In Part I of this two-part series, we are explaining the basics of revenue forecasting. This will include understanding what revenue forecasting is and learning how to do it effectively. Forecasting revenue can be challenging as your business grows but it’s important to actively participate as an owner. Partner, Katina Peters, touches on the key elements that significantly contribute to and impact how to forecast your revenue.
What we cover in this episode:
- 02:45 – Historical Data
- 05:21 – Market Analysis
- 07:31 – Sales Pipeline
- 10:11 – Understanding Revenue Drivers
- 12:21 – Customer Behavior
- 15:20 – Pricing Strategy
- 17:24 – New Product/Service Launches
- 20:40 – External Factors
- 22:22 – Assumptions and Sensitivity Analysis
- 26:35 – Feedback and Adjustments
A key element and one of the best metrics to assist in revenue forecasting and helping with budgeting, is historical data. Utilizing this will give you an idea of what has happened and what you could reasonably expect in the future.
Looking into past trends, seasons and patterns month over month can help predict what various data points as you plan ahead. For example, knowing that winter is slower than summer is critical in predicting cash flow, revenue, etc.
When you are in the initial stages of learning how to forecast revenue, market analysis is a great place to start. It is important to focus not only on a national level for your industry, but a local level. Consider the economy, trends, sources, and how they will affect you.
Revenue forecasting relies heavily on the market. Predicting good months and tight months can allow you to create two budgets. The first budget is the goal budget if everything goes according to plan. The second, more conservative, budget is for emergencies or unexpected costs when your income decreases or you have unexpected expenses.
Sometimes you may not prioritize your sales pipeline, but it is still crucial for revenue forecasting, just like everything else. The most effective way to understand your sales pipeline’s impact on your cash flow and revenue is by using reverse engineering.
First, find your goal amount of revenue. For example, if your revenue goal is $100,000/year, how will you accomplish this? How many new clients will you need to reach that goal?
To get those new clients, do you need to increase the amount of leads? Consider your conversion rate and back that up into the number of leads you need. Once you know how many leads you need, you can devise a plan.
Understanding Revenue Drivers
One of the most important elements when figuring out how to forecast your revenue, are the revenue drivers themselves. It works the same way as the reverse engineering to figure out how many leads you will need to meet your goal. What are you revenue drivers? Do you utilize X number of hours, tiered pricing, contracted hours, X number of jobs?
If your goal is $100,000 and you make $100 from each customer, you would need 1,000 customers. Working from the back end to the front can simplify your goal; there is no need to be overly complicated when building your strategic plan on how to budget. If you work towards using your revenue drivers to forecast, you will get more accurate revenue forecasting.
Obtaining and retaining customers is how businesses generate revenue. Understanding your revenue drivers and how to forecast revenue would not matter if you had no customers to generate revenue from. Remember to keep a close eye on your customer base.
Customer behavior is more so the psychology behind why your customers do what they do. Why they stay, leave, or come in the first place. The reasons are what is important to your company. If you are acknowledging your customers and retrieving the information you need from them, then you would know these answers.
For example, if your customers come to you and stay with you because of a certain system you use, but that system is pricey, you are going to want to budget for this system or you may lose all of your customers. Knowing your customer behaviors are a key element in budgeting and revenue forecasting.
You probably know what factors contribute to your pricing when you started your business. These factors drive the revenue. Making sure you have a consistent set pricing strategy that has evolved with your business will make your revenue forecasting close to accurate.
What approach do you use? How is the pricing done? How are you differentiating your pricing to stand out against competitors? What is the economic pricing strategy in your industry? These are all important to know.
New Product/Service Launches
If you are looking to launch a new product or service for your business keep in mind they may fall under the same model you have but require different strategies in all departments. Think about what the “ramp up” time to launch these new products/services will be. Compare that to what can actually be invested as far as time and money.
The goal you have for this launch needs resources and you must figure out if these resources are realistic with your revenue. How long will it take for this new launch to contribute to adding to your revenue? Will it be fast or take some time? Do you have the resources that you need for a slower ramp up?
External factors will affect all the other key elements. Although there are some external factors that you may never see coming, keeping up with the market and reviewing your historical data can help plan for trends or seasonal happenings.
Certain external factors are regulatory changes to your industry, technological advances just as AI, and certain industry disruptions. Noting all of these factors when you are revenue forecasting will help you with current budgets and future planning.
Assumptions and Sensitivity Analysis
Noting your assumptions is extremely important. You may sit down weeks or even months after you decide on something, until you finally implement it. At this point, you may have forgotten why you decided to price your product or service a certain way or why you set your revenue goal at a certain amount.
When you sit down to start your thinking process for your revenue forecasting, document your assumptions and considerations so you can reference back to them. This will help you avoid having to redo your planning and instead be able to fine tune it.
Your sensitivity analysis is just as it sounds, how sensitive is the revenue forecasting analysis you have. How volatile is it and can it be adjusted? Can you shift pricing or strategy to accommodate?
Feedback and Adjustments
Feedback is an ongoing process, a feedback loop. Monitoring and checking in on your team and your clients and then making the necessary adjustments to keep your business running smoothly and moving forward to revenue growth. Make sure to ask for the feedback since it can help yourself and your business improve and know what to budget for in your revenue forecasting.
Focusing first on what elements you need to put together and start your revenue forecasting is what this one episode is about. Gathering the correct information, and knowing where to get it from is the first crucial step in a successful implementation of revenue forecasting.