Revenue forecasting is important for tracking business performance and supporting related decision-making processes.
To prepare an accurate budget for your business, you need to develop a revenue forecast – an educated estimation for the upcoming year about how much money your business is likely to bring in. This involves making predictions about the future of your business based on data from the past and present and is an essential tool for keeping costs under control as the company grows.
A revenue forecast will allow you to determine how much you can spend, and what the business’s margins will be overall. Once you have a better idea of the total amount of money coming in and going out of the business, you can build a more relevant budget in line with long-term goals.
Forecasts can serve as a useful reminder of where the business should be – better affording you the ability to understand any deviations from the objectives you have set. Forecasting is also an essential tool to help plan for business growth, allowing you to align finances with new initiatives for growth, and to cut costs when business is sluggish.
It is advisable to begin with a monthly revenue forecast for the next 12 months, then an annual forecast for the following three years.
Follow these four steps to create a forecast:
1. Estimate expenses
An ideal place to start is to focus on your fixed costs and overheads, things like rent, utilities, technology, and salaries. Calculate the fixed costs required to keep your business ticking along, including rent and utilities, salaries, technology costs and marketing, legal and accounting fees.
Factor in variable costs that depend on your volume of sales, such as cost of goods and customer service time.
Both fixed and variable costs may have to increase to drive new revenue in the future which is why it’s worth estimating how these will affect your expenses in a growth phase.
2. Predict sales
Predicting sales for an established business is easier than doing it for a new business. A business with a history already has a sales forecast baseline of past sales. You can use sales revenues from the same month in the previous year, along with general economic and industry trends, to predict future sales.
There are two types of sales forecasting methodologies: bottom-up and top-down forecasts. Bottom-up forecasts are often more realistic as they project the number of sales the business will make, then multiply that number by the average cost per unit. You can also build in the number of locations, number of sales reps, number of online interactions, and other metrics.
A top-down forecast starts with the total size of the market, and then estimates what percentage of the market the business can capture. If the size of a market is R100 million, for example, you may estimate that your business could win 10% of that market, making the forecast R10 million for the year.
It’s a good idea to use both approaches and see how closely they line up. A bottom-up analysis can be more realistic and takes into account planned and predicted elements that might influence your sales.
3. Combine expenses and sales into a forecast
Deducting projected expenses from projected sales gives you predicted net revenue. To make a forecast, put past monthly expenses and sales in a spreadsheet up until the present date. Stretch these into future months and years and incorporate the planned and predicted factors and their expected impacts on revenue and expenses to complete your forecast.
Business accounting software packages can perform sales forecasts, including individual forecasts, by customer, based on existing sales data.
4. Test scenarios by adjusting variables
Variable expenses such as payroll, utilities, phone bills and commissions, change each month. Tweak the variables within your projected expenses and sales to reflect specific growth scenarios and provide you with insights into what the different scenarios will involve, and what they will require from the business.