When it comes to revenue planning, there are a few different ways to gather relevant data needed to produce a comprehensive budget, including resource-based projecting and market-based projecting, which take historical data into account, and analog-based projecting, which looks at comparable business models.
Resource-Based Projecting utilizes your company’s history to forecast your sales. Understanding the drivers of that history is an important step in developing accurate models that eliminate the “noise” in your historical data. The first step in preparing a resource-based projection is to identify key resource factors that will produce or limit revenue for your business. These factors fall into three areas: marketing factors that generate sales, production factors that limit sales and working capital components that limit sales. Resource-based projection figures report the number of sales your organization can support. Usually small, entrepreneurial ventures often focus on a resource-based approach because the model is limited by its resources rather than its potential.
After you have prepared a resource-based projection, you can estimate the market size and divide your sales projection into the market size to determine the implied market share. Ask yourself whether this share seems plausible given what you know about the competition and market. If the implied market share seems plausible, proceed with the resource-based projection. If not, adjust the projection as necessary.
Market-Based Projecting is a simple concept, but the implementation is often difficult to facilitate. In order to make a market-based projection, you need to estimate the total market size, and then estimate the amount of total market that is relevant or addressable for your company. Within the relevant market, estimate the share of market that you will capture, and multiply the size of the relevant market by the estimate market share to get a sales projection. The market-based figure produces the sales potential of the market. Large companies often focus on a market-based approach because they can afford the specialized research necessary for good market share estimates. In addition, they are limited more by market potential than by the firm’s resources.
Analog-Based Projecting is an alternative approach to sales forecasting for a new business because it involves comparing its business to an analogous business model. One advantage is firms are able to go straight to the bottom line because the projection is applied directly to the total sales of the business. It also minimizes the possibility of making modeling mistakes (regarding productivity rates, amounts of resources, market size and market share). This method is ideal for “cookie cutter” business such as retail shops, restaurants, and franchise operations. Consider a restaurant. The owner can grind through the calculations described above, computing numbers such as the number of patrons her restaurant can accommodate and her likely market share among some relevant group of restaurants. Alternately, the owner can simply rely on the fact that similar restaurants in her area have estimated annual and project sales volume ranging from $400,000-$900,000.
In order to produce an effective budget with realistic sales forecasts, you need to identify with method or combination of methods works best for your company’s business model. Often, applying historical data and using the lower of the resource- and market-based projections generates the most effective revenue targets because revenue likely won’t exceed the level justified by your resources or the level justified by your market potential. If your business has sales history, your best bet is to use history-based methods and leverage both models in parallel to forecast your sales.