How Do I Forecast Sales & Expenses Pt. 3

Forecasting business revenue and expenses during the startup stage is really more art than science. Many entrepreneurs complain that building forecasts with any degree of accuracy takes a lot of time–time that could be spent selling rather than planning. But in order to run the business, and to present the business to any third party, you have to have a set of thoughtful forecasts. More important, proper financial forecasts will help you develop operational and staffing plans that will help make your business a success.

“If you’re like most entrepreneurs, you’ll constantly fluctuate between conservative reality and an aggressive dream state which keeps you motivated and helps you inspire others.” 

Here are some guidelines for forecasting revenue:

Create Both a Conservative case and an Aggressive Case. If you’re like most entrepreneurs, you’ll constantly fluctuate between conservative reality and an aggressive dream state which keeps you motivated and helps you inspire others. By building two sets of revenue projections (one aggressive, one conservative), you’ll force yourself to make conservative assumptions and then relax some of these assumptions for your aggressive case. For example, your conservative revenue projections might have the following assumptions:

• • low price point
  • two marketing channels
  • no sales staff
  • one new product or service introduced each year for the first three years

Your aggressive case might have the following assumptions:

• • low price point for base product, higher price for premium product
  • three to four marketing channels managed by you and a marketing manager (Read my column on paying employees during the startup stage to learn how you can afford a marketing manager.)
  • two salespeople paid on commission
  • one new product or service introduced in the first year, five more products or services introduced for each segment of the market in years two and threeBy unleashing the power of thinking big and creating a set of ambitious forecasts, you’re more likely to generate the breakthrough ideas that will grow your business.

Use Financial Ratios to Check that Your Projections. The best way to reconcile revenue and expense projections is by a series of reality checks for key ratios. Here are a few ratios that should help guide your thinking:

• Gross Margin. What’s the ratio of total direct costs to total revenue during a given quarter or given year? This is one of the areas in which aggressive assumptions typically become too unrealistic. Beware of assumptions that make your gross margin increase from 10 to 50 percent.
• Operating Profit Margin. What’s the ratio of total operating costs–direct costs and overheard, excluding financing costs–to total revenue during a given quarter or given year? You should expect positive movement with this ratio. As revenues grow, overhead costs should represent a small proportion of total costs and your operating profit margin should improve. The mistake that many entrepreneurs make is they forecast this break-even point too early and assume they won’t need much financing to reach this point.
• Total headcount per Client. If you’re a one-man-army entrepreneur who plans to grow the business on your own, pay special attention to this ratio. Divide the number of employees at your company–just one if you’re a jack-of-all-trades–by the total number of clients you have. Ask yourself if you’ll want to be managing that many accounts in five years when the business has grown. If not, you’ll need to revisit your assumptions about revenue or payroll expenses or both.

Many entrepreneurs avoid building a detailed set of projections and end up regretting not spending more time on business planning since they would have avoided several missteps along the way. It takes time but not only provides your financial plan but makes you think long and hard about the decisions you make.