TABLE OF CONTENTS
- What Is a Revenue Forecast?
- Judgment Forecasting vs. Quantitative Forecasting
- A Revenue Forecast Helps Plot Your Company’s Future
A revenue forecast is essential to your small company’s success.
This projection can help you to understand your margins, improve production schedules, manage credit and anticipate when you’ll get paid.
Here’s everything your business needs to know about how to forecast revenue, including:
- Different revenue forecasting models
- The importance of estimating your expenses
- Why it’s good to have 2 sets of revenue projections
- How to check your key ratios
What Is a Revenue Forecast?
A revenue forecast is an estimation of the amount of money your business will generate during a particular period of time. Understanding the “right time” to make critical investments in your business starts with this forecast. Whether you plan to launch a new advertising campaign, increase inventory before peak seasons or hire another team member, your goals need to coordinate with your revenue projection.
A revenue forecast can be applied to your whole business, individual departments or specific initiatives, such as an advertising campaign. For businesses with aggressive growth plans, learning how to project revenue can help convince potential backers to invest in your business.
Comparing your latest financial data to your revenue projection is a great way to gauge your business’s progress. While no revenue forecast will be 100% accurate, projecting your revenues greatly improves your ability to make the best decisions for your business.
Judgment Forecasting vs. Quantitative Forecasting
There are many approaches regarding how to project revenue, but small business owners frequently use 2 revenue forecasting methods: judgment forecasting and quantitative forecasting.
Judgment forecasting is a prediction made by someone familiar with your business — typically either the business owner or another senior leader — relying on organizational knowledge and experience to provide an expectation of the year’s income and expenses.
Quantitative forecasting is more systematic and uses historical revenue data from your own business to follow tendencies and predict market progression. Recorded revenue data from other businesses in your industry also can be used to influence your quantitative forecast.
What’s the best way to forecast revenue? The answer can vary. Many business owners use a combination of each revenue forecasting method. By merging the 2, your analysis benefits from the precise, historical data as well as the intuitive advantage that comes from years of experience.
Let’s break down how to create your revenue projection.
1. Start With Your Expenses
There are 2 main categories of expenses that impact your business: fixed costs and variable costs.
Fixed costs are any bills or charges that remain the same regardless of how much your business is producing or how many clients you’re serving.
Some examples of fixed costs include:
- Property taxes
- Interest expenses
On the flip side, variable costs fluctuate with the ebbs and flows of the business.
Examples of variable costs include:
- Cost of goods sold (COGS)
- Materials and supplies
- Packaging materials
- Sales commissions
- Direct marketing
- Customer care
- Credit card fees
As you’re reviewing your expenses and folding them into your revenue projections, remember:
- If you’re preparing your marketing and advertising budget, double your original estimate. It’s common for these costs to exceed initial calculations.
- Record customer service interactions and direct sales as direct labor expenses. It’s important to keep tabs on these expenses as you scale.
- Much like marketing and advertising, legal, insurance and licensing fees can outpace your estimates. If you have no experience in these areas, it’s suggested you overestimate them — even by 3 times as much.
2. What’s Changed in Your Business?
When you’re working on a revenue forecast, consider the pieces of your business that have changed and could impact future earnings. Maybe you added personnel, new product verticals or have a more competitive pricing model. These matters as well as shifts in your competition and any other factors — such as new legislation — could affect your business, too.
3. Calculate Anticipated Revenues
At this point in your revenue projection, you should begin separating each source of income and segregating any variables for the business. This will provide a clear view of any positives and negatives in each revenue stream.
From each source of income, list the amount of revenue expected during the business’s review period (monthly, quarterly or as needed, etc.) for your earnings and revenue. Arranging your data this way will reveal the total expected revenue for the desired time frame.
Jennie’s Jellies expected $27,120 from farmer’s market sales and $91,630 from its grocery partners in the second quarter. With these figures, Jennie’s Jellies would have a total expected revenue of $118,750.
|Farmers Markets||Grocery Stores||Total Revenue|
4. Aggressive and Conservative Revenue Forecasts
By creating two versions of your revenue forecast — one aggressive and one conservative — you’ll force yourself to think boldly to achieve your growth goals and rationally in the event you need to scale back.
Jennie’s Jellies Example
- A low price point for their standard jellies, higher price for choice, small-batch jellies
- Increasing promotional efforts from 3 to 4 marketing channels managed by a new marketing manager, as well as adding 3 commission-based salespeople
- One new jelly or complimentary product added by the fourth quarter, with 3 more products introduced within the next 18 months
- Low price point, no additional premium pricing
- No new marketing channels introduced
- Sales staff remains the same
- 1 new jelly introduced each year for the next 36 months
The aggressive forecast is a fuller and more aspirational estimate. While there are no numbers tied to the bullets in these examples, when executed properly, the aggressive revenue forecast could incur more expenses than the conservative forecast, but generate greater opportunities for continued growth.
5. Double Check Your Key Ratios
Employing an aggressive revenue forecast will provide more opportunities while potentially driving greater expenses. You can balance your revenue and expenses by reviewing 3 ratios that that impact how much you can invest back in your business:
Your gross margin gives you the best view of your costs relative to your revenue, allowing you to make the most informed decisions for your business.
To determine your gross margin, subtract your total COGS from your total sales revenue and then divide that figure by your total sales revenue. The gross margin will be presented as a percentage.
Operating Profit Margin
This formula is a ratio of your business’s performance used to determine the percentage of profit you have produced from your transactions, before deducting taxes and interest charges. Also known as EBITDA, operating profit margin is calculated by dividing your operating profit by your total revenue and is expressed as a percentage.
Overall Headcount Per Client
If you aim to manage more client accounts in the next few years, how much you currently spend on headcount per client should be factored into your revenue and payroll assumptions. The formula for this is simple: Divide your current number of employees by the total number of clients you have. If you’re currently working alone with aspirations to increase your team, this ratio is especially important to you.
A Revenue Forecast Helps Plot Your Company’s Future
While establishing an accurate set of growth projections for your business takes time, a revenue projection gives you the best chance to achieve your goals. Be honest about your expenses and how your business has evolved — and don’t be afraid to make bold revenue forecast as you map out your growth. If you need additional help, you can find revenue forecasting software on the web.
Even as you experience the evolution and progression of your business, forecasting revenue will keep you in touch with your company’s financial health.
Concrete revenue projections will open your business to the possibility of leveraging financial products such as business loans to help expedite and accomplish your goals for growth.