement or new wage agreements).