By publishing overly-optimistic projections, your company could be at risk for internal financial problems, misleading investors, miscalculating inventory and staff, and more.
As we reach the halfway point in the year, it’s time to revisit whether your company has realistic or optimistic projections. Are your sales projections still on target? Now is a good time to review your projections and adjust them if need be for the third and fourth quarter.
Recently, a client met with one of our consultants. When the consultant began preparing their sales projections using our Sales Genie Tool, the client started complaining:
Our CEO, Ryan is too optimistic. He comes from a sales background, so he consistently over-projects sales whenever I, the CFO, ask for them. I don’t want to deal with sales! I’m not the salesperson. But our bank is frustrated that we’re not meeting our sales. I can’t trust Ryan to make smart sales projections goals anymore.
Having overly-optimistic projections is like waving a loaded gun… bad things will happen. Stakeholders in your company rely on these projections and it’s important not to mislead them.
Why are CEOs and salespeople so optimistic?
Sales-minded people often set “stretch” goals… an appropriate way to move a company forward, but it can shoot you in the foot. Basing projections upon stretch goals can create problems when getting financing and allocating resources. Your banker will wonder why you fell so short of your target and your inventory manager will be scratching their head wondering why there’s excess inventory. In short, what starts in sales can lead to issues in operations and finance down the road.
The “Bullwhip Effect”
The Bullwhip Effect is a term coined by Stanford University to refer to supply chain changes. The same theory can be applied to sales projections.
A financial leader who doesn’t want to (or doesn’t know how to) project sales typically trusts that the sales team is projecting correctly forgetting that they are prone to cockeyed optimism when it comes to their performance. The financial leader then submits projections based upon those forecasts to the bank and company management thinking that they’re completely accurate.
But in this example, sales overshoots the forecast by 15%. Operations has hired a few more people to manage the incoming sales and acquired more inventory. Sales sees the numbers coming in, still believing that those numbers are accurate; they give discounts freely and don’t collect in a timely manner. Accounting recognizes that the sales have happened and accounts receivable builds to an unmanageable amount.
All of a sudden, the financial leader is in a bind. Sales aren’t meeting the goal of a 15% increase; it’s more like 2% growth. Operations has tied up all the cash expecting increased sales. Accounting is attempting to collect all of the sales as quickly as possible. The company is out of cash.
Things have spiraled out of control due to one small, well-meaning error.
How can CFOs or other financial leaders counter over-optimism?
Unfortunately, most sales projections fail due to a one-faceted (sales only) approach to forecasting. When projecting revenue, it is imperative that you as the financial leader set guidelines and boundaries for your sales team to prevent optimistic projections from becoming gospel.
Here’s how you do it…
#1 Set Expectations
Schedule a meeting time for the financial leaders in your company to meet with your sales team. Set expectations as you move forward in creating sales projections.
These expectations could look like:
- Review projections quarterly and adjust them if need be at that time
- Have sales submit weekly reports to accounting to track trends
- Schedule weekly or monthly meeting to discuss projections
#2 Create Projections Together
The biggest cause of optimistic projections is the accounting department asking sales to provide a number without any validation or input. Without any questions, those numbers are blindly put into the forecast.
There are two different types of sales numbers you should ask for from your sales team: the actual projection and the goal projection.
The goal projection, or a stretch goal, is often what causes these optimistic forecasts. Their purpose is to set a number high enough to motivate sales team to reach it. Oftentimes, it is set higher than is possible to reach. But this sometimes results in sales improving over the previous month or year.
For example, ABC Company’s sales were $20,000 in 2015. When forecasting sales, ABC set their goal projection to be $30,000 or a 33% increase in sales. Historically, there has only been a 5% increase over the previous year. The actual goal should have been a 5% increase as that has been the trend over the past 7 years.
In a meeting, explain the difference between the two types of goals. You need to actual sales goal for your projections, not the stretch goal.
As we’ve said multiple times, there are three essential pillars within a business: accounting, operations, and sales. Communication between these departments is critical to the success of your company.
Set expectations between accounting and sales that communication should be a priority. If your sales team indicates that they underestimated sales, it is their responsibility to report that adjustment in sales. Ask sales to track sales. They should have a weekly average of sales that they need to hit. If there is a trend that they are not meeting the projections, it’s time to adjust.
Make communication an absolute priority. There is no shame in not meeting projections; the trick is to adjust expectations going forward.
By proving that you as the financial leader or CFO can add value to a company through setting realistic and accurate sales projections, you’ll be better equipped to set yourself up for success.
For more ways to add value to a company, download the Goldilocks Sales Method to start projecting accurately and building credibility through your sales forecast.
Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.
Click here to access your Execution Plan. Not a Lab Member?