If you don’t know where you’re going, you’ll end up somewhere else. As best it can, I think this describes why you should forecast.
Forecasting is the process of predicting the future based on past and present data and analysis of trends. The purpose of forecasting is to establish benchmarks and some certainty around financials as a business faces its future and the decisions it needs to make to survive and prosper.
Revenue forecasting is primarily concerned with volume of product sold and (therefore) the amount of revenue generated.
In a corporation, product managers normally forecast revenue.
It is important to forecast for the following reasons:
- It establishes goals and sales targets.
- It forces you to know your numbers – the numbers that are the proof of your performance.
- It focuses the business on the future by learning from its past.
- It enables you to plan around peaks and troughs in staff and inventory requirements.
- If you are publicly listed, your organisation needs forecasts for shareholders, investors and financiers.
- It highlights where different products are in the product life cycle.
- Accurate forecasts improve future business planning and decision making.
- Be as accurate as you can, even if the news isn’t good. I’ve written down forecasts by 10% in the past because it accurately reflected expected performance due to price erosion. (And, by the way, I was right.)
- Once you’ve been around the numbers awhile, you’ll get an intuitive feel for them and what’s happening. Go with your instincts. 99% of the time, your instincts will be right.
- If your actual performance is less than you forecast, you must be able to articulate why it happened. If you can’t explain it, you cannot learn from it.
- If you fail to reach forecast, you should have a plan for what you can do to close the gap between forecasted and actual performance.
- It’s very common in large corporations for someone else to add a “stretch” to your forecasts. You may or may not have any control or influence over it.
- If you have multiple product lines, forecast each product line.
- Forecasting a service business is no different than forecasting products. Most services break down into units.
- In B2B, make sure you adjust your forecasts to reflect weekends and public holidays. When business is shut, volume sold (and therefore revenue) will almost certainly decline and should be accounted for in forecasts. Same is true for Christmas holiday periods, when most businesses shut or run on skeleton staff.
- Seasonal businesses will experience peaks and troughs in sales and demand for product. For example, if you sell Halloween decorations, you will likely be busy September to October inclusive. A forecast showing high sales of Halloween decorations in January, for example, will not be believable.
- Always include assumptions. Someone else should be able to pick up your forecasts, read them and understand exactly how you arrived at your forecast numbers just by reading your assumptions. Assumptions therefore should be very detailed. As painful as it might be at the time, adding detailed assumptions can turn into a lifesaver later on.
How To Forecast
If you’re a brand new business with no trading history, it’s very hard to accurately forecast volume sold and therefore revenue. So, in the case of new businesses, keep your forecasts conservative. Under-forecast if need be. Almost no business launches and, within the first few days, goes crazy with sales. It takes time to build up sales, to get known as a supplier or, if you’re online, to attract website visitors. New businesses should make sure they keep detailed records of actual sales over the first 12 months. This will give them a basis for forecasting their year 2 of trading.
I believe in creating baseline forecasts. In other words, develop forecasts that take past performance and extrapolate it into the future – a do-nothing, status quo forecast. This do-nothing, status quo forecast should account for expected price erosion or decline in sales (or the opposite if you’re in a period of growth) and it should be adjusted for seasonal factors, working days and any other known factors that affect performance.
In addition to baseline, other factors will come into play. You might have a “stretch” added on by someone in corporate finance. Marketing might add campaign activity that they forecast will greatly improve sales over the defined period. These should be forecast separately to your baseline forecasts.
To illustrate, see the fictitious graph below. The baseline, status quo position is shown in blue. Campaign activity is forecast separately.
From your point of view, this achieves three important time-saving, stress-relievers:
- You can separate “stretch” from your actual forecasts as a way of checking the accuracy of your forecasting.
- If campaign activity does not go ahead, it’s very easy to delete it from your forecast. And,
- It’s easier to separate any additional revenue due to campaign activity from the baseline forecasts, offering you a method of measuring the success of campaign activity.
Once you merge all your forecasts together into aggregate numbers that are hard to separate, you lose the ability to quickly and easily isolate factors that drive or hinder performance. You’ll regret not have the granularity around your numbers.
EXAMPLE: FORECASTING BASELINE PLUS CAMPAIGN ACTIVITY.
Forecasting a service business is no different than forecasting products. Most services will break down into units – such as consulting hours (for professional services), number of rides (if you are a taxi company), number of meals (if you are a restaurant) and so on.
(You will need to calculate your average revenue from the sale of a meal or a taxi ride so that you can calculate the financial component of your forecast. This too will be guesswork so include your assumptions with it.)
Here are some fictitious examples of a revenue forecast. You can easily create them in a spreadsheet program such as Excel.
TABLE 1: PHYSICAL FORECAST (UNITS SOLD BY MONTH)
TABLE 2: FINANCIAL FORECAST (REVENUE EARNED BY MONTH)
The above numbers may be dependant upon:
- The unit price remaining the same throughout the period forecasted (and not being forced downwards due to competitive pressure).
- The promotion to generate the number of sales is launched as planned in January and generates the intended sales results.
- The distribution channels all meet their individual sales targets.
- No slump in June due to end of financial year in Australia.
READ: More about Business Planning