Understanding The Basics of Revenue Forecasting for Your Business
Revenue forecasting is a calculated prediction about the future financial performance of a business, which also illustrates projected business growth. A business owner can complete a revenue forecast through quantitative analysis, a more qualitative approach such as intuition, or a combination of both.
A revenue forecast is a financial document that can help a company secure funding from lenders, investors and crowdfunders. A forecast is like running a course before the actual race — that is, a way to prepare for the actual run.
Why is revenue forecasting important?
There are many reasons as to why a business would need to see into the proverbial crystal ball of its financial future. Revenue forecasting helps business owners make important financial decisions, such as budgeting business expenses.
You’ll want to develop a revenue forecast on the tenet that the business will continue indefinitely, unless you, the business owner, plan to sell the business, in which case, it will have a limited life, said Carroll S. Little, DPA, CPA, CGFM, a professor of accounting at Howard University School of Business in Washington, D.C. The business plan should span a minimum of three to five years and address as many risks as the preparer can identify.
Revenue forecasting allows a business to:
- Budget: Identifying business costs in advance will allow you to plan for these expenses. A revenue forecast serves as a blueprint for your financial decisions and will help you stay on track.
- Secure funding: If you’re considering a business loan, certain documents will be required, such as financial projections, a business plan and expense sheet. These documents will help you determine how much to ask for and also allow a bank to assess your level of risk.
- Address cash flow problems: Forecasting will give you a better idea of your operating cycle so your business always has available cash flow. Projected revenues allow business owners to plan and make cash flow adjustments when necessary.
- Effectively manage the business: A sales forecast allows a business to make more informed management decisions. It will help you identify trends and key drivers of your business. When matched with your accounting details, it can allow for more precise numbers and predictions. You can compare a forecast line-by-line to get a more detailed analysis.
Methods of revenue forecasting
A business can approach revenue forecasting in two ways — with a qualitative or quantitative approach.
Qualitative forecasting relies on instinct and experience and is typically used when there’s not a lot of data available to analyze, just as with a new startup. Expert opinion, for example, falls under this category.
Market research and the Delphi method are just two ways to perform a qualitative forecast. Market research involves conducting research to learn more about an existing market.
You can conduct primary market research by gathering information from surveys, field tests and focus groups. You can do this yourself, or by working with a market research firm. Alternatively, you can conduct secondary market research by reviewing information that already exists such as demographic data, industry statistics and company records and books. This method takes less time and can also save money while still providing a lot of information.
The Delphi method involves taking the opinion of several experts and compiling them into one collective forecast. This method is worthwhile because it combines information from many experts; however, the process might be outside of the scope of small businesses.
Quantitative forecasting relies on numbers. It takes the human factor out of the equation and lets the numbers tell the story.
Looking for business funding? Learn more about small business loans here.
Revenue forecasting for a new business
If you are just starting a business, you won’t have a history of sales and expenses as a starting point for a revenue forecast. So how can you make a prediction without historical documentation? You can use primary and secondary sources.
Primary sources provide first-hand information such as interviews and surveys. Secondary sources provide information secondhand via writing (i.e. encyclopedias, reports, etc.).
“Talk to someone already in the business and see what they’ve done in the past relative to the operations of the business, and give particular attention to what they say about revenue, expenses and cash flow issues,” Little said.
You can also visit stores similar to yours and conduct your own research. “Identify three to four locations and visit them,” Little said. If someone wants to open a store that sells jewelry, identify three or four stores, visit them, look at the types of customers that go in, note how merchandise is displayed, how (and when) employees address customers, note the timing of sales, and astutely observe what your “competitor” does and does not do, he said.
You can gather secondary sources from reputable resources like the Bureau of Labor Statistics. The “Industries at a Glance” section can offer valuable information about workforce statistics, earnings, hours and prices. You can also get free small business information from Small Business Development Centers.
If you’re a new business, follow the below steps to build your first year’s cash flow projection:
- Identify the start-up costs of your business and the amount of financing you need. The cost of doing business will include both recurring and one-time expenses, such as inventory, rent, prepaid insurance, loan repayments and equipment.
- Determine what your projected sales will be. You’ll need to consider things like the current market and economy, demographics, seasonality and even credit versus cash sales.
- Contact suppliers to determine the cost of goods sold (COGS). You should know the cost you will pay for products or services, including the cost for start-up inventory.
- Calculate expenses using real data — don’t just make numbers up. This includes loan payments, capital purchases, income taxes and more.
- Assess your cash position from a monthly perspective. The figure should be positive each month — if it’s negative, you’ll need to make adjustments such as increasing your loan amount or speeding up your collections process.
See here for a free financial projection template developed by SCORE.
The bottom line
It’s important to be forward-thinking to be successful in business. By being proactive and forecasting future revenues and expenses, you can plan more effectively, predict issues before they arise and implement actions for a profitable business for years to come.