Even when you are managing your small business successfully, wrangling with financial reports can be time-consuming. These seven steps can help remind you how to create a revenue forecast for your growing business.
Read on to find out what a revenue forecast is, how to forecast revenue growth, and why it’s important for your business's success and cash flow.
What Is Revenue Forecasting?
Revenue forecasting predicts your business's revenue over a certain time period, usually one year. The forecast uses data from present and past sales to make an educated prediction of future revenue.
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 by 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. For example, are there seasonal upticks, major public events, or 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.
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 labor.
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. Predict sales.
You can predict sales using a top-down analysis. This means using the total value of a market and then predicting how much of that market you expect your business to capture. It 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. 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.
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.
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.
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 (labor, 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.
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