Amidst today’s innovative and competitive business landscape, decision-makers need to have a clear picture of where their business is headed. Revenue forecast, being a key driver of financial management, plays a vital role. Analyzing, planning and taking data-backed steps toward growth is now more important than ever. If you run a small business or an early-stage startup - it can feel like a complicated process. But fret not, in this blog we will have a comprehensive discussion on how to forecast revenue and growth for small businesses.
A large number of businesses do not consider revenue forecasting a valuable practice. What might be the reason? Over 80% of sales teams do not have a forecast accuracy of greater than 75%. Inefficiency due to an unorganized approach leads to businesses downplaying forecasts.
Whether it is about projecting the trajectory of your business to external investors or preparing growth strategies that align with the future scale of your business, forecasting revenue is the primary exercise.
So how do you figure out the numbers and sketch the curve? How to get started with forecasting your revenue and growth for small businesses? What should be your approach while developing a forecast? We answer all of these and more, let’s dive in straight.
First of all, there’s a day and night difference between forecast and prediction. While both of them are estimations of future events – forecasting can be executed by integrating and shaping forward data associated with the past in a pre-planned manner. Prediction, on the other hand, is an estimate of future events backed by opinions and experiences.
A revenue forecast is an estimate of the anticipated revenue of a business entity over a period of time - usually analyzed for a quarter or a fiscal year. Basically, the capital that your business will generate in the upcoming few months and years is the revenue forecast for your business. The calculation is done on the basis of certain aspects and related data points. For example - the previous year’s financial performance, current market scenario, sales in the pipeline and ongoing trends.
If you figure out with sufficient accuracy - how much money your company will bring in during the next quarters, it will be easier to make better decisions on the following:
- The business expenses you can cover
- The investments you can make back to your business
- How you can move the needle with your pricing
- The marketing budget for best results
- People you can hire
- Growth objectives that you can target
Before we dive into how to forecast revenue and growth for small businesses, you need to analyze the various methods of revenue forecasting.
Similar to numerous other business processes, there’s no one-size-fits-all approach to revenue forecasting. Subsequently, two methods of revenue forecasting can be utilized by businesses. There aren’t any regulations on which one to choose either, for the best results - a business should carry out both procedures.
- Quantitative or Analytical Forecasting
A data-centred revenue forecasting method that analyzes numerous facts and statistics, and is driven by objective information. It can be your last quarter’s revenue performance, growth rate, profit margins, existing sales pipeline, market situations, upward or downward trends and a number of relevant projections – that contribute to quantitative forecasting.
- Judgement Forecasting
We talked about the data-backed forecasting method. What if you are a completely new startup and have no data whatsoever that can be utilized to create projections? Forecasting gets a bit more subjective in that case. Judgement forecasting revolves around estimating growth based upon experience and intuition. It can be your knowledge or your entire team’s experience that can be taken into account for revenue forecasting. Lack of experience in the relevant space would make it difficult for you to process judgement forecasting for obvious reasons.
Now that you are well aware of revenue forecast, its applications and the advantages it brings, let’s move on to the elephant in the room – how to forecast revenue. If you run a small business or a new startup, here is a step-by-step approach for forecasting your business revenue.
- Specify a Timeline
Revenue is forecasted for a predetermined time period. Usually, businesses consider year-on-year (YoY) revenue, forecasting for 3 years can be a good strategy too. With the ever-increasing competition, startups are trying to set revenue goals for every quarter of a year and hence, forecasting with respect to quarters. It should be kept in mind that the timeline should be realistic, and the bigger the timeline you consider - your chances of being accurate further decrease.
- List the Factors Triggering Your Growth
If your business is deeply related to known external factors that force growth every once in a while, then you should consider those while forecasting your revenue and growth. Analyze what could boost or slow down your sales in the forecast timeline that you have chosen.
For example - An online travel booking company’s revenue could well be driven by public holidays. So, during the Christmas vacations at the end of every year, the sales and revenue would probably increase significantly.
Additionally, think of your upcoming business plans. Do you have any product, campaign or update launches coming up soon? Are you working on pivoting to a new trending technology that will enhance your platform’s efficiency and serve more amazing features?
Answering all of these questions would give you a good idea for estimating the shift in business revenue.
- Determine Your Expenses
Your current and future expenses play a major role in forecasting the revenue and growth of your small business. Analyze both fixed and variable costs adding up to your expenses:
- Fixed costs: Property rent, payroll, internet bills, electricity bills, accounting, bookkeeping, insurance, marketing, legal fees and more fixed expenses.
- Variable costs: Inventory, labour costs, vendor services, packaging, maintenance, furniture, repairs, vehicle fuel and others.
Additionally, when your business is in its early stage of operations, expenses should be overestimated as compared to an established company. Why?
- You will have more advertising costs for bringing the initial traction
- Outsourcing certain services would be a necessity and might cost you much more than when you hire full-time employees
- Insurance and legal costs are heavy one-time expenses with yearly premiums thereafter
- Your office premises would always have something missing
- Estimate Your Sales
There are two approaches to predicting your sales:
Top-down approach: A more aspirational method of estimating sales, but most startups use this to predict their revenues, especially while raising money. The top-down strategy involves calculating the estimated sales based on the total market value of your exact industry, and analyzing what share of the total market are you going to cover. This approach doesn’t usually give accurate results.
Bottom-up approach: This is a more realistic way of forecasting sales. You basically consider your average ticket size and calculate the estimated sales by multiplying by the number of paid signups you expect over the duration of the forecast. This approach is particularly suitable for subscription-based and service-based businesses. For example - A marketing SaaS tool forecasting revenue by estimating the number of monthly paid subscriptions it sells over a year.
- Forecast Your Net Revenue using Estimated Expenses and Sales
Net revenue gives a clearer picture of a business’s growth trajectory. Now that you have the calculations of estimated expenses and sales ready, combine them to figure out the projected net revenue for the forecast timeline.
While starting out, you don’t need to complicate things and can just use an Excel spreadsheet for putting up your periodic sales estimations and expenses and calculating the net revenue. Ensure incorporating your future plans and external factors, and their impact on upcoming sales as well as expenses.
- Verify Your Forecast using Relevant Financial Ratios
You have made a revenue forecast for your business. How to find out if it is even realistic? There are some financial ratios that you can measure and compare for checking the accuracy of your forecast.
- Gross Margin
The ratio of direct costs to total revenue is the gross margin. For example - a production-based company would need the following approach to calculate gross margin:
Gross margin = (Total Revenue - Cost of goods sold)/Total Revenue
There’s a direct correlation between gross margin and your cash flow. The higher your gross margin, the better will be the cash flow for your business. As a consequence, you can invest more into your business and grow it beyond limits.
- Net Profit Margin
Net profit is nothing but the profit remaining after deducting all the business expenses from your revenue. Here’s how to calculate net profit margin:
Net Profit Margin = Net Profit/ Total Revenue x 100
Forecasting your small business revenue and growth is critical in forming strategies and actually meeting your business goals. As a small business, you already have more than enough on your plate to strategize and execute in a limited time. Amidst all the hustle, manually managing the bookkeeping and accounting can be immensely hectic. Fincent helps you automate your bookkeeping with a cloud-based automation platform so that you can track your business revenue, expenses and cash flow accurately. Additionally, forecasting revenue and growth becomes a task of minutes rather than hours or even days.