Forecasting II

FORECASTING, Continued...

The printed and the online Team Member Guide offer a detailed discussion on forecasting. You need two forecasts - a worst case and a best case. Put your worst case into the marketing spreadsheet, and your best case into the production spreadsheet.

The Basic Method is described in the Team Member Guide. In the Basic Method, we assume that whatever we sold last year will be repeated as our worst case. Open up the Courier to page 4, the Production page. Take note of the unit sales number. Let's assume it is 1200 and we have 87 units of inventory.

Bring up the decision workbook and enter 1200 into the Unit Sales Forecast on the marketing spreadsheet. We are forecasting that in the worst case sales this year will be the same as last year. Or, like me, I would be slightly more aggressive and add in the yearly growth rate to this number.

Bring up the production spreadsheet. The question is, "What do we want for our best case?" We don't want to stock out. Think in terms of months of inventory. For example, you might state a strategy towards inventory as, "We will carry up to 3 months of inventory in our best case." Three months is 25% of a year, so our best case is 25% greater than our worst case. In this example, 125% of 1200 is 1500, but we have 87 on hand, so we produce 1413. Again, watch the "production after adjustment" number. You may need to enter 1420 to actually get 1413 units produced.

Financially, the workbook is in worst case. It thinks unit sales will be the same as last year, and yet you've built enough inventory to satisfy an additional 3 months of demand. That puts 3 months of potential sales into the warehouse, and it locks up cash in finished goods.

When you look at the proforma Balance sheet, you are sitting on a huge amount of inventory. On the worst case Income Statement, sales are unchanged from last year, but profits are reduced because of the inventory carrying expense.

Pull up the balance sheet again and make an observation. From the balance sheet’s point of view, cash and inventory are variations of the same thing - assets. You can convert one to the other, so in some sense cash and inventory are like ice and water. In the worst case, a good portion of your current assets are converted into inventory. In the best case, you sell the inventory and it becomes cash. You become liquid.

What will happen to the balance sheet if your best case comes true? In your best case you sell all the inventory. Let’s find out.

Return to the marketing spreadsheet and plug in some ridiculously large sales forecast, say 3000. When you return to the Balance Sheet, the inventory is gone and you are swimming in cash.

If cash and inventory are essentially the same stuff, assets, then the relevant question is, how liquid are you? In your best case forecast, you are entirely liquid. In your worst case, your inventory locks up cash.

Now consider the man that every Capsim team hates, the loan shark, Big Al. If you have even $1 after buying all that inventory, Big Al won’t show up. The worst case came true, and you still have cash. You can avoid an emergency loan by planning for a small bit of cash in your worst case.

An important point - your worst case forecast has to truly be a worst case. Don't get too aggressive.