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The Fundamentals of Revenue ForecastingThe Fundamentals of Revenue ForecastingBy Kevin Hinton, Diane Chen

is nearly impossible to predict annual revenues precisely, particularly for new products or

usinesses, but it is critically important for companies to create high-quality revenue budgets. To

maximize the odds of being in the right ballpark relative to actual results, stick to a few key

undamentals.

Because of this, managers and analysts must make sure that the portion of budget negotiations driven by

conomic analysis is as strong and factual as possible. This means that managers must gather credible

ndustry information and customer feedback to answer questions such as:

How much money are customers spending or willing to spend to solve a particular problem? Howfast is customer spending growing?How strong are competitor products and/or other alternatives relative to the product(s) your companyoffers?How strong are competitors capabilities in areas such as sales, marketing, operating processes andcustomer service?Will the expected level of growth support all current competitors, or must the company take marketshare from others in order to grow?

With solid market facts and reliabletrend information as backup, managers must help their executives

nderstand what is possible based on current market and company realities and offer sound

ecommendations regarding the additional investment needed to hit desired targets.

inding credible market information can prove quite difficult, and managers should proceed with caution

when using third-party market research to develop revenue assumptions. A couple of years ago, this

rticles authors reviewed a set of market size estimates developed by a national market research firm.

hese figures included estimates of revenues for several companies, including two with executives we

new. We later learned that the estimates exceeded actual revenues of both companies by well over 100

ercent! Third party research data can be very helpful, but should generally be viewed as points of

eference, not as facts. Consequently, managers should review market size and growth numbers with a

ritical eye and obtain multiple sources of market information when available. Many times, in-market

ustomers and prospects prove to be the most relevant and useful sources of information about buyer

ehavior and spending, competitor product offerings and growth trends.

Be extremely disciplined in applying and evaluating key revenue assumptions. Experienced managers will

e familiar with the idea that projections are only as good as the assumptions on which they are built.

However, even the best executives, managers and analysts make mistakes with assumptions. Two

ommon ones follow:

Overlooking implicit assumptions.We have seen people with great analytical discipline makeassumptions without realizing it. For example, we know of a business that planned to double the sizeof its sales force to take full advantage of the markets potential. It did not occur to anyone that thebusiness might have difficulty staffing up. The managers of the business made the implicitassumption that the business would be able to add qualified staff on a timetable of its choosing. As itturned out, qualified employees were few and far between, and most needed substantial training

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Kevin Hintonis a business development and product management professional based in Washington, DC.

Kevin possess over 15 years of combined experience developing growth strategies, building revenue

udgets and managing products. Kevin can be reached at knhinton@yahoo.com

Diane Chen is a senior financial analyst with Starbucks Corporation in Seattle, Washington. Diane possessver 15 years of experience developing growth strategies, building revenue budgets and managing

roducts. Diane can be reached at dianech@gmail.com.

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before they could bring in any business. This became a contributing factor to a year-long negativevariance to budget. We have seen this kind of issue arise more than once, in different businesses,and we have watched budget variances occur as a direct result.Mistaking assumptions for facts. Any manager that has ever been thrown out of an executives officeafter presenting a draft of projections deemed totally insufficient has probably heard statements likeclose rates will never go lower than X, or the product will never launch later than Y. Anytimesomeone uses a never phrase, one can be sure that he or she is confusing likelihood withcertainty. Remember, nothing is certain beyond death and taxes. Like the managers of famedhedge fund Long Term Capital Management, many talented people have bet heavily and lost big onevents they felt were certain to happen.

Managers can do several things to guard against these kinds of mistakes. First, managers should never

ose sight of the distinction between likelihood and certainty. Second, managers should be disciplined about

uilding risk analysis, sensitivity analysis and probability analysis into their work. Third, managers should

make sure to create multiple revenue budget scenarios, including a best case and a worst case, and make

ure that the worst-case scenario really is in fact a worst case scenario. Fourth, managers should share

ssumptions with as many stakeholders as possible. In fact, budget stakeholders should be encouraged to

eview, comprehend and challenge assumptions. The ensuing conversation will enhance the quality of the

nal projections, and we have observed that budget discussions proceed far more smoothly when

ssumptions are made transparent.

Everyone Wins When the Fundamentals Are FollowedEveryone Wins When the Fundamentals Are Followedust as it can be painful to see actual results vary significantly from budget, it can be incredibly satisfying to

evelop revenue projections that stand the test of the market. We believe strongly that managers can

ncrease the odds of being in the right ball park relative to actual results by following the guidance that we

ave provided. By sticking to these fundamentals, managers and financial analysts can maximize the

kelihood that revenue budgets become a win-win for the people approving them and the people executinggainst them.

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