The weakest part of any business plan will be the projection of sales revenue.
Investors, for good reasons, dissect sales numbers and also carefully study the rationale behind the sales projections. The inability of the entrepreneur to adequately explain or validate how sales will be accomplished gives investors the opportunity to discount proposed valuations. The entrepreneur is usually ill prepared to defend the business plan in the absence of a good, if not excellent, marketing and sales strategy and written marketing and sales plan (MSP).
TOP DOWN APPROACH — NEVER DO THIS
The natural tendency of any new venture is to simplify the projection of sales by taking the size of the target market and multiplying by the penetration rate  it thinks it can achieve initially and over time. This approach is always doomed to failure, as there is no logical way to relate the assumed market penetration rate to reality. For instance, how does the market penetration rate change when the marketing-mix budget is doubled? Does the penetration rate double also? This top-down approach, as well as any other type of approach that derives sales projections directly from consideration of market size, is not effective and not respected by investors. The market penetration rate should be a derived quantity that naturally results from a bottom-up approach. A bottom-up approach is presented in this book.
EXISTING SALES ARE THE BEST INDICATOR OF FUTURE SALES
In the normal course of developing the business and securing investment, the new venture will advance through various stages. Prior to experiencing sales to early adopters, sales are nonexistent and can only be imagined. If the new venture has managed to create sales prior to professional investment, then it can rightfully point to those existing sales as evidence of the business opportunity’s viability. Existing sales are always the strongest position from which to project sales revenue. In the absence of existing sales, any evidence of pending sales in the form of actual orders or letters of intent to purchase are next the most valuable evidence to put forth as a basis for making sales projections. Other evidence of interest or intent to purchase may be garnered from information requests from prospects, though this is a more problematic and severely limited basis for making sales projections.
A BOTTOM-UP APPROACH IS BEST
For a new venture without any of the above evidence of sales, sales revenue needs to be projected using a combination of provable data about the markets and assumptions and judgments about how prospects are converted into customers. These assumptions and judgments will still be examined closely by investors, but they are more defensible and subject to testing at early stages by the new venture. As a result, sales projections become more credible and less subject to discounting by investors. This provides a pathway for entrepreneurs to argue for greater pre-money valuations.
Table 1 illustrates a bottom-up approach for estimating sales and key metrics.
Starting at the bottom, the two right-side columns describe two differing sales channels. One sales channel is B2C, where advertising and social media play key roles in creating awareness with the customers in the target market. The other sales channel is B2B, where personal sales are critical. The numbers, of course, are simply for example and have no relationship with any particular company.
With respect to the use of personal sales (one component of the marketing mix called “promotions”), the key parameters consist of those items that can be justifiably put forward by executive management; for instance, the number of sales representatives deployed, which is simply a matter of summing up the individual numbers of sales representatives in each sales rep organization.
Table 1 Key Metrics of the Sales Process
It is presumed for purposes of this example that the total number of available sales representatives is two hundred. It is further assumed that the number of qualified prospects is ten for each sales representative.
Each of the prior items is easily determinable by conducting a survey of potential representative firms. These surveys would occur in the early planning for the new venture as a part of selecting sales representative organizations. The darkened box is the major assumption for this part of the table, and it represents an estimate of how many of the qualified prospects would be converted to a sale.
In a similar fashion, advertising is broken down by reach (number of prospects who read the magazine) and frequency (publications per period of time) in order to determine the number of advertising exposures and qualified prospects. The darkened box, as before, is an estimate of how many qualified prospects can be converted to a sale. The two darkened boxes in Table 2 drive the calculations of the sales metrics.
It should be noted that the two assumptions concerning the conversion rate of prospects to customers are, at first thought, problematic in much the same way that the assumption of market penetration rate in the top-down approach is. However, such is not the case because the conversion rate represents a testable hypothesis. That is, once a promotions program is defined, it can be tracked for success and the conversion rate determined.
Adjustments in a promotions program can be made to increase the conversion rate, and over time it would be expected that the conversion rate would increase. The best promotions programs can then be discovered and scaled up to optimally support marketing and sales programs and ultimately achieve greater sales. Discovering the most effective promotions programs is best done as quickly as possible.
Moving vertically up more in Table 1, several key metrics can be calculated based on the assumptions. The number of expected customers is simply the sum of customers secured from the various factors just discussed. The size of the target market is already known (to some level of precision) from prior market analysis. The ratio of expected customers to the size of the target market provides the market penetration ratio. The cost of the promotions program is tabulated in a detailed spreadsheet (not shown here) for each promotions program. That cost estimate would include all relevant aspects of the promotions program, whether it is advertising or personal sales or some combination of both. The customer acquisition cost (computed as $ per customer) is calculated in a straightforward way, given that costs are defined and expected customer numbers have been estimated. Every company is different, so the exact buildup as shown in Table 2 can be modified as required.
Companies more dependent on social media presence can speculate on the growth of followers (via the use of growth-hacking tactics, social media campaigns, viral marketing, artificial intelligence (AI) methods, etc.) and their relationship to eventual customers and sales. A table similar to Table 1 can be built to establish appropriate metrics and gauge costs in proportion to sales. The important goal is to have reasonable assumptions and metrics that relate marketing and sales costs to eventual numbers of customers and sales revenue.
This approach provides some key metrics for the sales process:
- Number of customers
- Customer acquisition costs
- Market penetration rate
- The experience of executive management, particularly those in marketing and sales
- Public sources, especially those that research the uptake rate on new products and market introductions.
- Historical data from similar industries and companies, which may also be secured from interviews with sales personnel.
- Outside experts in the areas of interest to the company.
The result of the bottom-up approach is that data to be used for key sales metrics is predominately based on market research and marketing-mix decisions, which tend to be factual matters. Reliance upon speculative assumptions is minimized.
Sales projections are based on the same considerations as discussed above and as illustrated in Table 2 for an example company selling industrial products and relying upon external sales representatives and advertising. A social media company would use a similar approach but based on developing followers, customers, etc. to build up to a sales projection.
Sales projections are built up from the promotions part of the marketing mix. The promotions part of the marketing mix, also called the promotional mix, consists of advertising, sales promotions (discounts, coupons, etc.), and personal sales. A further point should be made with respect to the projection of sales as shown in Table 2; that is, the percentage of sales derived from advertising is a small fraction of the total sales. There is nothing intrinsically wrong with that, as advertising serves not only to provide leads to the sales team, but also may drive sales to an internal order-taking function.
Table 2 Estimating Sales Revenue
In any event, evaluation of how sales are most effectively made from a “cost of sales” viewpoint is not only very valuable but essential. Once promotional activities are underway sufficiently to be evaluated, they may be adjusted to provide a more optimal (e.g., cost-effective) approach. The sales projections become part of the set of integrated financial spreadsheets. Related spreadsheets showing the promotional programs costs, buildup, and details can also be included.
Sales projections are the most critical part of the build-up to estimating value. Thus, entrepreneurs should diligently create a marketing and sales model that can defended with reasonable assumptions. In time, as the company develops, actual sales and the underlying metrics used should be compared to modeling projections and improvements made so that the sales model is more reliable.
 Penetration rate is simply the ratio of the new venture’s customers divided by the number of customers in the segmented target market expressed as a percentage. Penetration rates can also be determined for the served available market (SAM) and total available market (TAM), which refer to, respectively, the number of customers who can actually be reached by the new venture sales channels and the total of all customers in the larger market for the product (or service) category.
 Promotion programs can be numerous, corresponding to different media, ads, and territories, to name but a few discriminators. Promotion programs include advertising and personal sales predominately, but they can be tailored for any approach to creating sales. In practice, sophisticated approaches for analyzing data and feedback from customers are used by specialist marketing and advertising firms; however, even relatively simple approaches can be quite effective.
 As used in this book, promotional programs are a part of the marketing communications (or MARCOM) effort. MARCOM consists of sales promotions, sales literature, advertising, public relations, trade shows, collateral materials, branding, packaging, online activities for social media, and customer service. MARCOM is considered the promotions element of the marketing mix.
Rocky Richard Arnold provides strategic corporate and capital acquisition advice to early-stage companies founded by entrepreneurs wishing to successfully commercialize high-value-creation opportunities, ideas, and/or technologies. More information about Rocky can be found at www.rockyrichardarnold.com. His book, The Smart Entrepreneur: The book investors don’t want you to read, is available for purchase on Amazon at http://tinyurl.com/pv248qq. Financial software for use by startups can be purchased on Amazon at http://www.amazon.com/gp/product/B00K2KPSI2. He posts articles about entrepreneurship on his blog at http://thesmartentrepreneur.blogspot.com. Connect with Rocky on Twitter @Rocky_R_Arnold; Facebook at www.facebook.com/rocky.r.arnold; Google+ at www.google.com/+RockyArnold01.