- June 11, 2014
- Posted by: firstname.lastname@example.org
- Category: Performance and Financial Modeling
If I asked you to predict the amount of revenue your company will generate next month, how accurate would your answer be? Would you be able to predict it within 5%?
If I asked you to predict your revenue for the next quarter, could you predict it within 20%?
Forecasting revenue accurately is vital to public companies. Inaccurate revenue projections cause the market to lose confidence in management. That causes the stock to plummet.
What happens when a mid-market company misses a few quarterly forecasts?
From many mid-market companies I’ve observed, not much. Typically the management identifies the general causes, things like:
- Losing a big customer
- Delayed purchase orders
- Not enough leads to follow up on
- Not being aggressive enough with their sales team
- A market contraction
Those are all common causes for missing revenue forecasts, and the biggest problem I see with mid-market companies is this:
The time is takes to correct a problem that is causing loss of revenue is far too long, anywhere from 90 to 180 days.
Let’s look at a hypothetical example. Today is June 11. Let’s say that the leadership team had received April’s revenue numbers by the time the monthly books are closed on May 20. The numbers were terrible, so management calls a meeting to discuss – which happens in the first week of June.
In the meeting, the team discusses why April’s revenue was 50% below the March revenue figure. The VP of Sales pulls out her spreadsheet that shows that April’s inbound lead count was identical to the March number, but it appears that the sales team failed to properly follow up on at least half of the leads.
Other than that, the team didn’t arrive at any other conclusions, other than the standard “We need to increase revenues of products X, Y and Z and our sales people need to sell better.”
The marching orders are for the sales manager to talk with the sales team and tell them to follow up with all of their leads. Then they’ll look to improve their CRM procedures to give better visibility in leads that aren’t touched, so they can prevent this from occurring in the future. Their CRM integrator will modify CRM by the end of June, and by the end of July, leads that are neglected will be visible and the sales manager will correct the problem.
On the surface, this sounds reasonable, right? The company had a poor performance, management to the best of their ability diagnosed the cause, and they implemented a solution to prevent it in the future.
If you take a step back though, looking at the situation from a wider perspective, what problems do you see here?
I’d list 3 issues to correct:
- It took 90 days to correct a problem that likely caused a drop in revenue. That means that the same problem probably occurred in May, June and most of July. 90 days is an eternity at a public company, you won’t survive if it takes you that long to react, but 90 days is status quo at most mid-market companies.
- The exact cause of the revenue drop might not have been identified, and if so, the bigger problem still exists. Could it have been a seasonal drop for the month? Did something happen in the marketplace? Did something happen with the sales team? Was there a change in the marketing programs? Sure, the company will make an incremental improvement to make sure that future leads don’t fall through the cracks in the future, but this type of reactive approach will only send the company searching for improvement after a bad month occurs, which brings me to my next point.
- The company isn’t forecasting revenue monthly, only annually, and the target is an aspirational +15% over their previous calendar year’s revenue. Monthly revenue fluctuations can cause complacency (if they’re higher than the target / 12) or panic (if they’re significantly lower).
The Most Important Issue to Correct
Problems always occur in marketing and sales in mid-market companies. They’re both inexact sciences, performed by human beings, who are unpredictable at times.
“The single solution that will make the greatest impact for mid-market companies is to get ahead of these potential problems by seeing them before they happen, instead of performing post-op analysis from the rear-view mirror.”
You accomplish this by forecasting monthly sales, each month for the next twelve months, on a rolling basis using logic to predict the:
- Amount of revenue that is already booked
- Amount of revenue in the back-end of the pipeline that his highly likely to come in
- Difference between the sum of these three and your aspirational target, which is either your revenue “surplus” or your revenue “risk” (i.e. the revenue that hasn’t yet been identified that you need to meet your aspirational target.)
Public companies have no option; they have to perform this accurately or their stock gets pummeled. Mid-market companies are often stretched thin on resources. They don’t, or won’t, devote the time and effort to try and change this, but there are good financial modeling tools that are affordable and can help you accomplish this in efficient and effective ways.
The biggest change you need to make is to commit to implementing the process.
The forecasting tool that I use is shown below. On the top line, you can see the monthly revenue target. The “marriage” revenue is contractual revenue that is guaranteed to be booked. The “engagement” revenue is revenue that is highly likely to materialize based on sales pipeline reports. The “dating” revenue is the difference between the aspirational forecast and the sum of the marriage and engagement revenue. This is the revenue needed to meet the forecast.
We update this every month, holding a business meeting to first discuss the changes in our marketplace, and then adding the numerical implications for each month over the next 12 months to update the model. (And for you CEOs and CFOs and board members out there, the tool I use also includes my expenses moving forward so I get an updated future EBITDA, cash produced, bank balance and return on operations % numbers).
To implement this, you need:
- A sales manager or VP of Sales who pays careful attention to the pipeline and has the data to produce forecasts based on real information
- A financial modeling tool
- A commitment to holding a meeting once a month to discuss the changes in the business over the last 30 days and the numerical impact of them moving forward
This gives you the ability to foresee challenges before they occur … which gives you the ability to prevent them and the ability to understand what’s happening on the revenue side of your business in real time, instead of in the rear-view mirror.
I wouldn’t run a business over $1 million without it.