Revenue Forecasting: 4 Step Guide
Picture this: You’re meeting with an investor and they ask you “what’s your expected revenue for the rest of this year?”
You have a few options:
- Give them your best guess
- Tell them you’re not sure (embarrassing!)
- Give them a number that’s based on data
Without revenue forecasting, you’re stuck with options 1 and 2, neither of which will instill much confidence in your investor.
Revenue forecasting is one of the most powerful tools at your disposal when it comes to financial planning. It helps you set goals, plan for the future and make smarter decisions about growth.
However, your forecast is only as effective as you make it. That’s why we put together this guide.
We’ll walk you through how to forecast your revenue step-by-step. We’ll also give you some tips to avoid common pitfalls that startups make with their revenue forecast.
Table of contents:
- What is revenue forecasting?
- Why revenue forecasting is important
- How to forecast revenue in 4 steps
- The do’s and don’ts of revenue forecasting
What is Revenue Forecasting?
Revenue forecasting is the process of estimating what your revenue will be over a specific time period—typically quarterly or annually.
For instance, if you want to know how much revenue you’ll generate next month, next quarter, or next year, a revenue forecast will show you where you’re headed at your current pace.
Your forecast is based on your past performance and the current state of your business. It is not a guess! That’s why it’s important to use data to build your forecast, which we’ll dive into a little later.
Why Revenue Forecasting is Important
There are a ton of benefits to forecasting your revenue. Just like with financial planning, scenario analysis, and financial modeling, revenue forecasting is all about preparing your company for whatever the future holds so that you’re not caught by surprise and can make the best decisions to grow your business.
Here are a few key reasons why you should forecast revenue.
Build a Realistic Budget
Business finances are similar to personal finances.
With personal finances, you plan your budget based on your income. If you get paid $5,000 per month from your job, you know you can’t afford to spend more than that. Aside from your fixed expenses (rent, utilities, etc.) you can also budget for things like food, going out, and other variable expenses as long as they’re within your income.
The difference with a business, though, is your revenue is rarely the same each month. Your revenue can fluctuate depending on how much you sell, how much you churn–if you’re a subscription company, and overall market conditions.
This can make it difficult to budget for operating expenses like marketing or new expenses like hiring employees.
Revenue forecasting helps bridge that gap, particularly for operating expenses. Your forecast gives you an estimate of how much revenue you’ll generate over the next few months or year. This will allow you to know how much you can budget for marketing campaigns, new hires, software, and other expenses that change over time.
Plan For New Hires
I mentioned new hires above, but it’s worth pulling out into its own section. Hiring is unique because unlike some other expenses, it usually needs to be planned months in advance and your revenue plays a major role in your hiring decisions.
When you’re thinking of hiring a new employee, you need to be sure you’ll be able to afford them long term, not just in the moment. If your revenue forecast shows revenue increasing over the next 12 months, that might give you the assurance that you’ll be able to afford to grow your team.
The opposite is also true though. If your forecast shows a decline or slowdown in revenue growth, your hiring plan might be more conservative.
Prepare for Investors
If you’re planning to do a fundraising round, or have current investors, they’re going to expect to see a revenue forecast for your business. They might ask what your projected revenue is for the year and what you’re projecting for the next year.
Your revenue forecast will allow you to give them numbers that are based on data, not just what you “hope” to reach. Sure, you might want to bring in $1M in revenue next year, but does your revenue forecast support that?
That’s why a revenue forecast is a must-have for pitching potential investors and meeting with your current ones.
How to Forecast Revenue
Alright, now that we’ve covered some background information and set the stage, let’s dig into how to build a revenue forecast!
Instead of giving you generic tips, though, we want to give you a step-by-step example.
We’ll do it using a fictional SaaS company that sells drag-and-drop design software for small businesses. In this example, I’m the founder and I want to forecast revenue for the next 12 months. Here’s what the process looks like:
1. Choose a Revenue Forecasting Software/Tool
First, you need something to build your forecast in. You have a couple of options:
- Dedicated software
A lot of companies use spreadsheets for revenue forecasting. However, there are several downsides to going that route, which we touch on in this article.
When given the choice between complex spreadsheets and a dedicated tool that’s easier to use, I’ll go for the dedicated tool nine times out of ten. And that’s the case here.
For this example, I’m going to use Finmark for revenue forecasting. Not only is it our own software, but it makes the process extremely simple, particularly if you don’t want to deal with a bunch of Excel formulas or search for templates online.
If you want to follow along, or if you just want an easier alternative to spreadsheets, you can try Finmark for free here.
If for some reason you prefer to use a spreadsheet or another tool, you can take the same approach I’m taking here, but the process will be different depending on the tool you’re using.
2. Add Your Products
Since we’re forecasting revenue, we need to make sure all of our products and revenue streams are included in our forecast.
We’ll start with products. Products are the items you sell. They could be physical products, subscription plans, or whatever else you’re selling.
For our fictional company, our main product is our subscription, which we offer in three different plans:
- Basic – $20/month
- Pro – $50/month
- Premier – $100/month
Each plan level is a separate product, because customers can subscribe to any one of them.
Let’s add those into Finmark. You’ll just need to fill in the plan name, price, subscription frequency (monthly, quarterly, or annually), and churn rate for the plan.
If you’re unsure of what your churn rate is, check your actuals. If you don’t have the data on-hand, you can estimate. However, we highly recommend using actuals here so your forecast is as accurate as possible.
You’ll repeat the process for all of your individual plans.
Here’s what all of our plans look like once we’ve added them:
If you have non-recurring revenue, you can add that in too. For instance, let’s say our company also sells design templates customers can use with our software. They pay a one-time fee for each template and they can use it as much as they want.
We can add that in as a separate product.
If we sell multiple templates, we can add them all in. So here’s a look at all of our products.
Once you’ve added in all your products, you can move to the next step.
3. Add Your Revenue Streams
We have our products added. Now we need to set up revenue streams for them.
A revenue stream is the way we make money from the products we added in step two.
We’ll start with our subscription plans.We’ll add a revenue stream called “Subscriptions” since that’s how we’ll make money from each plan.
We’ll add all three of our subscription plans to this revenue stream.
We also need to add our revenue stream for our templates. We sell those as one-offs, so we’ll choose “One Time Purchases” as our revenue stream for those.
Once your revenue streams are in, it’s time to forecast your growth!
4. Add Your Revenue Driver
You have your product and your revenue stream. The last part of the equation is your revenue driver.
A revenue driver is what your revenue growth is based on. If you project you’re going to grow your subscription revenue 5% month over month (MoM), what is that 5% based on?
In Finmark, we give a few options for revenue drivers:
- Base subscribers with monthly growth: Build your forecast based on your expected monthly growth rate. This is a great option, particularly to start out with. You set your initial number of customers and then a projected growth rate for each month.
- Marketing led conversion: Build your forecast based on conversions from marketing campaigns. If you use ads or other paid marketing channels to acquire customers, this is a great option to forecast the revenue you’ll generate from those channels.
- Sales led conversion: Build your forecast based on sales quotas. If you have a sales team, particularly outbound sales with quotas, this will help you forecast the revenue they’ll drive.
- Custom: Manually build your forecast by entering your projected customer growth for each month. This option is mainly used if you’ve built your model in a spreadsheet and just want to port the data over.
For this guide, we’ll stick with just the base subscribers with the monthly growth option. It’s the simplest and most straightforward way to forecast revenue. If you want to see how to forecast with marketing and sales led conversions, check out this guide.
To forecast our growth, we’ll just need to input a few details.
- Acquisition start date: What month do we want to start forecasting from?
- Acquisition end date: If there’s a date you expect to stop acquiring leads, you’d enter it here. This is good for time-specific campaigns (i.e. summer sale) or if your revenue growth changes over time due to seasonality.
- Initial customers: How many customers will you acquire on the acquisition start date? This is the base number of customers for your forecast. If you already have existing customers, you can enter those numbers here.
Here’s what we’ve entered for our fictional company.
Lastly, we need to enter our expected monthly growth rate. How much do we expect our customer count to increase each month?
This step is very important. The growth rate you put here should be based on data. On average, how much have you historically grown your customer count MoM?
If you’re a new company and don’t have historical data, you can work backwards based on your revenue and customer goals for the year.
Here’s a rough example of how it might work.
If you have a goal of reaching $200K ARR for the year, calculate how many customers you need to acquire in order to reach your goal.
$200K ARR works out to roughly $16.6K MRR. Now, let’s say you’re currently generating $6K MRR and have 120 customers. You need to add an additional 10.6K in new MRR throughout the rest of the year to reach your goal.
Your average revenue per account (ARPA) is $50 (6000/120). So you need to add about 212 new customers (10.6K/50) to reach your goal of $200K ARR. Based on those numbers, with a growth rate of about 5%, we can reach our goal in 12 months.
That was a lot of math–I know! Luckily, if you have actuals, you can skip that. You’ll just enter in your historical growth rate (try to stick to your average growth rate from the past 3-6 months) and Finmark will handle all the calculations for you.
Back to our fictional company. We have historicals, and it shows that we’ve grown my 7-10% MoM for the past six months. To avoid overestimating our growth, we’ll choose a growth rate of 8%.
Here, we can see what our forecasted number of new customers will be in 12 months. Once we click Add, we’ll be able to see our revenue forecast.
We’ll follow the same steps to forecast revenue growth for our template sales. And here’s what our total revenue forecast looks like after adding in our forecasted template sales.
We can also see the forecasted revenue per product and per revenue stream.
Boom! Just like that, we have a complete revenue forecast for our company. You can follow the same steps to forecast your revenue for your business.
The process will be different if you’re using a spreadsheet or another revenue forecasting tool, but the same general concepts apply:
- Add your products
- Add your revenue streams
- Make your assumptions for how much you’ll grow
If you want to build your forecast quickly and easily like in our example, I highly recommend using Finmark.
Bonus: Create Alternative Revenue Forecasts
We created a single revenue forecast for our business, but as we all know, growing a startup comes with ups and downs.
In order to prepare for those highs and lows, it’s a good idea to create alternative scenarios for your revenue forecast.
In addition to the base model we just made, we recommend creating two additional scenarios:
- Upside scenario: This scenario forecasts the best case scenario for your revenue growth.
- Downside scenario: This scenario forecasts the worst case scenario for your revenue growth
We can easily create these new scenarios in Finmark by duplicating the initial scenario we just created.
We’ll call the new scenario our Upside Scenario. Don’t forget to add in a note to remember what you change with each scenario.
Repeat the same steps to create your downside scenario.
Next, we just need to change our assumptions for our growth rate for each scenario.
Remember, our fictional company has grown subscriptions by an average of 7-10% MoM historically. We’ll use that range in our upside and downside scenarios.
For our upside scenario, we’ll assume a growth rate of 10%, since that’s the most we’ve ever grown in a month. For our downside scenario we’ll be a little more conservative and assume a 6% growth rate just to add some buffer.
After editing the upside and downside scenarios with our new growth rates we can compare the revenue forecasts against each other.
In the GIF below, the orange bar is our base scenario, the yellow is our upside scenario, and the red is our downside scenario.
With this, we can see our base, best, and worst case scenarios and plan for things like hiring, marketing spend, and our overall growth strategy!
Do’s and Don’ts of Revenue Forecasting
Now that you know how to create a revenue forecast, let’s go over some best practices to make sure your forecast is as useful as possible. Here are some do’s and don’ts of revenue forecasting.
Do Base Your Assumptions Off Data
You’ve probably noticed a recurring theme throughout this article—data! So many founders make the mistake of creating revenue projections based on their most optimistic expectations. The problem with that is it can lead you to overestimate your revenue numbers which can be devastating for your business.
The only thing worse than overestimating your revenue is making decisions based on those predictions.
For instance, let’s say you forecast you’ll reach $1M in ARR in 12 months because it sounds good, but you don’t have data to support your assumption.
You build your hiring plan with the assumption you’ll reach $1M in ARR. However, it turns out your ARR is only $600K after 12 months. You’ll end up hiring people you can’t afford and the end result is an uncontrollable burn rate, layoffs, and stunted growth.
Long story short, data is your friend!
Don’t Try to Create the “Perfect” Forecast
The perfect forecast doesn’t exist. Even if you go through every detail with a fine tooth comb, it’s impossible to predict exactly how much revenue you’ll have in three months, yet alone 1-2 years from now.
Between today and three months from now, any number of things can happen. A new competitor could pop up and disrupt your entire industry. You could see a spike in customers after your product goes viral. Your growth could stay flat for an extended period of time.
The point is, business is dynamic.
Revenue forecasts aren’t meant to be crystal balls that predict your exact future. They’re meant to give you guidance so you can make more informed decisions.
Spending days or weeks trying to forecast every penny you’ll generate next quarter isn’t the best use of your time. Instead, try to get your forecast as accurate as you can, and make adjustments as things change.
Which brings me to my next point…
Do Update Your Forecast Regularly
Your revenue forecast shouldn’t be something you make at the beginning of the year and leave sitting to collect dust.
As things change in your business, you should update your revenue forecast to reflect the changes.
For instance, your initial forecast might’ve accounted for 3-4 specific marketing campaigns to run throughout the year. But after doing two, you might make adjustments based on the results you got. Whether it’s trying a new channel, optimizing your ads to convert better, or lowering your performance expectations, it will all impact your revenue forecast.
How often you update your revenue forecast depends on your business. An early stage startup that’s doing a ton of testing to figure things out might need to make adjustments monthly, whereas a more established company might update their forecast quarterly.
The most important thing is not to treat your revenue forecast like a static document. If you’re consistently checking and analyzing it, it can be an extremely useful tool for growth.
Don’t Create Your Forecast Alone
Unless you’re a solo-founder and doing everything on your own, revenue forecasting requires input from multiple people.
Marketing can tell you about their planned initiatives to drive leads and revenue. Sales will give you insights into the pipeline and sales velocity. Everyone involved with generating and retaining revenue can give you recommendations and data that you might overlook. This can be helpful if you’re not as “in the weeds” day-to-day with marketing and sales.
Something else to keep in mind is sharing your revenue forecast with your team. It’s something our very own founders at Finmark have been doing and it gives the entire team visibility into where we are and how all of our roles impact growth.
I’ll admit, it helps that we build financial modeling software that makes showing your revenue forecast a lot easier 😉.
Do Use Your Forecast to Plan Your Growth Strategy
Like I mentioned earlier, your revenue forecast is more than just a report for viewing. You can (and should) use it to plan your growth strategy.
Remember, your forecast shows you where your company is based on your current plan. But what if you want to grow revenue faster? Or maybe you want to measure the impact certain activities will have on revenue growth.
By creating multiple scenarios, you can test plans before putting them into action and see how they’ll affect your revenue growth.
For example, in the screenshot above, we’re looking at a revenue forecast based on two different scenarios:
- Green: This scenario assumes this company will convert more leads
- Orange: This scenario assumes the company will convert an average number of leads
This data can help set goals for what their target conversion rate needs to be in order to meet their revenue goals.
If you want to learn more about how to create, compare, and analyze multiple growth scenarios check out our scenario analysis guide.
Don’t Be Too Conservative (Or Too Aggressive)
When you’re building your revenue forecast, something to be cautious of is being too convervative or aggressive with your assumptions.
An overly-aggressive revenue forecast can lead to spending money you don’t have. It also hurts morale when you’re constantly falling short of your forecast.
Believe it or not, an overly-conservative forecast also isn’t great. If your revenue grows faster than you anticipated, you could find yourself understaffed and/or overworked. On top of that, if you’re consistently under-forecasting your revenue, you might not be growing as fast as you could.
Let’s say you forecasted you’d do $1M in annual revenue; but you end up doing $1.5M. If your forecast would’ve been more accurate, you could’ve planned to hire more people or invested more into marketing campaigns throughout the year, which in turn could’ve boosted your revenue even more.
This is why we always recommend using data as much as possible for your forecast—it’ll give you guidance for your assumptions.
There’s nothing wrong with setting aggressive goals for revenue growth, or wanting to prepare for slower or declining revenue, but try to be realistic. Following the steps we laid out in this guide will help a lot. But it’s also helpful to self-regulate so you know when your forecast seems “off”. And by “off”, I mean unrealistic.
Ready to Forecast Your Revenue?
Revenue forecasting doesn’t have to be overly-complicated or so complex that only financial pros can do it. If you have the right tools and understand how and why your business grows, you can build a revenue forecast that’ll help you project growth, present to investors, and make informed decisions about where to take your company.
And if you want the easiest way to forecast revenue, I highly recommend giving Finmark a try. Not only can you forecast revenue, but you can also create your entire financial plan for your startup. Did I mention you can try for free?