Quick and Dirty Forecasting Tricks: Limiting Factors
You are a small or medium sized business and your initial research indicates that there is a demand for your product or service. Either that or you are trying to decide why your initial revenue forecast was so far off the mark. You are not alone.
In all of my 25 plus years in banking, I only saw one or two forecasts that were anywhere near accurate. Reflecting on this, I realised that a big part of the problem in determining the sales or revenue was the way we traditionally approached this activity. We would use Statistics Canada data or some other data base to determine what the total expenditures on our product or service were in our area and then estimate what our market share would be. Most businesses in an attempt to be conservative would choose 1%. The problem with this, is that the expenditure for our area would be hundreds of millions or some other equally large number. For a major business, like Nordstrom or some other equally large business, this number is meaningful but not for a small or medium sized business whose sales maybe less than 5 million or even in the hundreds of thousands. In the overall scheme of things these numbers represent a very small percentage (less than 1%, probably less than 0.1% even) of the total market available. So how can we arrive at a meaningful sales or revenue figure?
After much thought, I developed what I call my “Quick and Dirty Forecasting Methods”, they arose from the realisation that you cannot sell what you don’t have. I realised that every business has constraints on what it can sell. In a retail business it is inventory, in a service business – it’s hours, for a restaurant – it’s seat and average menu price, for a hotel – it’s rooms, etc. The key is to determine what the limiting factor is. But I’m selling via the internet some would say I’m not as constrained as I would be if I was selling from a physical location. But you are. If you are selling merchandise, you are still constrained by how much you can invest in your inventory and also by how fast you can restock to meet demand.
The following shows how this method would work for a physical retail location.
You still need to do some research only in this case these numbers are readily available on the internet or from sources such as Dun and Bradstreet’s Key Business Ratios. You will need to know:
what the average markup is for your business, the markup varies depending upon the type of retail business you have
the turnover rate for your business (the number of times your inventory sells in one year, it varies according to the type of retail business)
how much you have to invest in inventory
and lastly, if you can get it the average amount of markdowns (the amount of goods you have to put on sale) in your particular retail business.
For the purposes of our calculation lets assume that the business is a high-end women’s clothing store.
The mark up for women’s’ clothing varies between 100 and 200 %. Let’s say we use a 200% mark up.
The turnover rate for this category is approximately 4 times.
We have $100,000 to invest in inventory
Using these figures our initial inventory is worth $100,000 + $200,000 (markup of 200%)
We know that the average turnover for this type of retail business is 4 times per year so therefore, our original investment in inventory will produce annual sales of 4, our original investment in inventory worth $300,000 retail. This gives us an annual revenue of 4X$300,000 or $1,200,000.
This figure represents the upper end of our potential revenue if everything goes well but in retail it rarely does so we will have to adjust this figure for markdowns and theft. For example, if 25% of the inventory is marked down by 50%, sales will be approximately $1,050,000. For the sake of conservatism this is the figure I would use as my forecast.
For restaurants this calculation would be number of seats x the number of times the seat turns in a day x the average meal price.
For a business that sells hours it is a little more complicated. Here I use the average number of hours in a typical day – 8 hours
The number of working days in the year (can be found on the internet) –252
Less days for holiday (let’s say 4 weeks or 20 days) which sets the number of working days at 232
This is the number of days that you have available to sell or stated another way 232 x 8 hours = 1,856 hours.
Unfortunately, if you are a single operator it is unrealistic to expect to sell all of these hours. Some of them will be spent on marketing, some on administration maybe even some sick days so we have to reduce the number of hours for sale. It is usual for sole operators to budget on being able to sell 60% of the hours. This would give us 1,856 x 0.6 hours to sell or 1,114 hours. If you multiply this number by your hourly rate it will give the revenue figure for the year. Alternatively, if you want to make $150,000 a year you will have to charge $134 per hour. The way to increase revenue is to hire employees, as it’s expected at least 80% of their time to be chargeable.
This method of forecasting can be used for any type of business once you know what the limiting factors are. Since its based on realistic numbers it should provide you with a more accurate revenue forecast.