See Also:
ProForma Financial Statements
Cost Center
Weighted Average Cost of Capital (WACC)
Standard Costing System
Activity Based Costing vs Traditional CostingPercent-of-Sales Method – DefinedThe percent-of-sales method is a technique for
forecasting financial data. When forecasting financial data for strategic planning, budgeting, or for developing pro forma financial statements, analysts can use the percent-of-sales method of forecasting to create reasonable projections for certain key data.
The idea is to see how a financial statement account item relates historically to sales figures, and then to use that relationship to project the value of those financial statement account items based on future sales estimates. Because this method of forecasting requires the items to be estimated based on relations to sales figures, it is necessary that movements in the items to be forecast are highly correlated with fluctuations in the sales figures. If there is no clear correlation between the item to be forecast and sales figures, then that item must be forecast using a different technique.
Here is a very simple example. If, after examining and analyzing historical financial statement data, an analyst determines that inventory levels are typically at 30% of sales, and the sales forecast for the coming year is for $100,000 dollars in sales, then, according to the percent-of-sales method of forecasting, the analyst can estimate inventory of approximately $30,000, or 30% of the estimated sales figure.
Percent-of-Sales Method – Three Step ProcessThere are three steps in the percent-of-sales forecasting process. The first step is to analyze historical financial statement data to determine which items are correlated with sales figures and which are not. Only the items which are correlated with sales figures can accurately be predicted or forecast using the percent-of-sales method. Items that have no concrete relation to sales figures must be estimated using a different technique.
The next step is to forecast sales for the fiscal period in question. Of course, because all projections in the percent-of-sales method of forecasting depend on relationships between financial statement items and sales figures, it is very important to get an accurate sales forecast.
The third step in the percent-of-sales method of forecasting is to forecast the values of certain appropriate financial statement items using the sales forecast from the previous step in combination with the historical relation between the financial statement item and the sales figure.
Percent-of-Sales Method1. Analyze historic financial statement data
2. Forecast sales for the fiscal period
3. Forecast financial statement items using sales forecast