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FAQ - How accurate do sales forecasts need to be?

- for ERP (enterprise resource planning) and MRPII (manufacturing resource planning) systems in particular.

Definition of Sales forecast - "A request from sales/marketing to operations to have product, components and/or manufacturing resources available to meet a perceived need."

In any company, everyone has to recognise that the sales forecast is not exact but should be as accurate as you could reasonably expect for the business you are in and that, through measurement and correction of errors, the sales forecast accuracy is improving on a product by product basis. It is the job of the execution departments (planning, purchasing and production) to be able to meet the sales forecast given this expected level of accuracy. You do not need an accurate forecast to plan and control your business but you do need everyone to work to an agreed forecast that is updated regularly with any significant changes.

The first stage in deciding the level of forecast accuracy you should get is to decide what to forecast. If you are making essentially similar products using a common resource, the most important forecast is the volume by family. This will enable the critical resources you need to be available. If you have long lead time items to purchase for every order, you need to forecast specific part numbers rather than families of products.

The next important factor is the point in time to compare the orders forecast to the orders received to measure accuracy.

A company that would like to ship from stock will need to measure the accuracy by part number at the effective procurement lead time. The procurement lead time will be supplier's lead time for a distribution company or cumulative lead time for a manufacturing company taking into consideration any safety stock of material, intermediate products or sub-assemblies.

A make to order company will need to measure either the forecast accuracy by part number at the cumulative lead time or by product family at the time needed to add resource, if this is longer than the cumulative lead time.

An engineer to order company will need to include design time to the cumulative lead time for the measurement point.

In addition to the above, companies may choose to measure forecast accuracy by family at the time needed to create the business plan i.e. 12, 15 or 18 months.

If you are in a mature and stable business you should expect a reasonably accurate forecast. If the business is new and growing, the forecast will be less accurate. In either case the way to determine what you forecast accuracy should be is to start with the accuracy you have achieved in the past using the criterion above, this is the minimum starting point for forecast accuracy. If you do not have a formal forecasting process at the moment, you should start now.

Forecast accuracy should be measured in units of production not value unless there is no sensible unit of production (a company selling a service for instance). An important reason to measure forecast accuracy is to be better able to plan the future supply chain and value adds in factors such as selling price and even exchange rates into the forecast accuracy which do not effect the supply chain. Average selling price and exchange rate should be forecast as a separate exercise for financial planning.

The mathematical calculation is generally (forecast sales - actual sales) / forecast sales. The reason forecast sales is taken as the divisor is that it is less likely to be zero and so give a divide by zero error.

Once you are measuring sales forecast accuracy, the next stage is to improve it. This is achieved by investigating any forecast errors outside the historical accuracy of the forecast (see statistical process control).

Finally, unless you are supply limited, the sales plan should be the date and quantity of shipments you expect your customer will require. If your customer requests product in line with the plan but you are unable to ship that product, it is still a hit as far as plan accuracy is concerned. Conversely, if your customer requests shipments on a different date from the plan it is a miss even if you could have shipped it according to the plan.

Jargon Warning - If you are not familiar with any of the terms used above, you can look them up in the free Jargon Buster on this site or, for more details, purchase the book "Business Excellence". Business Excellence is available in e-book format in addition to the paperback and is a component of the ERP Class "A" toolkit which you can also purchase and download from this site. Click here for more details.