Knowing how much revenue, is coming into your business is a fundamental part of any company’s financial management. But how do you go about setting up a revenue forecast to predict that future path of your income? And what benefits does a drilled-down revenue forecast have for your owner-managed business?
Nicola Pearson explains the importance of understanding your business model, researching the market and building up the data you need to produce a meaningful forecast.
What is a revenue forecast, and why is it so important for a small business?
A revenue forecast, in the simplest terms, is a prediction of what your sales income will be in the future. In most cases, this forecast will look ahead for the next 12 months – anything beyond that is quite difficult to predict and liable to be prone to inaccuracies.
Your revenue forecast then forms part of a bigger cashflow plan, allowing you to get a good handle on the current and future financial health of the business. Costs and expenses are much easier to forecast because they are a known quantity. But with revenue it’s much more difficult to predict, especially if you’re a startup with no data to base your forecast on.
There’s no exact science to running a forecast, but you do need to be as methodical as possible. A revenue forecast is one area that will be picked apart by any potential investors or lenders. You need to have done your homework and make sure the forecast is watertight with evidence to back it up. You could use industry benchmarks or try breaking down the market in some way to give a more granular view of predicted sales and revenue.
Should your forecast look at multiple scenarios?
Given the inherent difficulty of predicting the future it can make sense to run multiple forecasts for different scenarios. This way you have all bases covered.
- Be ambitious – one forecast can be truly ambitious, looking at the best-case scenario and setting some aspirational targets for sales, revenue and income.
- Be realistic – the next forecast can be more down-to-earth and based in reality, with highly attainable targets that you can be confident of hitting.
- Be prepared – the final forecast can be a worst-case scenario; something you want to avoid but can plan for if things start to go downhill.
Having these different scenarios gives you a framework to work within. Your costs are likely to be reasonably predictable, so you can confidently forecast how much cash must come in for the business to break even.
For new businesses, it might be unrealistic to cover these costs purely with sales revenue, so you may need to factor in extra working capital and access to funding to cover the expenses.
How easy is it to produce a revenue forecast?
Creating your first forecast is much harder for startups, mainly because you don’t have much data to hand. An established business should have access to a much larger pool of data.
To create the forecast, you will need to think about:
- Detailed research – if you’re a new startup, you need to do more research, find out the industry averages when it comes to sales and look at the value of the marketplace. It depends greatly on what products or services you’re selling too.
- Your sales potential – you need to think about the constraints on your output and capacity. You might be limited on your sales potential, based on what you can output. If the business is just you, as the owner, providing a service, there’s a limit to the number of hours you have available – unless you bring in other people to replicate what you do.
- Pricing limitations – there will be a limit on what people will pay for your product or service in the current market, unless you can prove your service is better than the competition. An established brand, like Dyson, can sell a £400 hair dryer. People will buy at that price point because Dyson has built up that brand and can charge a premium price. If you’re new to the market, you may have to pitch your pricing lower.
- Your pricing and value – it’s vital that you know your value proposition and how this links to your price point. Are you aiming to be a value product selling high volumes at a lower price, or a premium product selling fewer units at a much higher price? This will all feed back into your revenue forecast.
Once you have a forecast, how can this be put to practical use?
You definitely need to keep going back to the forecast once it’s been run. Remember, this is not a rigid plan. The chances are that the reality of your future path is not going to go exactly as your forecast predicted. Because of this, you need to keep reviewing the forecast and updating it with your latest knowledge and data.
The Covid pandemic has been a great example of this. No-one doing a revenue forecast in 2019 would have predicted how 2020 would actually pan out. For some businesses, revenues just fell off a cliff. If you were a restaurant, you would never have predicted having zero revenue at all for months on end. Other businesses, like online supermarkets, would never have predicted the extra sales.
If you’re running a restaurant business, you might predict a good summer now that restrictions are likely to be lifted in June 2021. But your sales will be dependent on customer attitudes, weather, restrictions, borders being open and import/export channels being there for the food.
Factoring all these elements into your revenue forecast is vital, if you’re going to run different scenarios and plan for each outcome.
Getting your forecasting up and running
In the current climate, businesses are starting to see the value of forecasting, especially as we feel the impacts of Covid, Brexit and the economic downturn. Having a forecast at the start of the year is a good idea, so you can track your progress and inform those big business decisions. Now is the perfect time to kickstart your forecasting process
You need to:
- Research your market and do the homework
- Try and find examples within the industry to sense-check your forecasts
- Think about your different product lines and growth percentages and break things down to a granular level – it won’t be the same for all products.
- Think about seasonality/drops in sales and build that into your model
- When preparing the forecast, think about the data you don’t have which would have been useful and start to collect that ASAP. The more data you have, the more accurate your forecast will be.
If you want to get in complete control of your revenue forecasting come and talk to us.
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