Now is the time to get started on financial projections for the coming year, and these are the fail-safe steps that will help you do just that.
Remember the story I told in my last blog, the one about the CEO who doubled his sales as a result of projections? That CEO was focused on revenue streams. That’s where all projections have to start. You must determine what your revenue streams will be, either by service or product line.
Total revenue or total sales over the course of a year don’t just happen. Three ingredients go into generating those revenues. The first is the number of customers your company has. The second is the transaction frequency, or how often your company is expected to do business over the next year with each of those customers. And the third, of course, is the average transaction value. If you had a hundred customers and did business with each 10 times a year, with the average transaction $1,000, you’d have sales for the year of one million.
The other thing to focus upon is the velocity of these sales transactions. Velocity is likely to move up and down over the year, and you’ll have months or seasons where velocity is comparatively higher than at other times. Your company won’t record the same level of sales each month, so give thought to how that will vary.
The next step in the approach is to establish the gross margins of each revenue stream. The gross margin is a very, very important number in your financial statement, and a topic into which we’ll delve more deeply in a future newsletter.
In order to make informed future financial decisions, you must know the gross margin. That’s a combination of looking at the direct costs to produce each revenue stream, and adjusting your sales prices as needed to hit your targets.
Let’s define direct costs, as opposed to overhead costs. A direct cost is any expense related to generating that sale and delivering it to the customer, while overhead costs are not directly related to that sale.
The final step is studying overhead needed to generate revenue streams. Most businesses, I think, let overhead be where it is, realizing it will cost so much to generate those revenues. Some CEOs will take it a step further, saying, “No, let’s allocate a portion of overhead to each of those revenue streams.”
The result of projections is peace of mind for business owners, because they’ve laid out a plan. If you’d like a plan for the year ahead, get in touch with me.
I offer a 100 percent guarantee on my work. I take on only clients I can help. Call me and let’s talk about your business. My phone number is 630-269-7646.
Projections can help CEOs chart a course from zero sales at the start of the year to the sales objective desired by year’s end
Years ago, I sat down with a new client, and we chatted for hours. The topic: Whether I could help him determine if he would have sufficient inflow of cash to double his company sales from $4 to $8 million in the coming year.
It turned out he had a good command of his product line and product margins. On that basis, I told him we could work together to produce a set of monthly projections designed to determine if he would experience a cash shortfall.
Together, we determined there would be a shortfall. As a result, he approached his bank to increase his credit line. His company ended up doubling its sales. I helped him again the next year. Sales doubled again. I then constructed a model to help his people perform projections, and they took over in year three.
The point of the story is that the client would not have doubled his sales in two consecutive years had he not benefited from financial projections that told him he’d experience a cash shortfall, and would need to extend his credit line.
Therein lies the benefit of projections. If CEOs follow them, the projections force them to focus on the numbers. The ritual of establishing projections helps set a starting point and an end point, or goal. The projections lay out a course for the company to go from zero sales on day one to the desired year-end sales goal.
Projections are also helpful as a scoreboard with which to compare actual results. As you move through the year, you always want to compare how well your company is doing with what you projected it would do. This gives you an opportunity to adjust your actions to achieve your desired results.
Finally, projections enable CEOs to flesh out action plans for marketing and sales teams. Unless you have a methodology or program that says, “This is what we’re going to do to achieve these sales numbers,” it’s not going to happen.
Marketing and salespeople benefit from action plans that flow from the projections. What’s more, those action plans can be broken down by month, week or day to give key employees a blueprint for action. By monitoring those plans, a CEO can determine whether or not employees are getting results.
Next time around, I’ll lay out best practices in developing realistic projections, to help keep companies focused on the numbers.