What is revenue forecasting?
Revenue forecasting is a manner of estimating how much (in monetary terms) can be expected to be generated through sales. The field is associated with the act of making predictions on future revenue. This can be helpful for different purposes, including guiding corporate strategy and decision-making, managing risk, setting goals, making deployments for new business areas and so on.
Why is it valuable?
Forecasting revenues is valuable because it allows you to have an idea of how your business will be performing in the future. It helps you find out how much money will be available to invest in your company’s departments, infrastructure or other resources. It is useful in the planning stage of expansion, to decide whether you should work on a new product or wait for the existing ones to reach their peak. It provides valuable insight into the risk that your company is taking in generating revenue. And lastly, forecasting can help you ensure that all your costs are controlled and that they do not exceed the amount that you will be earning from sales.
How is it done?
Revenue forecasting is a combination of information gathering and analysis, data interpretation and financial estimation. It requires knowledge of different methods used in estimating future revenues, which will be discussed further below. The process for doing this is called revenue forecasting method selection.
Revenue forecasting methods
There are many different ways to get an idea of what the revenue might be in the future, but these are just some of the most popular methods. The types of methods vary depending on your company’s needs. Some companies prefer to estimate based on current accounting records, while others base their estimates on history, customer purchasing habits and market dynamics. But whichever method you choose to use, it is always important to recognize that all of them have pros and cons.
Forecast source selection – This is one of the most common methods used in forecasting sales revenues. With this method, data on sales are combined with historical data related to expenses and pricing variables. Then all of these data points are used to predict the revenue that will be made in the future. One major problem with this option is that it does not consider customer growth and pricing capabilities. Most companies, however, try to balance between these two factors in their forecasts.
Actual revenue data – This is a more accurate way to predict revenues because it becomes more representative of management’s actual expectations regarding the growth (or lack thereof). However, this method requires significant data collection efforts and can be time-consuming to develop. Historical data – Using historical data provides an approximate estimate of the possible future revenues for your business. However, it also requires significant amounts of time for research and analysis before you can make an accurate estimate.
Models – Using some sort of forecasting model, such as that created by the program, PERT (Program Evaluation and Review Technique) can help to minimize bias and provide you with more accurate estimates regarding the future. Some of these models are based on demographics, market research and/or on historical data. However, they do not always take into consideration growth or the effect of new product launches.
Customer behavior – Because your customers are likely to change their spending habits over time, it would be best to collect information on how many potential customers there are in your target market (and their purchasing habits) before estimating future revenue. This is because if you use information that is not representative of current trends then you could be generating inaccurate estimates. While this method is not as accurate as models, it does provide you with a baseline to compare your estimates against. Inputs and outputs – This method considers the effect that changes in each variable (input, such as volume of orders) has on the price and quantity you need to produce in order to meet the demand. It is generally conservative because it assumes that all the variables would remain constant. Some companies like to use input and output methods when estimating their revenue. However, other organizations feel that these methods don’t take into consideration growth and new product releases.
Revenue Forecasting Methodology
Revenue information gathering: determining what data should be collected, how much of it should be collected and where it should be collected from.
Analyzing the data: the purpose of this step is to make sure that what you have gathered has been as accurate as possible. It is during this stage that you should determine how much data is required and for what time period.
Financial estimation: it varies from company to company and depending on their financial model, but financial estimates take into consideration all of the information that was obtained during the analysis and financial calculations take into consideration costs. After all, revenue predictions can only be made if your company’s expenses match up with the amount of money you will be making through sales.
Let’s look at how one business turns information gathered throughout the year into a forecast for next year.
Revenue information gathering: the customer service department collects data on its sales for the past year and also any other data that might be helpful in calculating next year’s sales.
Financial estimation: management decides that they want their business to forecast a 15% increase in revenue from last year. This is based on external company information, such as a new product that a competitor has launched or positive market forecasts. Then they take into account the internal factors, such as past performance of their existing products and expected prices. They assess which products need to be improved and forecast accordingly.
Analyzing the data: they look at current data from individual customers who have placed orders through customer service. They then use this data to calculate what they think their sales will be for next year.
The forecast: based on the current data from the previous year and by taking into account any additional data they have collected, management generates a forecast of how sales will be in the upcoming year. In the end, they generate a revenue forecast for next year.
Advantages and Disadvantages
As we have said before, there are both advantages and disadvantages of using revenue forecasting methods. Let’s take a look at some of them:
It gives you a quick idea of what you expect your future revenues to be. It provides a more accurate estimate of your revenue compared to just looking at your historical data. It doesn’t take into account changes in the economy, competition or the customers’ buying habits. It can provide you with a general idea of what your business looks like, which is helpful in determining how much money you need to generate for the year. Customers may find it difficult or impossible to predict their spending habits. You might need to modify the way you do business so that you are better prepared for future sales increases. It can be difficult to adjust for changes in the economy, competition or the customers’ spending habits. You might need to update your forecast frequently due to external factors. It can be difficult to make changes in your business strategy based on information gathered during the year.
The purposes of revenue forecasting are different for each company, but one thing is certain: if you don’t have a clear idea of how much money you expect to bring in next year, then it’s likely that you won’t have a very good idea of what you’re going to do with your profits. It’s important that you keep budgeting for future growth and additional expenses so that you are able to predict future sales accurately. The above is just a brief overview, as it’s never as simple as deciding what you want to forecast and writing down those numbers. There are a lot of factors to take into account and if you don’t consider all of them, then your business could suffer. Business managers that are looking to make proper Budgets for their organizations in order to generate usable revenue forecasts can look to Fintalent, the collaborative platform for tier-1 Strategy and M&A professionals, to hire all of their expert budget analysts that can handle all of their Planning, Forecasting and Budgeting needs.