When it comes to projecting sales, there are 3 highly effective ways to approach gathering and analyzing the relevant data needed to produce a comprehensive forecast. The first two, resource-based projecting and market-based projecting, take historical data into account. The third, analogous-based projecting, involves looking at comparable business models. As with most things, applying a combination of approaches to projecting revenue is recommended for “kicking the tires” over any one stand-alone approach and lends credibility to the final forecast.
This approach looks at your company’s history to forecast your sales. Many times, your historical data can be “noisy”, making it difficult to wrap your arms around the data. Focus on identifying and understanding the key drivers of that history to minimize or eliminate that “noise”.
Preparing a resource-based projection is about identifying the key resource factors that will produce or limit revenue for your business. These key factors include:
- Marketing factors that can generate sales
- Production and/or delivery factors that may limit sales
- Availability of working capital that could generate or limit sales
Financial forecasting using the resource-based projecting method will yield the volume of sales your organization can support. Small businesses tend to focus on a resource-based approach because the model considers the reality of the resource constraints typical in small businesses.
While the concept is simple, the implementation of a market-based projection is often difficult for small businesses. To make a market-based projection, you need to estimate the total market size, and then approximate the portion of total market that is addressable for your company – your company’s relevant market size. Within this relevant market, estimate the share of market that you will capture, and multiply the size of the relevant market by the estimated market share to get your sales projection. The market-based figure will yield the sales potential of the market. Large companies often focus on a market-based approach because they can afford the specialized research necessary for making good market share estimates. Also, unlike a small business, revenue for larger companies tends to be limited more by market potential than by the company’s available resources.
This approach to sales forecasting is often used by startup businesses and by existing business considering launching a new product or entering a new market. That’s because it involves comparing a specific business to an analogous business model. The most obvious advantage to this approach is that it allows you to go straight to the bottom line as the projection is applied directly to the total sales of the business. You’ll be able to see right away what the expected profits will be. In addition, modeling mistakes are minimized (regarding productivity rates, amounts of resources, market size and market share) because you know the answer from the beginning. This approach works particularly well for businesses in well-established markets such as retail shops, restaurants, and franchise operations.
Putting It All Together
In order to produce an effective budget with realistic sales forecasts, a combination of all three approaches will, in most cases, work best. Couple that will a few scenarios for best, worst and most likely outcomes, and you’ll have a road map for taking your business where you want it to go. And, even if your business has a finance staff in place, consider using a CFO for hire or virtual CFO for added finance help and to support you in the process. Our expert team at Barba CFO has extensive experience building sales forecasts and budgets and we are well-versed in leveraging technology to create a dynamic financial model to help your business set and achieve its goals. Call us or fill out our contact form to speak with us about how our CFO services can help your business.