How to do Revenue Forecasting?
Revenue Forecasting vs. Sales Forecasting
Revenue forecasting is a critical part of any business plan and strategy. A solid forecast can help you take advantage of opportunities in your industry, make smart decisions about investments, and prepare for the future.
But how do you do it? What should be included in your forecast? And, overall, why is revenue forecasting important? We’ve put together this guide to help you answer those questions and start forecasting the right way. It includes best practices and revenue forecasting methods.
Revenue Forecasting Definition
Revenue forecasting is a process of estimating the future revenue of a company. It’s typically based on historical data, but can also be influenced by external factors like market conditions and economic trends. Revenue forecasting is also known as sales projection.
The goal of revenue forecasting methods is to provide businesses with a reliable estimation of the income they can expect to generate within a specific period.
By analyzing historical data, market trends, and relevant factors, revenue forecasting aims to offer actionable insights that enable informed decision-making, efficient resource allocation, and effective strategic planning. This empowers enterprises to proactively respond to changing market conditions, seize growth opportunities, and mitigate risks, ultimately fostering sustainable financial success.
Why Is Revenue Forecasting Important?
Revenue forecasting models can improve a company's decision-making abilities. By accurately forecasting how much revenue a business can expect, it can adjust its output, investments, and even marketing. Here’s how:
Cash Flow Management
Revenue forecasting is primarily undertaken to optimize the business's cash flow and credit management practices. It allows them to effectively monitor the cash flow of the business to ensure that payments are received and made per the schedule.
This will help avoid unintentional delays in clearing vendor invoices, improving the business's creditworthiness. Revenue forecasting additionally helps obtain the best terms from vendors.
Implementing accurate revenue forecast models is key in the planning process. Understanding the revenue available means management makes better decisions about what to do with it. From here, companies can adapt investment strategies and adjust focus.
By making forecasts based on valid statistical methods, you can show investors that the company is competent and confident in its predictions. Forecasting revenues demonstrates a long-term focus from a company, which increases your investment potential.
Revenue forecasting enables companies to determine expenses and allocate budgets for departmental activities. This means they can keep track of costs and determine a reference point to compare performance as they scale.
Revenue forecasting enables business leaders to make informed decisions about crucial activities including recruitment. Businesses can accurately predict how many new employees must be hired and how much they can be paid based on the business's financial outlook.
Preparing for Difficulty
Although unwanted drops in revenue are often unpredictable, there are many situations where you can forecast this based on current data and trends. If this is the case, the company can implement measures in advance to help it get through these periods. For example, if analysts forecast a drop in revenues, the company might implement new marketing and promotional practices to counteract this and attract new customers. It might order less stock from suppliers or slow down production to avoid an accumulation of unsold items.
How to do Revenue Forecasting?
To effectively conduct revenue forecasting, several key steps must be followed:
- Gather and analyze historical sales data, identifying patterns and trends over time.
- Factor in relevant market variables such as economic indicators, industry trends, and competitive landscape shifts.
- Collaborate with sales and marketing teams can provide valuable on-the-ground insights.
- Utilize advanced analytics tools, such as predictive modeling and machine learning algorithms to enhance the accuracy of projections.
- Consider any external factors that could impact revenue, such as regulatory changes, technological advancements, or shifts in consumer behavior.
- Develop multiple scenarios, including best-case, worst-case, and most likely outcomes.
- Regularly monitor and update your forecasts as new data becomes available. Continuous refinement of your forecasting approach based on real-time data and feedback will improve the accuracy of predictions over time.
- Communicate these forecasts to stakeholders within the organization to foster alignment and informed decision-making.
Revenue Forecasting Methods
There are many different types of revenue forecasting methods or revenue forecasting techniques. One common method/technique is bottom-up forecasting, where you estimate the sales of each product or service, and then add them all up to get an overall estimate. Another is the top-down forecasting model, which starts with the overall market demand and then breaks it down into individual product categories and subcategories.
Usually, most revenue teams create a customized revenue forecasting model based on the features of multiple models. This process helps the company get the most accurate data as per its requirements. Here’s more information about the three approaches:
Bottom-Up Forecasting Method
Resource-driven forecasting, also known as bottom-up forecasting, allows teams to schedule all their planned work and match resources to projects accordingly. Planned work includes both projects in the proposal phase and also projects currently underway.
From here, an organization can translate the scheduled work into accurate, time-phased revenue forecasts, providing insight into an organization’s capacity to successfully deliver the work within the estimated time of completion.
This transparency provides teams with a clear understanding of the project pipeline but also allows resource schedulers to mindfully balance resources across the organization’s project workload. Resource-driven forecasts should be monitored on an ongoing basis and adjusted accordingly to highlight capacity shortfalls and surpluses, call attention to projects that are both ahead and behind schedule, and incorporate new work that enters the sales pipeline.
Pipeline Revenue Forecasting Method
The pipeline revenue forecasting model involves tracking and measuring the organization’s future sales -- or their sales pipeline. The idea is that some percentage of the sales forecast will turn into real work. The tricky part with this approach is trying to take an educated guess about what the size of each deal will be, and what the “some percentage” of the pipeline is. Many organizations will use the percent likelihood of an opportunity, represented by the stage it is in, to factor in the total revenue forecast.
That being said, it is usually not until much later in the sales process that a reasonable estimation for size and duration is made. This limits how far into the future this type of forecast can reach.
Backlog Revenue Forecasting Method
Similar to the pipeline approach, using your backlog for financial forecasting involves looking at the total amount of revenue that your organization has contracted but has not yet earned. When using backlog as a revenue forecasting model, you don’t need to worry as much about factoring for uncertainty, but rather realistically distributing the revenue growth over time. This distribution can be done by calculating the typical run rate of your team for a given period and dividing that into the total revenue figure.
This calculation will represent how long it will take the organization, at its current size, to earn what is currently in the backlog. This approach works well when a high-level view of the growth rate is all that the organization requires. It also assumes the organization has a historical track record of delivering work very similar to what’s in the backlog. Quite often, professional services organizations will sync their backlog with their pipeline to build a more holistic, long-term revenue forecast.
Revenue Forecasting Through Historical Performance Method
For organizations that run a recurring revenue business model, such as managed service providers, this approach may work well. It involves assuming the organization will earn at least the same amount of revenue during this current period as it did during an equivalent period in the past. With historical performance as a baseline, current conditions are then analyzed to assess how they may affect that performance. Winning or losing a major client, introducing a new service line, or outside market factors are all examples of events that should be taken into account.
What is the Difference Between Revenue Forecasting and Sales Forecasting?
Revenue forecasting and sales forecasting are closely related concepts in the realm of business planning and financial management, but they focus on different aspects of a company's financial performance.
Revenue forecasting encompasses all the sources of income a company generates, including not only sales of products or services but also any other forms of revenue, such as interest income, licensing fees, subscription revenue, and more. It provides a comprehensive view of the company's overall financial health by considering all revenue streams. Revenue forecasting takes into account not only the direct impact of sales activities but also the broader financial landscape and various income sources.
Sales forecasting, on the other hand, is a subset of revenue forecasting that specifically focuses on predicting the volume and value of sales a company will make over a defined period. It is typically concerned with the quantities of products or services that will be sold, their pricing and the associated revenue. Sales forecasting involves analyzing historical sales data, market trends, customer behavior, and other relevant factors to estimate future sales performance accurately.
Revenue forecasting best practices by o9 Solutions
Effective revenue forecasting is a cornerstone of successful business planning and decision-making. By employing best practices in revenue forecasting, organizations can gain valuable insights into future financial performance, allocate resources strategically, and navigate potential challenges with confidence.
In this context, implementing a well-structured and comprehensive approach to revenue forecasting becomes not only a means to anticipate financial outcomes, but also a powerful tool for shaping a resilient and proactive business strategy.
The Forrester Wave™ for Collaborative Supply Networks 2022
o9 received the highest possible scores in ten criteria across the Strategy and Current Offering categories.
About the author
o9 SolutionsThe Digital Brain Platform
o9 Solutions is a leading AI-powered platform for integrated business planning and decision-making for the enterprise. Whether it is driving demand, aligning demand and supply, or optimizing commercial initiatives, any planning process can be made faster and smarter with o9’s AI-powered digital solutions. o9 brings together technology innovations—such as graph-based enterprise modeling, big data analytics, advanced algorithms for scenario planning, collaborative portals, easy-to-use interfaces and cloud-based delivery—into one platform.