What is Revenue Forecasting?
Revenue forecasting is more of an art than a science—for professional services organizations at least. Although the inputs used for revenue projections are quantitative in nature, successful professional services executives will often layer in their perspectives on the business, the market share, or key accounts. Perfecting the qualitative aspect of forecasting business revenue comes with years of experience working in professional services organizations.
The underlying planning and forecasting model, however, is something that every services manager should know how to build, and build well. There are quite a few different approaches to building a revenue forecast for a product or service. In reality, organizations will mix and match models to develop the most accurate forecasting method they can. Given that there are many different ways to predict future revenue, here are a few of the most common:
The Pipeline Approach to Revenue Forecasting
The pipeline forecasting process involves tracking and measuring the organization’s future sales — or their sales pipeline. The idea being that some percentage of the sales forecast will turn into real work. The tricky part with this approach is trying take an educated guess around what the size of each deal will be, and what the “some percentage” of the pipeline is. Many organizations will use the percent likelihood of an opportunity, represented by the stage it is in, to factor the total revenue forecast. That being said, it is usually not until much later in the sales process that a reasonable estimation for size and duration is made. This limits how far into the future this type of forecast can reach.
- Pipeline data is usually accessible and easy to understand.
- Historical win rates can add confidence to the model.
- Sales team could be overly optimistic, leading to inflated projections.
- Doesn’t include in-process work.
- Doesn’t provide great detail for when the revenue will be earned.
The Backlog Approach to Revenue Forecasting
Similar to the pipeline approach, using your backlog for financial forecasting involves looking at the total amount of revenue that your organization has contracted but have not yet earned. When using backlog to forecast revenue, you don’t need to worry as much about factoring for uncertainty, but rather realistically distributing the revenue growth over time. This distribution can be done by calculating the typical run rate of your team for a given period and dividing that into the total revenue figure.
This calculation will represent about how long it will take the organization, at its current size, to earn what is currently in the backlog. This approach works well when a high-level view of the growth rate is all that the organization requires. It also assumes the organization has a historical track record of delivering work very similar to what’s in the backlog. Quite often, professional services organizations will sync their backlog with their pipeline to build a more holistic, long term revenue forecast.
- Easy to calculate.
- Doesn’t require heavy factoring.
- Can be utilized for demand capacity planning.
- The timing of revenue is an approximation.
- Only valuable as a planning tool.
Resource-driven forecasts, also known as bottom-up forecasts, allow teams to schedule all of their planned work and match the right resources to projects accordingly, using resource scheduling software and their best judgement. Planned work includes both projects in the proposal phase and also projects currently underway. Then, an organization can translate the scheduled work into accurate, time-phased revenue forecasts, providing insight into an organization’s capacity to successfully deliver the work within the estimated time of completion. This transparency provides teams with a clear understanding of the project pipeline but also allows resource schedulers to mindfully balance resources across the organization’s project workload. Resource-driven forecasts should be monitored on an ongoing basis and adjusted accordingly to highlight capacity shortfalls and surpluses, call attention to projects that are both ahead and behind schedule, and incorporate new work that enters the sales pipeline.
- Very accurate and detailed forecast.
- Can include both pipeline and in process work.
- Adjusts as project managers make schedule changes.
- Useful for highlighting capacity shortfalls or surpluses.
- Useful for highlighting projects that are ahead or behind schedule.
- Requires disciplined process to ensure accurate resource bookings.
A sophisticated resource management tool is needed to decentralize the process properly.
Historical Performance + Effects of Change
For organizations that run a recurring revenue business model, such as managed service providers, this approach may work well. It involves assuming the organization will earn at least the same amount of revenue this current period as it did during the same period in the past. With historical performance as a baseline, current conditions are then analyzed to assess how they may affect that performance. Winning or losing a major client, introducing a new service line, or outside market factors are all examples of events that should be taken into account.
- Can be performed quickly.
- Takes into account market factors in addition to backlog and pipeline.
- Can be performed in tandem with other approaches.
- Requires in-depth understanding of the firm, and the market it operates in.
- Needs to be consistently assessed for accuracy.
- Doesn’t highlight capacity requirements.
- Not appropriate for traditional services business models.
How Professional Services Firms Actually Forecast Revenue
So how do professional services organizations actually forecast their revenue? The real answer is likely some version of “all of the above.” Not only does every professional services organization approach revenue forecasting differently, but each one will also use a different mix of the techniques discussed above to come up with their final number.
Combining the backlog revenue forecasting model, a bottom-up approach to revenue forecasting, and the pipeline forecasting method would be an example of how this might play out in a real-world setting. Organizations that champion this forecasting process typically leverage PSA software to aggregate and validate their predictions. For standardized, repeatable work that has already been won, the organization may use their backlog to get a high-level view of revenue forecasts. Committed work that demands customization may require the addition of the bottom-up, resource-driven plan. From there, it may make sense to layer on pipeline work by using opportunity size, start date, duration, and likelihood to then model uncommitted revenue. This consideration allows the organization to accurately time-phase their revenue forecast and also commit to capacity planning around how they will deliver the work. Because resource-driven models understand capacity beyond the resource dimension (e.g. titles, departments, offices), the revenue forecast is useful for many decision-making processes.
What all Revenue Forecasts have in Common
Regardless of which revenue forecasting approach an organization chooses, there is one thing that all professional services organizations must do—check their work. Forecasts are only useful if they can be trusted. Professional services organizations need to be consistently measuring how accurately they can forecast work. If accuracy is lacking, then it’s time to evaluate a new approach. If forecast accuracy is a concern for your professional services organization, then take a read through our post: 6 Common Revenue Forecasting Mistakes Professional Services Organizations Make. We take a look at some of the common issues that come up during revenue forecasting, and how to avoid them.