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Salt Lake City Bookkeeping Blog

What Every Business Owner Should Know About Forecasting Revenue

Posted by Leanne Armstrong on Aug 22, 2018 9:00:00 AM

What Every Business Owner Should Know About Forecasting RevenueEvery business owner needs a budget to help keep their spending on track. Forecasting revenue is the ideal way to get an educated estimate of how much money your company is likely to earn, versus how much you can reasonably expect to spend over the coming year.

Most companies create revenue forecasts on an annual basis to help with critical decisions like:

  • how much they should invest in various marketing pursuits,
  • how many employees they can afford to hire,
  • whether or not they can handle the payments on a new business loan, and
  • how to manage costs during anticipated slow periods

But if money is tight or you’re not yet established, don’t be afraid to review and update this living document monthly.

Remember, while preparing regular, realistic revenue forecasts may take a bite out of your already limited time, the pay-off includes better informed business decisions and a significantly healthier cash flow. 

Forecasting Expenses

The best place to start when creating a revenue forecast is with your overhead costs. Expenses are typically much easier to forecast than business income or sales, especially when they involve items that remain relatively fixed.

Your fixed expenses may include:

  • Rent or Lease payments
  • Utility, Phone, and Internet bills
  • Wages or Salaries
  • Professional Fees associated with Accounting, Legal Assistance, Insurance, and Licensing

But whether you’re calculating fixed or variable costs (think customer service, direct sales expenses, or cost of goods sold), bear in mind that it’s better to overestimate than to fall short in your projections. Marketing, advertising, and legal expenditures are just a few of the areas that commonly escalate beyond expectations.  

If you’re currently a one-man or one-woman show, you should also make a point of tracking the time you invest in customer service and direct sales activities. This will improve your forecasting abilities down the road when your client base increases, you take on more staff, and these activities translate into a direct labor expense.

Forecasting Revenue

Although forecasting a company’s annual revenue can be challenging - and mostly involves a best guess scenario - there are a few elements that will help make your forecast as useful as possible:

  • Always start with last year’s income statements as the foundation for this year’s predictions
  • Examine your various revenue streams individually to better account for the factors most likely to affect them
  • Supplement the data in your financial statements with information about changes to your company’s pricing, products, personnel, or competitors
  • Make it a habit to produce both a best-case and worst-case revenue forecast

There’s nothing wrong with dreaming big. In fact, most businesses experience better growth when owners allow a certain amount of optimism and inspiration to carry them forward.

But it’s important to recognize that there are many biases – both conscious and unconscious – built into forecasting. By creating projections at both the conservative and the aggressive ends of the revenue spectrum, you’ll be better equipped to balance unexpected realities with entrepreneurial enthusiasm.

Reconciling Expense and Revenue Projections

One effective method for managing the delicate equilibrium between best-case and worst-case thinking is to reconcile your expense and revenue projections. There are a number of financial ratios that can help evaluate the validity of your forecasts, including calculations that determine gross and profit margins.

One of the biggest mistakes you can make in forecasting is to assume that your expenses can simply be adjusted to make up for missed revenue targets. Unfortunately, it’s not always as easy to cut costs as many business owners think. So to ensure your projections are sound, pay close attention to:

  • The forecasted relationship between your total direct costs and total revenue, especially if your income expectations are overly optimistic. Customer service and direct sales expenses for example, are far more likely to increase over time than to decrease.
  • The forecasted relationship between your total direct costs plus fixed expenses and total revenue. While it’s true that the higher your revenue, the smaller the role overhead typically plays in your total costs, the resulting profit margin will inevitably take time to manifest.

A lot of entrepreneurs avoid growth projections because they’re too busy to address them, are uncomfortable working with numbers, or believe that the value of forecasting revenue is limited when their venture is growing by leaps and bounds.

The reality is that runaway growth can be just as dangerous as no growth at all if you don’t keep a firm hand on costs - and a lack of knowledge about company finances has brought many a business to ruin. Working with a seasoned mentor or accounting professional with experience in your industry is one of the best ways to make sure your dreams keep pace with your revenue.

Topics: Financial Forecasting, cash flow forecasting, Business Budgeting, Growth Coach