Modeling sales in Excel is fun. Sales always goes up (at least that is what the sales and marketing department will tell you).
However, sales rarely go up at a constant rate month after month. Projected sales have peaks and valleys that reflect the introduction of new products, favorable press, additional store locations or new distribution relationships.
A rapid sales growth spurt is what I call an ?inflection point?, or a point where the sales graph changes shape, hopefully for the better. The following graph shows the comparison between a typical CAGR continuous growth versus modeling inflection points:
Financial inflection points can come from a number of sources:
- Opening A New Store
- New Distribution Relationships
- Appearing in the Press
- New Product Lines
Inflection Point: New Stores
The easiest inflection point to model is opening a new store. If your company already has other store locations you will have good estimates of how that store will perform sales wise and what the costs are likely to be.
Inflection Point: New Distribution Relationship
Getting onto the shelf of a new store is a huge win and potentially a game changer. For example, if you own a food company and Whole Foods starts selling your product, strap yourself in because it could be an exciting rocket ship ride to the top. If Amazon starts featuring your book or DVD that can only lead to good things.
Inflection Point: Positive Press
A news story in national newspaper, magazine or website can cause a massive inflection point, especially for any company that has an internet presence. I attended a talk by a knife maker who had an article in a national gourmet magazine. The day the article hit the newstands his phone rang off the hook ? first the east coast woke up and read the article then the calls were coming from the east coast and finally the west coast. By the time the day was over he had thousands of orders, which was years of production.
Inflection Point: New Product Line
The most common way to increase sales is adding a new product line. Notice I said product line because revisions to an existing product does not drive an inflection point. For example when Microsoft releases a ?new? version of Windows it might cause a slight blip in sales as a few people adopt but overall it will sales to be on mostly the same trajectory.
Contrast this scenario with the iPhone or iPad when they were first released. A pop in sales because a new product was launched. Yes, there is still a sales pop when new versions are released but these are typically baked into the projections for existing products.
The way I like to model growth in Excel is to have three sources of growth:
- Base line growth percentage
- Additional Percentage growth
- Additional Dollar Amount
Here is what the model looks like in an Excel worksheet:
Base line growth is similar to inflation, this type of growth happens organically. Typically this growth is relatively small, at most 10% per year depending on the inflationary environment and the growth prospects for the industry. One important baseline assumption is seasonality, which is not modeled here.? Usually sales will increase or decrease according to the time of the year.? A seasonal holiday spike for a retail store could be modeled either through modifying the baseline growth based on historical trends or adding an additional percentage growth.
The additional percentage growth is a multiplier that accounts for inflection points. I like to use this for new products or stores where the launch will increase sales by a known amount. For example, if I go from four Excel courses to five courses my sales will hopefully increase hopefully by 20%. Similarly going from 10 stores to 11 stores will likely increase sales by 10%. Obviously, the exact percentage increase is matter of great debate and will be the subject of many meetings.
The additional dollar amount is best used for contacts in the sales pipeline. For example your sales team might be aware of a large $25 million contract closing in six months and that expected sale could be added as a specific point in the projections.
One word of caution: don?t double count. I have been in many meetings where the sales team throws around numbers and its easy to put them in three places. The $25 million contacts should be reflected in only one place: either the additional percentage or the additional dollar amount.
There are a couple of problems with modeling the inflection points in practice:
- Technology: Versions vs. Game Changers
- Speed of the ?Pop?
- Inflection goes both ways
There are some activities that look like inflection points but are not inflection points.
My thinking: inflection points = game-changing activities.
I use words ?new product line? for a reason. Think about the iPhone or Microsoft Office ? they come out with a ?new product? every couple of years but its really an update of an existing product. An incremental product update will have a sales pop but then likely the sales will go back to their regular sales & growth run rate .
The second modeling problem with inflection points is the speed of the ?pop?. Every business would like to launch their product and be greeted with praise shouted from the rooftops and a tidal wave of money. Life doesn?t work that way. Overnight success can take decades. Model a gradual inflection point where sales ramp up over weeks or months as your customers discover your product, you build trust and your product is recommend via word of mouth.
The third point to be aware of is that inflection points can go both ways. I?ve presented some upbeat examples but the reality of business is that sometimes products are retired, stores are closed and press can be very negative. Inflection points can be just as easily negative as positive however if I presented a post about sales going down and store closings it might give you a ?case of the sads? and that?s not what Excel SuperStar is all about.
If you are running a start-up the most critical financial piece of information is the timing next big inflection point. Once you know where the inflection point is likely to be all capital raising activities should focus around getting funding to get past that inflection point, usually by at least a couple of months.
For example, if you are planning a new product line to be launched in six months and you expect that each month before the product launch will burn cash at $10,000 per month, you might want to target funding of $100,000, which would be more than the $60,000 that the Excel model suggests.
There are three of reasons for funding beyond the inflection point: 1) you might miss your target deadline 2) developing the product might cost more than expected 3) things could cost more and take longer than expected. The worst situation an entrepreneur can encounter is having insufficient funding right before a critical inflection point.
It is possible to go too far the other way ? funding way beyond the next inflection point. This may appear like a high quality problem but it can be problematic. I believe that many of the current batch of Social Media Web 2.0 IPOs now fall into the over-funding category. Investors want a reasonable return on their money they have invested with? the company. In order for the company to meet those return targets the capital needs to be deployed in a profitable activity that generates returns.
For example, imagine a daily deals website which raised a billion dollars through an IPO.? A billion dollars is far more than is needed for years of growth, essentially funding to multiple inflection points. Investor expectations are that their billion dollars will create $100, $200+ million in value over the next year, either through cash profits or retained earnings. Because I have to manage the funding over many inflection points the math gets complicated ? my next inflection point might be in six months and generate $20 million in value over the next twelve months, leaving a $80 million shortfall for the year. The excess cash will likely provide incentives for management to deploy funds into activities that may not provide economic benefits but ?look good? to short term investors and the press.
EDITOR?S NOTE: Before I get a ton of nastygrams, the preceding analysis is a look through into the fundamentals of the company. I concede that it is possible to trade a high volatility stock that has no cash flow and ?buy low and sell high?. The problem is that owning companies with no cash flow is a game of musical chairs ? when the music stops, if you are the last one owning a non-cash generating company you will likely not have a seat and end up loosing your house, car, boat?
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