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Creating a resilient and accurate forecast

budget planning Nov 02, 2023


Today we're going to look at creating a forecast and how to go about that process.

Next week we'll wrap up by bringing it all home and talking about goals, KPIs, and creating a plan.

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Over these last few weeks, we’ve discussed how to create a budget. I kept it pretty high level because the reality is many businesses will have different budget needs.

We’ve analyzed past performance.

We’ve projected what we expect for the future (next year) with the capital and operational budgets.

And we’ve presented these to the appropriate parties, potentially getting some approvals along the way.

But until we have a good sense of what our expected revenue is, it’s hard to truly finalize any of this information.

And I’m sure you’re expecting something complicated here. But we’re not going to do that.

Complicated budgets and forecasts aren’t implementable or understandable.

  1. Define our revenue streams
  2. By Stream, analyze:
    1. Historical sales
    2. Contracts & Sales pipeline
    3. Sales & Marketing initiatives
    4. Capacity constraints
    5. Market conditions
  3. Establish 3 scenarios
    1. Baseline
    2. Best case
    3. Worst case

Factors in Revenue Forecasting

Historical Sales

AI powered tools make pulling this historical data and extrapolating it forward more easy than ever. I recently used a tool, Fathom HQ, that upon linking my data with Quickbooks provided an immediate forecast based on past results.

Brex has been integrating AI into their forecasting tools, making easier than ever to get quick insights (see how else they’re using it here).

If you don’t have access to one of these handy tools, consider looking at seasonality and straight line increases based on the last few years data. Keep it simple so it’s easy to understand.

Contracts & Pipeline

Signed contracts, without delivered service/product, are a great starting point for projecting revenue in the coming year. It’s generally pretty certain the contract will perform, so it creates a great foundation for a “worst case” scenario.

Discounting contracts slightly for cancellations and delays in performance of the contract help add to that certainty as well.

Sales pipeline can be different from company to company, so it’s hard to give guidance on certainty. Consider discounting these based on close percentages and certainty of lead. For example, a $100,000 with 70% close certainty could be reduced to $70,000 in the forecast. If your certainties are high overall, consider discounting even more based on expected close percentage.

If you close 40% of leads and have $75,000 forecasted on $100,000 in contracts, you’re overoptimistic. Look to change your certainties to get your forecast closer to the 40% close rate, or $40,000. Sure, you could close more, but we also might not based on known history.

Sales & Marketing Initiatives

As you’ve talked about budgets and strategic objectives, you should have gotten a good sense of the initiatives you’ll have for the next year and the goal of each.

For those that are sales and marketing related, it’s now time to figure out how those expenses will translate into a forecast.

Don’t overweight this, as we tend to assume the best with these. The problem with that is things rarely turn out exactly as we expect.

The key here is to be conservative but optimistic.

If you understand your metrics like CAC and LTV, your spend should work, though probably less efficiently, in line with previous norms. Using these norms but discounting them slightly will get you a good sense of what you can expect from new initiatives.

Capacity Constraints

Capacity constraints can come in the way of production, supply chain, or people limitations.

Being in service businesses, our constraints were always a function of the question “how many people can we realistically hire?”

Our inability to hire more quickly limited our ability to service our current clients and take on new clients.

With product businesses, production and supply chain may be more prominent. Being limited in how frequently and in what quantity you can get your product from suppliers can put a limiting constraint on even the most in-demand product.

Market Conditions

I’ve said it before and I’ll say it again: don’t over index for market changes. So many small business owners worry about the markets, but it doesn’t really matter for most businesses.

Sure, you might see a downturn, but a well run business will thrive through hard market conditions. There are always outliers and you want to build a business that is that outlier.

Some great forecasting tools have been released that make this whole process significantly easier. Brex, for example, has integrated AI to provide valuable insights into future revenue, expenses, and market conditions instantaneously.

What used to take days (and weeks) of data gathering can now be provided in almost a snap of your fingers.

Read here how Brex is using AI to superpower your accounting team.

Creating your Scenarios

When building out the scenarios, we want to be extremely clear on what’s driving each scenario. We want to use the factors mentioned above, as well as best case and worst case scenarios of each.

Let's break it down.

Revenue by stream

Using the factors mentioned above, identify one thing driving each of the factors.

Is it percentage growth?

Is it a 3 month, 6 month, or 12 month trend?

Is it a specific measurable, like CAC or LTV?

Identify one driving factor for each service or product. For example, break down each “line” as such:

Service 1

  • Historical Sales: establishes our “baseline” or starting point; percentage growth, accounting for market conditions.
  • Contracts & Pipelines: model out contracts as they’re “written,” but discount contracts that occur later in the year. With the pipeline, rate these based on certainty and only count revenue at a percentage of the estimated total.
  • Sales & Marketing Initiatives: use marketing metrics or percentage of increase expected to estimate this. It’s by far the most “squishy” part of the analysis.
  • Capacity Constraints: see the total of the 3 items above and see if capacity will limit your ability to deliver. If it does, discount (or reduce) the amount of sales in this area.

Do this for each service or product to establish a baseline.

Best case and worst case scenarios

Next, we want to think through the best case and worst case scenarios.

For Contracts & Pipelines, assume a high and low close rate, respectively.

For Sales & Marketing, assume your initiative was ineffective and effective.

I always like to tie numbers back to units, hours, or whatever drives that revenue line forward. It’s a lot less abstract than a straight dollar amount and forces you to ask “is it realistic?”

As you work through this process, walk through each variable one at a time. We want to understand the impact of each.

Complicated forecasts and models sound like a great idea. But complicated forecasts are often hard to understand. It’s better for the parties reading the forecast to be able to understand the variables, which means reducing the number of things impacting each number.

See how scenario planning keeps your growth on track in any economic climate.

Comparing your Forecast to Budget

Now we want to incorporate the budget.

We need to ask:

  1. Do they make sense together?
  2. Does the revenue fall within historical expectations?
  3. Does the profit align with where we’ve been historically?

At this stage we’ll typically continue to make adjustments to each forecast and budget, but we’re getting close to “locking” it and moving on.

We’re to the point of making hard decisions about our strategic objectives.

  1. Is it realistic to complete them all?
  2. Do they stand to be “profitable” on their own?
  3. Which holds highest priority now that we know the numbers?

We’ll dig into these points more next week as we start to wrap up this process.


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