<< Building Quality Financial Projections – Start-up Sales Projections Part 2 >>

When projecting sales for a startup business there are generally two ways come up with what we have called “a reasonable range of sales.”  The first is the Breakdown method where you take a large potential market and break it down into a smaller target market and finally determine a percent of market capture.  The second is a Buildup method where you calculate breakeven point for your company and then determine the buildup of sales over time to achieve profitability.

Let’s use a hypothetical maternity clothing store in Fargo, ND as an example.  The numbers in this example are not 100% real but they are pretty close and should give you a good idea of how to use this method.

The Breakdown Method

The more local and the more specific the target market the more reliable the Breakdown method becomes.  The example of a maternity clothing store is perfect because it is a niche market but also statistics are readily available for the demographic set.  When you research data is that already available from another source we call that “Secondary Market Research”.   When you conduct your own survey or gather your own data we call that “Primary Market Research”.

To figure the Total Market and Target Market for maternity clothing we use secondary market research data.  The total market for maternity clothing is of course women, which account for about half of the 150,000 people in the Fargo / Moorhead MSA.  But specifically, pregnant women is the target market, therefore if we look at the number of babies born in Fargo at the two major hospitals in the area we can find that each year approximately 9,500 babies are born.

But this alone is not enough information to do a sales projection.  The second step is to make an assumption about “Market Capture” and finally conduct primary market research on the average dollars spent on maternity clothing during pregnancy.  To determine market capture you have to weigh the 4 P’s (product, place, pricing, people) against the competition to come up with an estimated market capture.  For example if we are a high end maternity clothing store in a community with lots competition we can expect to have  a lower percent of market capture but we also have a higher price per item of clothing.  On the other hand if we are going to start a second hand clothing store in a community with limited competition we can expect a higher market capture but lower margins.  At this point we have only one part of the equation solved – Target Market X Market Capture = # of Customers.

The final part of the puzzle is to determine the average annual spending on maternity clothing.  One way to determine this is to survey friends and family who have recently had a baby and ask how much they spent on average.  I had a student of one of my Entrepreneurship classes conduct this very survey and found that the average spent on the first pregnancy for clothing was $500 and about $300 on the second child.  Now again, we can’t expect to capture all of these dollars because some of it will go to the competition therefore you have to make another assumption about how many of these dollars your company will capture.  For the purposes of this example we assumed $200 of the total budget.  Therefore the second half of the equation is  – # of Customers X Capture of Annual Purchases = Sales Projection.

So to lay out the example:

Target Market X Market Capture = # of Customers
9,500       X             20%           =        1,900

# of Customers X Capture of Annual Purchases = Sales Projection
1,900                X                          $200                     =          $380,000

Let’s be clear… NOBODY should believe that this business will do exactly $380,000 in sales.  That is not the purpose of this exercise.  Nor should you believe that within the first year that it is a reasonable sales projection.  This number, $380,000, represents a basis for determining a Reasonable Range of Sales for this startup company.  It is a target to be achieved once the business has met its full potential for the current business model in its current market.

With this information we need to determine what will happen to the business is we only achieve 90% of the projection, or 85% or 50%.  We also need to estimate approximately how long it will take to get to that sales goal.  Will your company still be in business if it takes 18 months instead of 12 or 24 months instead of 18 months.

The number one reason why half or more of all startup businesses fail is because they RUN OUT OF MONEY!  But I believe the reason why they run out of money is because they think they are going to get to break even before they actually do…they over estimate their sales and the speed at which they will achieve them.

Take the graphic above for example.  Given the breakeven point and the sale projection this entrepreneur is expecting to burn the amount of cash where the sales are below break even.  Say that length of time is 12 months.  But what happens if the length of time to get to break even is even 50% longer (18 months instead of 12) as in the graphic below.

The amount of cash burned is almost twice as much because in the beginning months you burn more cash until you get to break even.  The “VOLUME” of the area below breakeven must be considered…the relationship is NOT one to one.  This is the single biggest reason why sales projections are so important.  You have to project different scenarios (best case, expected case, worst cast, super awful case) and prepare for the worst.  It’s the only way your startup business will survive.  And guess what…?  The assumptions for your projections come from your business plan so you can’t achieve quality sales projections without  a quality business plan.  If you put garbage in, you will get garbage out.

Part two will focus on the Buildup method for projecting sales which works best when you have a national market or a non-niche product.