What is revenue forecasting?
Revenue forecasting is essentially creating an estimation of a company's profits and growth based on the information on the business you already have, as well as the historical data.
In other words, revenue forecasting allows you to predict critical financial metrics, such as margin, profitability, spendings, and more. It can also act as a base for sales forecasts.
Why is revenue forecasting important?
Alright, the definition of revenue forecasting was fairly simple - but why do we want to discuss it in the first place?
The answer to this question should be of particular interest for financial managers. Naturally, revenue forecasts, sales forecasts and growth rates are of great interest today. But why should they pay particular attention to revenue forecasting?
That’s because they can use it to:
- monitor the overall performance of the business and its scalability,
- predict the future expansion of the company,
- make decisions based on data-based estimations, not just wild guesses,
- optimize the profits in future periods,
- set realistic goals for teams, projects and departments,
- plan how to expand and invest in the business in new markets.
All of the points above provide the company with a significant competitive advantage - the one you can use to impress your customers even more. Apart from that, such in-depth analysis can also improve growth rate and future revenue - a great news for any sales team!
How to do revenue forecasting?
Revenue forecasting brings about numerous benefits. However, to enjoy them, you need to complete the forecasting process for a given time period. Let’s see what’s hidden in it for a typical service company.
1. Choose the right tool for the job.
You have to start with basics - and you don’t want to start an endless Excel sheet with revenue forecast you cannot really understand. That’s why you need a project accounting tool to help you.
Keep in mind that not all project portfolio management tools include finances in their scope of features. In fact, many of them focus only on resource management or time tracking. However, a typical project-focus business needs more to create an accurate resource forecast and make forecasted revenue as accurate as possible.
How to choose the tool for revenue projections?
To ensure the accuracy of the estimates and revenue projections, your tool needs to have:
- built-in project budgeting module, with predicted and real costs and incomes,
- extensive module for employee’s wages, with various types of contracts (i.e. regular employee, contractor, etc.),
- different types of billing methods for projects (i.e. time and material projects, fixed price projects, maintenance projects),
- comprehensive accounting module with settlements,
- various project reports for finances, as well as finances combined with tracked hours and progress.
Only these features combined can provide you with all the details you need to create an accurate revenue forecast, sales forecast or revenue growth prediction.
If you are interested in finding all of these features right away, look no further and start a trial with Primetric.
2. Add all the projects to the equation.
A typical service company has numerous endeavors it has to consider while budgeting. Now it’s the time to use them to forecast revenue, too.
What information should be included in estimates?
At this stage of the revenue forecasting process, you need to gather the information on all the sources of incomes and costs in the company. That includes:
- billable and non-billable projects,
- costs of different types of employment,
- company overheads (i.e. costs of recruitment, equipment, technologies, offices, etc.),
- the costs of support departments,
- planned purchases and investments,
- total revenue from previous time period.
If you had done a good job in the previous step, your project expense tracker should have a feature that allows you to specify all the costs any project manager can think of.
Here’s how it looks like in Primetric:
3. Choose the right resource forecasting method
When you gathered all the data on your company’s current endeavors, you now need to take a sneak peek at their future. At this point, there are 2 resource forecasting methods that can help you do that.
Revenue forecasting methods: bottom-up planning
Using this resource forecasting method, you focus on the customers, sales forecasts and predicted growth rate.
At this stage of revenue forecasting, you analyze the projects that are currently running, all the prospective operations that are already in the pipeline, and combine them to see an approximate total revenue. This allows you to see what activities in your company generate profits at the time being.
Then, combine the data with your target statistics for the next time period and historical data. Calculate the growth rate and use them as a reference for your estimation. With this value, you can create an approximate revenue forecast for the next period.
If you have any doubts on how to do that, use our guide to creating cost estimation in project portfolio management. It's perfect for both financial managers and the sales team!
Revenue forecasting methods: top-down planning
The second resource forecasting method is a top-down planning.
In this method, you start by focusing on your company’s environment, not on the company itself.
In short, you and your project managers should start researching the market for your services and its growth, as well as the state of the competition you face up against.
Then, check your current position in this environment and the part of the market you are likely to capitalize on. Calculate the future revenue you are likely to acquire in the next time period.
Then, estimate the sales you expect to complete in the next period and the profits they are supposed to generate. Deduct the costs of sales, marketing and other supporting processes to create a more exact value. You now know how to forecast revenue and predict revenue growth - your estimate is complete!
Revenue forecasting models
Alright, but what if I want to incorporate a more data-driven approach into the revenue forecasting models above, you may ask?
In such a case, you need to use some of the resource forecasting models. Here are some you may want to consider:
Straight line revenue forecast method
This is a simple, yet very efficient method of revenue forecasting. In short, it uses historical data to predict any future growth.
Let’s imagine that your business was very lucky (and well managed, of course), and in the last three years it grew by 10, 30 and 20 percent. As you can see, on average it grew by 20 percent a year.
Based on this data, you can expect your business to grow by another 20% this year, too - and you can use that value for revenue forecasting.
Moving average revenue forecast method
Moving average revenue forecast method is a perfect choice for those who value short-term precision over long term generalizations.
In this technique, the average historical growth of a company is calculated for shorter periods, for example weeks and months. Then, the indicators for a few of these periods (the more, the better) are placed on a chart that shows overall trends in the company, as well as some seasonal changes.
In other words, the moving average revenue forecast method shows the company's general direction, as well as some fluctuations it should consider while making estimations.
Time series revenue forecast method
The time series revenue forecast method focuses mostly on the repeatable patterns that should be taken into account by financial and project managers while predicting revenue growth.
This method measures the revenue growth data at various points and organizes them in a data order. Then, an average value is calculated based on the historical data on the graph
This technique allows managers to see how their company grows, and how external factors affect its performance both in the short and long term. Additionally, it is also a very good method of predicting trends impacting the industry as a whole.
Linear regression revenue forecast method
In general, linear regression revenue forecast method depicts the relationship between two or more data points on a graph. For example, it is perfect for combining the data on sales and profits, but also other factors that can affect each other in the business.
The data gathered by a linear regression revenue forecast method are very easy to visualize and interpret. Both parameters of choice are to be put on the axis, and their average value should create a single line - just like in the chart we have prepared for you above.
If the line created by the data goes up, it indicates a positive correlation between the two factors.
However, when the line goes down, it shows some significant challenges created by the lack of common ground between the factors.
Revenue forecasting: FAQ
When should I update a revenue forecast?
Naturally, revenue forecasting is not only done once. For a forecast to be exact, it needs to be adjusted whenever something starts to have a great impact on your business.
In other words, you should update a revenue forecast when:
- there’s a significant change on the market (i.e., war, pandemic, crisis, or opposite, a great opportunity for your business),
- you have managed to unexpectedly acquire a new, large customer,
- your company has launched a new initiative that is supposed to generate significant profits,
- your business has experienced a significant loss or gain of money for any reason.
Why is seasonality important for revenue forecasting?
If you want to try revenue forecasting in the short-term, the seasonality has a huge chance of affecting your estimates.
What is seasonality?
Seasonality includes all the fluctuations caused by the periods with more and less demand in the industry. For example, marketing agencies should notice a spike in demand right before Christmas, when more customers want to advertise their services.
However, some service companies - for example, in the IT industry - can expect a steady flow of new customers throughout the year, and seasonality does not apply to them.
Still, for the companies that do have better and worse periods throughout the year, seasonality can be a valuable source of information for short-term estimates. If the demand changes periodically, you can include that information in your predictions, making them more accurate than before.
Make forecasting revenue simpler with Primetric!
Do you want to get even better at forecasting revenue?
You’ve come to the right place!
Primetric offers a variety of features that can help you create accurate forecasts without performing complex calculations.