Each year, we develop a budget for our consulting firm, Whitestone Partners. This includes a revenue forecast. While creating a forecast for current clients is easy, it can be harder to predict potential revenue from clients who are in various parts of the sales pipeline. We have a technique we use that is very helpful in predicting this type of revenue. You might want to try it, too.
In terms of the nitty gritty, you can use paper or a white board when you employ this technique, but we find it helpful to use Excel, because you can set it up to do the calculations for you. Next, get ready to work with some numbers and calculations.
First, in the left-most column, list the names of all prospects. At the bottom of this column, add one more item, “Unknown.” Use this box to add together total revenue from clients you'll pick up throughout the year that you have not yet identified.
In the next column to the right, enter the amount of revenue you expect to receive during the year if you close the client. Remember: If you think it will take six months to close the client, you will bill for only the second half of the year. Make sure to factor this consideration into your estimate of revenue.
In the third column, enter the probability that you will close the deal (obviously, this assessment will be between 0 percent and 100 percent). If any client might offer more than one possible piece of work, with a separate and different probability for you to close the deal, create multiple line items.
For example, consider two possible projects at the Acme Machine Company. Project A would bring in $150,000 and has a 75 percent probability of closing. Project B would bring in $500,000, but has only a 20 percent chance of closing. Create one line for Acme -- Project A, and a second line for Acme -- Project B.
In the fourth column, for each row, multiply the contents of the second column (the expected revenue if the deal closes) by the contents of the third column (the probability that the deal closes). So for example, the fourth column for Acme -- Project A would be $112,500 ($150,000 x 75 percent) and for Acme -- Project B it would read $100,000 ($500,000 x 20 percent).
In the fourth column, in the row titled “Unknown,” put your estimate of revenue that will come from clients you have yet to identify. Admittedly, this can be somewhat of a crap shoot, but if you have been in business for a few years, history should be a good guide for helping you make this estimate.
The sum of the entries in the fourth column will be your forecast of revenue from the list of prospects. What you have done here is to discount the potential revenue from each prospect using your assessment of the probability that the revenue will come to fruition.
A simple example, where you will intuitively know the answer, will help illustrate the concept: Suppose you have ten prospects, each of which you expect to generate $200,000 of revenue if you can the deal. Further, you assess the probability that each will close, at 20 percent. This will mean that two of the ten may close. Two new clients at $200,000 each will be $400,000 of incremental revenue.
You’ll reach the same conclusion, following the process we've outlined. That, is multiply each of the ten estimates of $200,000 of revenue by the 20 percent chance each will close; then add up the ten results (i.e., $200,000 x 20 percent = $40,000 and $40,000 times ten, which equals $400,000).
These are still estimates, and reality usually varies from estimates -- sometimes significantly. This notwithstanding, the process outlined above is the best we have found for estimating revenue from a number of potential sources, where there is uncertainty around whether any of those deals will close.
It is what we use and what we teach to our clients. We hope it helps you as you tackle budgeting for your small business.