No matter how you grow your business, there’s one thing you need to protect your cash flow along the way: a revenue forecast.
A revenue forecast involves making predictions about the future of your business based on data from the past and present. It’s an essential tool for keeping your costs under control as you grow.
Here’s a seven-step approach to developing a revenue forecast for your business, including how to check if your projections are realistic using key financial ratios.
Step 1: Decide on a timeline
A reasonable approach is to make a monthly revenue forecast for the next 12 months, then an annual forecast for the following three years.
Step 2: Consider what may drive (or hinder) growth
What factors could lead to growth or shrinkage in your revenue? This could include predicted factors, which will influence sales without you doing anything. They might be seasonal upticks or be based on your historic sales data.
Also consider any planned factors – specific steps you might take to drive revenue. Are you planning a big marketing campaign, or launching a new product for a specific demographic? Are you hiring additional sales staff or adopting new technologies to increase efficiency?
For gift hamper company Don’t Buy Her Flowers, occasions such as Mother’s Day bring a spike in sales, says founder Steph Douglas. However, in 2020 with many retailers closed and more customers looking for gifts online, the company had a bumper year. “March 2020 was up 102% compared to March 2019,” says Douglas. “Then we saw the halo effect of this for other gift giving occasions throughout 2020. For example, sales for Father's Day in June were 51% higher than our record breaking Mother's Day and then by Christmas we were up 72% from Mother's Day.”
Step 3: Estimate your expenses
Before considering the effect that predicted and planned factors might have on revenue, start with the easier task of estimating expenses.
You’ll need to calculate the fixed costs required to keep your business ticking along, including rent and utilities, staff salaries, technology costs and fees for functions such as marketing, legal and bookkeeping. Then factor in variable costs that depend on your volume of sales, such as cost of goods, packaging and labour.
Both your fixed and variable costs may need to increase to drive new revenue, so estimate how the predicted and planned factors you shortlisted earlier will impact your expenses.
Step 4: Predict your sales
One method of predicting sales is a top-down analysis. Start with the total size of the market, and make a prediction of how much of the market your business will capture, or how much you will increase your market share by. This gives a rough idea of what’s possible, but its simplicity means it can lack predictive power.
A bottom-up analysis can be more realistic and takes into account planned and predicted factors that might influence your sales. Take the average value of one sale, for example, the average basket value for a retail business. You can also consider the number of sales you make. Then draft your forecast based on the number of sales made and the value of those sales.
Step 5: Combine expenses and sales into a forecast
You’ve already outlined the factors that could affect revenue over your chosen time period. Now combine the estimated effect these factors will have on sales with their associated expenses.
A simple formula for projecting sales is: Number of customers x average sale value x number of units = projected sales.
Deducting your projected expenses from your 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. Then stretch your current sales and expenses forward into future months and years. Incorporate the planned and predicted factors and their expected effects on revenue and expenses.
For Don’t Buy Her Flowers, the trading conditions under Cover restrictions have continued to bring unusually high growth. “In February 2021, we were up 613% on February 2020, [so we] have planned 2021 Mother's Day accordingly,” says Douglas.
Step 6: Check your forecast using key financial ratios
You can use the following ratios to get a feel for whether your forecast is realistic.
This is the ratio of total direct costs to total revenue. For example, a manufacturing company’s margin would be calculated like this: (Total revenue - the cost of goods sold) / total revenue = gross margin.
In general, the higher your gross margin, the more cashflow you have for expansion.
Operating profit margin
This is your profit after deducting all operating expenses from your revenue.
The formula is: Operating income / revenue x 100 = operating profit margin
As revenues grow, you should expect to see positive movement with this ratio.
Step 7: Test scenarios by adjusting variables
You can now tweak variables within your projected expenses and sales to reflect specific growth scenarios. For instance, making an additional 100 sales calls each day could result in one extra sale/unit (assuming a 1% conversion rate). But remember, to make money you often have to spend money. You might need to hire two additional salespeople to hit 100 extra calls, which will add to your expenses.
Understanding your revenue forecast will help you better manage your cash flow, ensuring there's always enough money to pay your suppliers and expenses on time. The American Express® Business Card has a 54 day payment period, giving you more control over your cash flow and when you make your payments¹. Find out more here.
- The maximum payment period on purchases is 54 calendar days on Gold & Platinum Business Charge Cards and 42 calendar days on the Basic Business Charge Card, it is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date.