Even when you are managing your small business successfully, wrangling with financial reports can be time-consuming. We’re here to help speed things up with a seven-step reminder on how to create a revenue forecast for your growing business.
We’ll recap on what a revenue forecast is, how to forecast revenue growth, and why it’s important for your business' success and cash flow.
What is a revenue forecast?
Revenue forecasting is the process of predicting your revenue over a period of time (typically 12 months) by using historical and current sales performance data.
Understanding likely future revenue is useful to businesses in two ways. If you know that revenue is likely to increase, you can make plans for investment or other costs. And, if revenue is forecast to fall, the business can take steps to improve the forecast, such as finding new ways to drive revenue or reducing costs.
How to forecast revenue in 7 steps
1. Decide on a timeline
Typically, revenue is forecasted over 12 months. It can also be helpful to provide a top-line annual prediction for the next three years. Remember, the further out the forecast, the more uncertain it is.
2. Consider what may drive or hinder growth
Before you start predicting how your business will perform, you need to consider the external factors that could drive or slow your sales over the next year.
- Seasonal upticks.
- Major public events.
- Upcoming changes to the law that might impact your sales.
Think about your planned business activity and predict how things like expansion, marketing campaigns or new product launches might affect sales or how the adoption of new technology that might speed up order processing or manufacturing.
For gift hamper company Don’t Buy Her Flowers, occasions such as Mother’s Day bring a spike in sales, says founder Steph Douglas. But 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 with 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.”
3. Estimate your expenses
Future expenses are critical when creating a revenue forecast. Remember that your business probably has fixed costs that are easier to predict and variable costs that will increase or fall based on sales. These expenses might include things like material costs, packaging and labour.
Both your fixed and variable costs may need to increase to drive new revenue, so think about how the predicted and planned factors you shortlisted earlier will impact your expenses.
4. Forecast sales
Here's how to forecast sales:
- Determine total market size (number of potential customers).
- Define your company's market penetration by dividing your current sales by the total market size.
- Quantify your customer purchasing capacity by calculating the maximum value of purchases per customer each year (number of products x unit price).
- Compare this to average customer purchase value each year to understand your sales potential.
- Assess competitor sales and if/ how these are growing in comparison and adjust sales potential accordingly.
Forecasting sales using a top-down analysis, which means using the total value of a market and then predicting how much of that market you expect your business to capture, is a useful way of predicting possible sales, although it isn’t necessarily accurate.
A bottom-up analysis can be more realistic. Take the average value of one sale, and then consider the number of sales you make. You can then draft your revenue forecast based on the number of sales made, and the value of those sales.
5. Combine expenses and sales into a forecast
Once you have outlined the factors that could affect revenue over your chosen time period, you can combine the estimated effect of those things on sales with the 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 COVID-19 restrictions continued to bring unusually high growth. “In February 2021, we were up 613% on February 2020, [so we] planned Mother’s Day 2021 accordingly,” says Douglas.
6. Check your forecast using key financial ratios
You can use the following ratios to determine whether your forecast is realistic.
Gross profit margin 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
Read our article on the gross profit margin formula for more detailed information on calculating the gross profit of your business. In general, the higher your gross margin, the better your cash flow.
Understanding and anticipating your gross profit margin helps you maintain a healthy cash flow, which in turn allows you to reinvest in and grow your business. The American Express® Business Gold Card can boost your cash flow with its payment period of up to 54 days, which gives you even more flexibility to balance incoming and outgoings¹.
Operating profit margin
Operating profit is the profit your business makes after deducting the total operating expenses from your revenue.
The operating profit formula is:
Operating income / revenue x 100 = operating profit margin
As revenues grow, you should see positive movement with this ratio.
7. Test scenarios by adjusting variables
With a revenue forecast complete, you can test it by tweaking variables within your projected expenses and sales to reflect specific scenarios.
For example, a potential scenario could be: what would happen to your revenue forecast if you make 100 more sales calls each week, generating an additional two sales per day? What impact would this have on costs (labour, technology costs) and revenues (additional sales)?
Tests such as these allow you to understand the factors likely to have the biggest positive (and negative) impact on your revenue, allowing you to both plan for and protect your business.
How to perform a profit forecast
Once you have forecast your predicted revenue, you can use this to forecast profit. First, determine the expected costs associated with generating your projected revenue, including direct costs such as materials, labour, and overheads, and indirect costs such as marketing, sales, and administrative expenses.
Once you have a clear outline of your expected costs, subtract these from the projected revenue to calculate the expected profit margin. This will give you an estimate of the net income that the business can expect to generate based on its revenue projections.
To ensure accuracy in your profit forecast, it's vital to regularly review and adjust your revenue and cost projections based on actual performance data. This will help you identify any discrepancies or inefficiencies and make informed decisions about how to optimise your business operations for maximum profitability.
1. The maximum payment period on purchases is 54 calendar days and 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. If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card.