Explain the weaknesses of using the percentage of sales method in forecasting.
Percentage of sales technique is a strategy in financial forecasting approach. Experts who use this approach consider that most balance sheets and income statement accounts vary with sales. The chief causes for choosing this method is the sales forecast and pro-forma financial statements (i.e., forecasted). The respective creation of these statements allow firms needs to source for external financing (Benjamin, 18).
Here, it is assumed that most of the balance sheets and income statements fluctuate with sale. In this method, various assumptions are made about the future using past performance thus posing an inherent risk and it is for this reason that percentage of sales method has its limitations (Benjamin, 26). The intent of this paper is to discuss the demerits of using this method in forecasting.
Sales methods of predicting that are used by diverse companies must follow certain requirements. For example, they should satisfy the existing applications of the company's requirements considering the type of industry. (Lasher, 116).
There are various limitations in using the proportion of sales method in the process of forecasting. In this method, the approximations are usually based on estimations and therefore lack details. As a result, a slight change in a business asset value in the future could result to a wrong prediction. Apart from this, this method does not consider the various types of assets in forecasting. This can result to wrong estimates in the future especially if there is a change in asset types. Since the business climate changes over time, it is hard to use the past to predict the present and the future. This is however what this method applies. Because of the limitations above, this method is not effective as a means of prediction (Lasher, 289).
Because of such limitations, several industrial applications prefer the use of top-down sales forecasting. In this type of forecasting, the organization approximates the potential of sales and then creates transaction quotas and finally a sales forecast. Others use the Bottom-up forecasting analysis. This allows an organization to divide the market into different segments. After this, there is a deliberate attempt to forecast the demand of each segment in different manners.
Benjamin, Brian (2012). Demand media: Limitations of the percentage of sales forecasting method. Chron.com. Retrieved from http://smallbusiness.chron.com/limitations-percentage-sales-forecasting-method-14621.html