Updated: May 19
Special guest article written by Andrew Childress, of TheFP&AGuy.
Unless something is seriously broken, chances are that revenue is the largest item on your income statement. And, cost of sales is probably your biggest expense.
It only stands to reason that the revenue line deserves the most attention in your financial analysis and planning. The problem is that your forecasting and analysis process might not actually give it the attention that it deserves.
For many businesses, recognized revenue is controllable in the short-term through backlog and timing shipments. But eventually for all businesses, recognized revenue is driven by sales. For that reason, when we talk about forecasting revenue in this article, we mean forecasting sales transactions. We use the terms interchangeably.
Embedded in the revenue line item are countless customer stories. They tell the tale of three critical factors that drive your revenue: win rate, deal generation rate, and deal size.
In this article, we’ll focus on the importance of your sales forecast and the need to incorporate the three factors above. You’ll get ideas for how to predict revenue in more accurate and precise ways so that your overall forecast is more realistic than ever. Plus, you’ll learn to leverage your CRM data for more meaningful conversations about the future of the top line.
The Challenges of Sales Forecasting
The first thing we know about every forecast is that it won’t come true. But when you stake your company’s success on lofty revenue goals that are unrealistic, you create serious risks. Imagine that you hire a new team based on anticipated revenue growth, but then several key deals don’t close. Now what?
John Kenneth Galbraith once said, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” Your forecast won’t be correct, but you have to understand its implications and if it is based on realistic assumptions.
When I ask around in my FP&A network, these are the statements I hear most often about revenue forecasting:
“My sales leader consistently over-promises and under delivers on revenue.” - Let’s face it: most salespeople are optimists. It’s only natural that their forecasts include optimistic growth projections.
“My sales leader consistently sandbags expectations and aims low in revenue projections.” - Aiming short of expectations is just as common. It stems from the mindset of “under promise and over deliver” so that sales teams outperform heroically and meet or exceed goals.
“My sales projections include unrealistic expectations based on win rate, sales rep ramp, or market size.” - These expectations are often forced top-down when the overall forecast doesn’t deliver the needed growth. While it’s natural to expect improvements over time, a problem arises when these metrics are totally disconnected from reality. In essence, you gamble that the future is far different than your track record.
“Our revenue forecast doesn’t include the sales team.” - Too often, a sales forecast doesn’t include those closest to the customer. Revenue forecasts often become “top down” exercises based on the need for growth and expansion. These create misaligned forecasts that simply don’t create accountability.
Whether you over promise, under deliver, or aim too low, all of these factors lead to inaccurate, unrealistic revenue projections. And that can have serious implications on the way your company operates. To combat this, you need a model of your sales process that can produce a sales forecast.
How to Build a Meaningful Revenue Forecast
So, we have covered the importance of building a revenue forecast, but how do you tackle building a revenue forecast?
While there’s no “one size fits all” approach to revenue forecasting, many principles are universally applicable. Here are three key pillars to consider as you build out a revenue plan.
Involvement Creates Engagement
If you hear the phrase “that’s not my forecast, that’s finance’s forecast,” you’ve got a problem.
The revenue forecast is a truly cross-functional exercise. Your sales team needs a voice. Complement that voice with financial analysis and vetting of the included items.
Forecasts are often a balancing act between a “top down” (marketshare or valuation driven) and “bottoms up” analysis. The two approaches will rarely agree. Solicit input from sales, but ensure that your plan matches what your business or company leaders expect for overall results.
Of course, every plan includes a bit of “stretch” - that extra mile of performance that helps the company achieve its overall targets. In many cases, that creates a commitment beyond what your business leaders sign up for. Partnering with your sales leader can bring opportunities to the forefront to help cover those stretch items.
Another benefit of partnering with your sales team is that it drives the right conversations around resourcing. If you’re pushed to deliver significant revenue growth, you may need to sync and ensure that you have enough resources. Since it takes time to ramp sales reps to effectiveness, it’s important to start this conversation early.
While you won’t be able to blindly accept sales input as the sole source of revenue detail, bring them along for the journey. You’ll drive better conversations that bring important details to the forefront, giving finance the opportunity to include these nuances in the forecast.
Model Open- and New-Pipeline
There are only three factors that matter for long term sales forecasting: win rate, deal generation rate, and deal size. Your bottom up analysis should incorporate all three of these factors. Then when bottom up and top down don’t agree, rather than argue about the merits of one vs. the other, you can ask the question, which of the three factors do we need to change in order to meet that plan? Do we have the resources, market, and knowhow to do that?
Using win rate, deal generation rate, and deal size, you can build a model of your sales process reflecting::
Open pipeline - deals that your sales team is currently working. These typically live in a CRM system like Salesforce which includes pipeline details (win rates by stage and deal size) for these opportunities.
New pipeline - Deals not yet in your pipeline. This will make up the bulk of your longer-term forecasts. These sales are driven by the three factors—and time.
You need realistic assumptions about all three drivers. Too many businesses bank the success of their revenue forecast on one or more of these factors that may not play out. To be realistic, you can use applications like Funnelcast which analyze your Salesforce data to give you empirical independent measurements of each of the three factors. More important, Funnelcast can project both your open- and new-pipeline revenue based on your historic performance, and allow you to explore what-if scenarios that reflect changes in the three drivers.
Your sales forecast is more than a number. It’s a set of assumptions, beliefs, and plans you’ll follow to deliver the number. It forces you to consider what the team can deliver. That means drilling down to plan your sales forecast in detail, considering the possibilities of what may happen.
This is the art of segmentation - the way you divide and detail your plan. Common segmentation details to consider:
Business type - new customer acquisition has considerably different win rates, generation rates, and deal sizes than expansion business.
Lead source - what channels do you use to acquire new opportunities, and what is the associated cost for them?
Market - what types of customers and industries do you sell to? Monitoring this factor can help you adjust as macroeconomic trends evolve.
Use case - your product may not be a “one size fits all” suite. Understanding how your funnel might pick and choose the options in your product is essential to document the potential size of each opportunity.
In nearly every business, the mix of these factors has a significant influence on profitability. Therefore, you’ll need to go beyond the high level assumptions to create a sales forecast. Segmenting the revenue forecast helps you monitor forecast versus actuals and adjust your operating plan.
If the success of your revenue plan is built on lofty premises that you’ll close every high effort, new deal, you’re taking too much risk. But without enough detail in your plan, you won’t know the risk factors.
There’s a balance you’ll need to find in your sales forecast process. You won’t have enough time to build a forecast that anticipates every level of detail. Spend time thinking about the right segmentation for your business so that you can address the most important questions. A good forecast application will let you easily test segmentation scenarios to determine which segmentation provides the most insight and highest fidelity forecasts for your business.
Document and Test Your Assumptions
Would you bet your company on the accuracy of your sales forecast? It sounds like a statement made in jest, but it’s too often reality. Should you count on lofty assumptions just to sustain your company? One way to test this is to backtest your model. What did it predict last quarter, last year? How do those compare to actuals?
One challenge is that revenue often becomes the plug in a forecast. After all, growth can cover most business challenges. After you’ve built out an operating structure, simply layering in more revenue can help the business reach profitable scale. It’s up to FP&A to call out when assumptions differ radically from history or are based on unrealistic assumptions. With a robust analysis of the three factors (win rate, deal generation rate, and deal size) you will be well equipped to spot any magical thinking.
Take a metric like win rate, for example. Based on history, how many leads does it take to convert to a revenue producing opportunity? This metric has a dramatic impact on how your pipeline translates to revenue. The problem is that most forecasts assume it improves over time - without a plan for how to accomplish this.
It’s Time To Revisit Your Revenue Forecasting and Analysis
As you walk away from this article, I’d encourage you to ask the following about your revenue forecast process:
Have you incorporated win rate, deal generation rate, and deal size in your model? Have you made reasonable assumptions about these factors?
Does your commercial team feel included in the forecast process? Forecasts are ultimately about accountability. As you measure actual versus expected results, it’s important to know what areas you underperformed or outperformed within. If your forecast or budget moves so rapidly that sales isn’t included, it’s time to rethink the plan.
Do you have deep enough revenue analysis to test actuals versus the plan? If you find yourself thinking “I can’t measure our plan versus the actuals,” your process needs consideration. Forecasts center around accountability, and you might need a better way to compare actuals versus plan performance.
Does your revenue forecast include defensible, documented assumptions? If not, it’s impossible to drive the conversation about how results differ from expectations.
Appropriately resourcing your revenue function starts with a robust model of your sales process. If you’re struggling with how to do that click here to learn how Funnelcast can help. It’s an application that uses your CRM data to automatically build a holistic model of your revenue engine—incorporating the three factors of win rate, deal generation rate, and deal size. Funnelcast helps you better understand your pipeline and how the three factors translate to revenue over long time scales (up to next year).
Check out the Funnelcast live demo (uses fake data, keep your secrets).