If you've ever managed a small business, no doubt at some point you've been asked to prepare a forecast, normally under the premise that the company's board or investors want to see some updated figures. Whilst it’s tempting to try and a run a small business off instinct alone, a revenue forecast is an extremely important tool used by investors, lenders and management to inform business critical decisions or to provide funding.
Here's a brief guide to revenue forecasting that will give you some guidance on how to make sure you’re painting an accurate view your business:
A revenue (also known as turnover, sales, income) forecast is 99% of the time, is the bit of a business plan third-parties care about most and they often insist on seeing monthly figures. A monthly revenue forecast not only tells someone the magnitude of a business opportunity, but more crucially the timing and velocity of growth, and for small businesses, timing is everything. They can't afford to think in terms of years or even quarters, 90 days is a very long time in the life of a growing business.
Revenue Forecast Versus Sales Pipeline – what’s the difference?
A sales pipeline is a list of orders/deals/opportunities a business hopes to sell. A revenue forecast is how these orders are recognised as income, on a monthly basis, through time - also known as Revenue Recognition.
Revenue recognition tells someone the period over which income is earned from a customer, not just when it is invoiced, paid or sold to the customer.
Why Does Revenue Recognition Matter?
Here’s an example that outlines why revenue recognition is so important:
A company sells a 12-month subscription contract to a customer for £120,000, with payment 50% upfront and 50% at the end. Its only costs are staff salaries that come to £100,000 a year (£8,333 a month). How much profit does the company make? It's obvious when looking at this over the year the company makes £20,000 from the sale. But how does this look in management reporting:
- Reporting revenue on a Contract Basis (in the month of sale), makes it look like the company made £111,667 in month 1 and lost 8,333 each month for the rest of the year. It looks like the business is in decline; Or
- Reporting revenue on a Billing Basis (£60,000 payment in months 1 and 12), would make it look like the company made £51,667 in month 1, lost 8,333 for 10 months and then made £51,667 in month 12. This paints a very confused picture and no one can tell if the business is stable. However;
- Reporting with proper Revenue Recognition would show £10,000 in revenue and £1,667 in profit each month of the year. A far better view of the actual reality.
What If You Don't Sell Monthly Subscriptions?
Revenue Recognition isn’t just important for licence or subscription based businesses, in fact, it's even more important for businesses selling projects- particularity fixed-priced services.
For a project based business, revenue should be recognised over the period of delivery of the project. For example, if a business sells a 3-month project, revenue should be spread over the 3-month period the project is delivered. If you don't do this, I can ensure you, the picture will quickly start to become confused when you are running multiple projects in parallel and taking on more costs. Soon the only way you'll know if everything is OK is checking you still have cash in the bank and you'll be nervous every time you have to pay someone. This is often why small consultancy or service businesses struggle to know how much profit they are making.
How Do I Get Started?
Firstly, if you haven't got a CRM and are struggling to keep on top of customer conversations, definitely consider using HubSpot CRM. Its great and completely free. You can use this to centralise all your customer information, track whether customers are opening emails and can even see who is viewing your content online.
After this, you've got two options:
- A spreadsheet - you'll need to agree a format with your accountant and agree some discipline like not changing figures retrospectively once reported. I wouldn't recommend this approach if you expect multiple people to contribute, if you're using a CRM system or are looking for a simple, automated solution.
- Try out QuarterOne for free. We'll connect directly to your live CRM data and the application has been specifically designed for seamless collaboration.
So there you have it, a brief explanation of Revenue Recognition, why it’s important and what tools you can use to make your life easier.
If you’re interested in hearing more, or setting up a free-trial with QuarterOne, contact one of the team today.