How to forecast revenue: A guide to boosting your business’s growth

If you plan to apply for a small business loan, you’ll need to prepare a detailed revenue forecast before lenders will consider your request. This type of report will also provide some much-needed information that will help you know when you can afford to hire an employee, launch a marketing campaign, or expand your operations. 

Revenue forecasts are useful both for startups and existing businesses. We’ll cover what a revenue forecast is, how to prepare one, and best practices to follow.

• What is revenue forecasting?
• Benefits of forecasting revenue
• Types of revenue forecasting
• How to forecast revenue
• Forecasting best practices

What is revenue forecasting?

Revenue forecasting is the process of using existing data and metrics to predict your business’s future revenue. This includes using historical and current financial data to determine what the upcoming revenue could be in a given period (monthly, quarterly, or annually).

Benefits of forecasting revenue 

The main benefit of forecasting revenue is the ability to plan and make financially viable decisions. If business expansion is in your future plans, forecasting revenue can help with decisions regarding:

• Staffing and hiring: Forecasting revenue gives you a more accurate view of whether you can afford to hire and expand your staff. 
• New market expansion: Forecasting revenue with new market expansion in mind allows you to estimate how much more you could be earning in an additional market.
• Removes guesswork: Forecasting revenue helps you make better decisions based on your current and future expenses to make it more accurate.

4 revenue forecasting methods 

There are four commonly used methods to make accurate revenue predictions for your business, including:

• Moving average forecasting
• Straight-line forecasting
• Time series forecasting
• Linear regression forecasting

These methods share similarities, like the ability to compute results within Excel or Google Sheets and the use of historical data to draw final conclusions. They also hold their distinguishing features like using averages, statistics and external factors to influence the results.  

1. Moving average forecast  

The moving average forecast uses an average of a group of numbers to determine trends within your revenue data.

• For example, taking any revenue historical data set and using the average of the previous year’s data can give you a projection of revenue to come. 

2. Straight-line forecast 

The straight-line method uses past growth rates to lay the framework for future predictions of revenue growth. It’s arguably the easiest to compute since it requires the most basic math.

• For example, look at the average growth rate for the past year and use it as a prediction for what the current year and future years will look like.  

3. Time series forecast

Time series forecasting uses existing data to focus on how external trends affect revenue growth.

• For example, a time series forecast looks at the existing data and identifies patterns that could be repeated in the future, like seasonality.  

 4. Linear regression forecast 

Linear regression forecasting uses predictive analysis to show the relationship between data points graphed on a plot line. It's used to make a trend line that shows the growth or decline of revenue based on a data set.

• For example, if you plotted out your revenue for the past 12 months, a trend line could be used to confirm an upward or downward trend between the points.

How to forecast revenue in 5 steps

Revenue forecasting should be performed as a step-by-step process. Below, we’ve included a system that will help you achieve the most accurate revenue forecast for your business. The steps include:

1. Deciding on a timeline
2. Forecasting your expenses
3. Forecasting your sales
4. Calculating your prediction
5. Repeating the process 

1. Decide on a timeline

Before forecasting your revenue, you’ll need to decide how far into the future you want to look. This will be determined by your specific goals. For instance, if you want to determine whether you can add a second location in two years, then you’ll calculate a two-year forecast. 

However, keep in mind that the further into the future you plan, the more you should expect a degree of error. This is a result of unseen internal and external forces that may arise.   

2. Forecast your expenses 

To forecast your expenses, refer to your past expense records or research expenses for your industry if you’re a startup. You’ll need to calculate two types of expenses:

• Fixed costs: These are expenses that remain the same every month. They include rent, fixed salaries, utilities, insurance, phone, internet, technology, postage, advertising, marketing, legal, accounting, and bookkeeping expenses.
• Variable costs: These are expenses that can change every month, but taking an average will give you a baseline to run with. They include the cost of goods sold (including materials and supplies), packaging costs, sales, cost of labor, marketing, and customer service costs as they directly relate to the sale of your product.

3. Forecast your sales  

If you own an existing business, look at your past sales figures and then consider the following factors to make an educated guess about future sales on a month-by-month basis:

• Your customers: Identify your customer base and determine which customers you’ll include in the forecast. Remember, common wisdom says that you’ll get 80% of your business from 20% of your customers.
• Your service area: Do you have plans for expansion? If so, include your current geographical area as well as the area you plan to include in the future.
• Market conditions: What is the state of the market? Will it remain steady or increase?
• Business position: Consider the position of your business within your industry and factor in your growth expectations.
• Seasonal adjustments: Many businesses have increased or decreased sales in a seasonal cycle. If your business falls into that pattern, take this into consideration.

If you own a startup and don’t have historical records to work from, forecasting your revenue may take some extra work. It will take meticulous research on your part, and the outcome should be based on this research rather than guesswork. Here are some good sources of information:

• Look at the most recent consumer spending habits in the Consumer Expenditure Report from the Bureau of Labor Statistics (BLS) to see how in demand your products or services are.
• Find detailed information about your industry on the BLS’s Industries at a Glance page.
• Check the most recent Producer Price Index to determine price stability for your industry.

4. Calculate your prediction

Next, you’ll take all of your research and mold it into a prediction for your future sales. If you offer more than one product or service, you should do this for each of those areas and then combine them for a total figure. Here’s how to arrive at that figure:

• Determine how sales are calculated for your industry: For example, if you own a service-based business, sales are typically calculated by billable hours. Retail forecasts, on the other hand, are typically based on sales per square foot.
• Create a profile of your ideal customer: For regional businesses, use the data from the Census Bureau to determine how many of your ideal customers live within a reasonable radius of your business.
• Estimate your market share: Do this by determining the total number of available customers and then predicting how many of them will buy from you. Remember, your customer base will increase over time, and that should be reflected in your numbers.
• Determine how often your customers will buy from you: This will vary by industry. For example, beauty salons can count on customers booking a service every four to six weeks. On the other hand, a tree-trimming service might estimate once a year.Predict the average dollar amount of each purchase for each of your product or service categories.

To arrive at your projected sales volume, take all the figures you have and input them into this formula:

Number of customers x average sales price x number of yearly purchases = Yearly projected sales

Next, deduct your total projected expenses from step two and you’ll have your revenue forecast.

Yearly projected sales – total projected expenses = Revenue forecast

5. Repeat the process 

It’s easy to be overconfident or too conservative in your projections. That’s why it’s a good idea to run these numbers three times. Run an optimistic projection, a pessimistic one, and a middle-of-the-road one. You can adjust your projections monthly as you see how real-world sales compare to your predictions.

• Optimistic projection: Use data in a best-case scenario with all external and internal factors working in your favor.
• Middle-of-the-road projection: Use data averages and stay slightly more conservative with your predictions.
• Pessimistic: Use extremely conservative data to create your projection, assuming external and internal factors do not work in your favor.

Forecasting revenue do’s and don’ts

There are proper guidelines to follow to prevent your forecasting from going off the rails—most of it surrounding the data and your expectations. For example, it’s wise not to make your forecasts without assistance. Information can be easily misinterpreted due to human error, so it’s best to have a second set of eyes. Below we’ll discuss other do’s and don’ts to keep in mind. 

Do base assumptions on data  

Internal data from historical figures as well as external data like seasonal spending and trends can be a benefit to your forecast. For example, if every September to November you see an uptick in your sales thanks to a popular annual festival, it’s safe to say you can expect the same rise in sales year over year.

Do make sure your forecast is regularly updated  

Trends change (sometimes overnight), and the only way to combat the ebb and flow of revenue expectations is to update your forecast regularly. For example, if you own an ice cream shop and you’ve found that ingredient prices are steadily on the rise, your forecast should be updated to reflect this. 

Don’t expect a perfect forecast

With forecasting, it’s better to be conservative with your expectations.Since a forecast is an estimate, you can never expect a perfect result. To be safe, always prepare for a percent error to allow for any unforeseen circumstances.

Don’t exclude pertinent data 

An example of this is underreporting revenue and cash income. Although some may see this as taking a more conservative approach, you can’t expect an accurate forecast without all the information.

Taking your forecast further

Following the steps and tips above can get you going in the right direction, but to take your forecasting even further, you need to start with a strong foundation. This comes from your revenue and expense tracking. 

In order to produce the most accurate revenue forecast, consider using tools like accounting software to take human error out of the equation. This way, you can be confident in knowing that your historical records are as accurate as possible.