Business Finance

Revenue Forecasting: What It Is and How to Do It

Apr 15, 2022 • 9 min read
revenue forecasting
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      As a small business owner, it’s easy to get caught up in day-to-day operations and neglect things like revenue forecasting. That can cause problems though, especially as your overhead goes up and you need to scale at a certain rate to stay profitable.

      Fortunately, once you’ve made a few forecasts and established your systems, regularly projecting your company’s revenue becomes a lot more achievable. Here’s what you need to know about the steps involved to get started.

      What is Revenue Forecasting?

      Revenue forecasting refers to using historical data and educated assumptions about your business, industry, and the economy to estimate your company’s future gross sales.

      In other words, it involves the combination of quantitative and qualitative information to create models of how much your company is likely to earn. 

      You can then use the models to plan by tweaking inputs that reflect decisions, outcomes, and external variables.

      Revenue is a high-level metric, but it has significant implications, such as:

      • You need it to set realistic business budgets
      • It’s largely responsible for your company’s general profitability
      • It can quickly express the scale of your business or market share to a third party
      • The way it trends over time represents your company’s growth or lack thereof

      Because revenue impacts many aspects of your business, forecasting it is highly beneficial. Your projections can help you make more intelligent business decisions, win over prospective investors, and set appropriate long-term goals.

      For example, say you’re debating whether or not it makes sense to have your sales manager expand the sales team in the coming months to keep up with an anticipated spike in demand.

      With a sophisticated revenue forecasting model, you could project the impact hiring salespeople would have on your company’s earning power. Comparing it to the expense you’d incur to hire them would tell you whether they would be healthy for your cash flow.

      How to Forecast Revenue

      You’ll need to do a lot of preparation before you can use any revenue forecasting methods. Let’s look at the most important steps to take.

      Build Accurate Financial Statements

      Before you can start trying to predict the future, you need to have an accurate picture of your past. In financial management, that means building a reliable set of financial statements, including a balance sheet and an income statement.

      Almost every sales forecasting method relies on historical company data to some degree. Without concrete numbers to rely on, you’re making guesses with little basis in reality.

      If your company is too young to have sufficient data, it’ll be harder to create an accurate forecast. You may be able to use numbers from similar companies and tweak them, but your projected revenue will be inherently less reliable.

      Document the Context Behind the Numbers

      Your company’s historical data tells an important story, but it’s ultimately an incomplete one. You’ll also need some context to supplement your quantitative forecasting.

      Take the time to document your business plans, the lessons you learn from mistakes, and the reasons behind your decisions. They can help you decipher your revenue numbers and factor any improvements you make into your future sales projections.

      It’s also beneficial to perform regular variance analysis and investigate the differences between your expected and actual numbers. Once again, the things you learn can help refine your future forecasting.

      For example, say it’s the end of 2025, and you want to forecast your revenue for 2026. Your business is seasonal, so you use forecasting methods that base each month’s revenue on numbers from the same month in the previous year. 

      When you estimate your March 2026 revenue, you see that you had a slight drop off in sales last March. Without any context, you might assume there’s some seasonal reason for this, which would skew your projections downward.

      However, upon checking your notes, you see it was because your sales leader and best sales rep left the company that month. Since that isn’t a recurring revenue issue, you can adjust your forecast to reflect better March numbers than you saw last year.

      Pick a Spreadsheet or Software

      Once you have the information you need to start forecasting your revenues, you have to decide whether you want to use a Microsoft Excel spreadsheet or financial forecasting software to do so.

      Spreadsheets are the traditional choice and give you complete control over the forecasting process. They let you build your forecasts from the ground up, and you may develop greater insight into all of the factors affecting your sales.

      However, building your revenue forecasts from scratch takes significant time and effort, and your models are much more susceptible to human error. If you transpose a number, you can throw off all your numbers and spend hours searching for the problem.

      Meanwhile, software streamlines the forecasting process by linking directly to your company’s data. It may also help you manipulate the data more intuitively, but you always give up some degree of control.

      Choose Your Forecasting Methods

      With all your forecasting information and tools prepped, you have what you need to start the revenue forecasting process. However, you’ll have to choose between many different approaches, and each has its own strengths and weaknesses.

      When selecting your favorites, consider which variables they depend on and your current revenue growth pattern. For example, some methods are better for seasonal businesses, while others make more sense for a company scaling at a steady rate.

      3 Revenue Forecasting Methods

      Here are some popular, easy-to-understand revenue forecasting methods. As you review them, keep in mind that you may need more advanced analytics to get meaningful insights for your business in practice.

      For example, you may have to use multiple forecasting methods in conjunction, project each revenue stream individually, or make modifications for external economic factors.

      1. Straight-Line

      The straight-line method is the most straightforward way to forecast, though that’s not related to the name. Its simplicity can make it one of the less accurate approaches, but it also lets you estimate your revenues with little time and effort.

      The straight-line method is best when:

      • A rough estimate of your projected revenues will suffice
      • You know you won’t take the time to run a more thorough revenue forecast
      • Your business has had a steady growth rate for years and you expect it to continue

      To forecast future revenue using the straight-line method, just multiply the latest year’s revenues by your company’s historical growth rate.

      For example, imagine that the 2022 calendar year is coming to an end, and you want to project your revenues over the next year. In 2021 and 2022, your gross revenues were $500,000 and $525,000, respectively. That equals a 5% growth rate year over year.

      To get your 2023 numbers, you’d multiply $525,000 by 1.05, which equals $551,250. If you wanted to forecast further into the future, you’d continue to multiply each year’s annual revenue by 1.05.

      2. Weighted Moving Average

      The weighted moving average method of forecasting revenue is similar to the straight-line method, but it’s more granular. As a result, your forecast accuracy will often be better, especially over short time horizons.

      It makes the most sense when:

      • Your business isn’t seasonal
      • You have less historical sales data available
      • You’re not trying to forecast very far into the future

      To forecast revenues using the weighted moving average method, you take a weighted average of trailing data points to predict the next in the sequence. Typically, you’ll place greater weight on more recent data points.

      For example, say you have the following gross revenue amounts over the previous four months:

      • January: $6,400
      • February: $6,800
      • March: $7,250
      • April: $7,000

      To create a revenue projection for May, you decide to use the weighted moving average method. You give 50% weight to April, 25% to March, 15% to February, and 10% to January.

      Your formula would look like the following: 

      ($6,400 x 10%) + ($6,800 x 15%) + ($7,250 x 25%) + ($7,000 x 50%) = $6,972.50

      To create a sales forecast for your June revenues using the weighted moving average method, you’d repeat the process by using the months of February through May.

      3. Simple Linear Regression

      Straight-line and weighted moving average methods involve the manipulation of revenue data alone. Linear regression takes a different approach, instead using the relationship between revenues and an independent variable to make predictions.

      As a result, linear regression makes the most sense for your business when you have something you believe is a clear driver of revenues.

      For example, say you’re unsure whether it’s worth paying for direct mail marketing. You decide to use linear regression to forecast your sales and get the answer.

      You have the following data from the previous year:

      Last Year’s Data

      MonthNumber of Letters SentRevenue

      Using the average correlation between the two variables, you can estimate that mailing 83.25 letters to client leads generates an average revenue of $7,545. It costs you $500 to send 83.25 letters to client leads early in your sales pipeline.

      Say you spend the next year using email marketing instead, then repeat the linear regression with the new data.

      If you find that investing $500 in email marketing each month generates higher sales activity and more than $7,545 in revenue per month, you’d know it’s the better marketing tool.

      The best method for revenue forecasting is the one that applies most to your business and situation. If one of the methods above seems relevant, just get started! You can always correct course later. 

      About the author
      Nick Gallo, CPA

      Nick Gallo is a Certified Public Accountant and content marketer for the financial industry. He has been an auditor of international companies and a tax strategist for real estate investors. He now writes articles on personal and corporate finance, accounting and tax matters, and entrepreneurship.

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