How To Use Driver-Based Revenue Forecasting for Your Small Business
As a small-business owner, you need accurate data to plan for the future, especially when it comes to cash flow and revenue forecasting. An SMB growth strategy needs the most accurate forecasting model available to ensure staffing levels, equipment needs, and marketing budgets are met.
According to Gartner, 78% of surveyed organizations use driver-based revenue forecasting [1]. Additionally, organizations that Gartner surveyed maintain that, between the three predominant forecasting methods—driver-based, run-rate, and risk-based—driver-based forecasts are the most accurate.
In this article, we’ll draw from Gartner’s recommendations on developing an effective driver-based forecast [2] to explain how to create one for your small business.
What is driver-based forecasting?
Driver-based forecasting identifies your small business' main value drivers to allow you to build a plan and budget based on those drivers. An SMB can use driver-based forecasting to outline potential growth, which is key to your company's survival.
Your planning budget operates around driving more work to your business, and it can model potential growth using various factors. For example, consider a business that manufactures small batches of high-quality parts through the use of multi-axis, CNC milling machines for companies that need precision components. This manufacturing business may use manufacturing-specific ERP software to gather data points about material shortages, supply chain issues, or product quality issues based on customer feedback. Using these data points—among others—manufacturing businesses can more accurately forecast revenue and productivity in the coming year and beyond.
How to build a driver-based forecasting model
This five-step process outlines how to connect driver-based forecasting to business goals.
Step 1: Define your business goals and key metrics
Business goals are qualitative in nature, and are often a simple statement. Let's say you want to become the top marketing agency in your city within three years. To do that, you need to increase your revenue, the key quantitative metric behind that goal. As such, you need the staff and technological tools to monitor and manage growth with the help of revenue management software.
Step 2: Determine which drivers impact performance
How does your company measure success? Is it through the number of people you've helped? The number of lives saved? The number of products sold? More people in the door? Determine which drivers measure the success, impact, and performance of your company as you move towards your goal based on your business model. You might want to get 30 more people walking into your retail store every week because each person spends an average of $50 in your store to drive growth against your competitors.
Drivers should be something you can easily control and have minimal diminishing returns. What is your company best at? Does your business have a committed social media following that engages with your posts? Are you able to continuously optimize your production process to lower costs without losing quality? Leverage your strengths and grow.
Step 3: Identify variables that influence drivers
Watch out for two variable types that influence drivers: static and dynamic. Static variables rarely change year over year, and you can make assumptions based on those variables. For example, your clothing boutique thrives on holiday shopping and seasonal changes, allowing you to pinpoint peak business periods. You might also assume that when you stock a new line of popular fashion pieces, your sales will increase due to buzz surrounding new trends.
Dynamic variables, sometimes known as indicators or leading indicators, can build on your past output to determine how your business will fare. But these variables change with time because you are adding to the output as weeks and months pass. For example, your business grows steadily because you increase your loyal customer base over the course of several months. You add five new returning customers per month, and they stay with you to grow your revenue base.
Step 4: Establish how to measure drivers—and who does it
You need to measure business drivers to forecast how they will help your business move forward. For instance, you're a manufacturer that custom-makes stem bolts for large equipment manufacturers. Your team wants to break into the South American market, so you increase your sales presence there by hiring three bilingual sales reps who know your product lines very well.
You'll need a great customer relationship management (CRM) tool to track prospects, sales, and revenue to see if your sales team is coming through in your target market. Then, designate who, perhaps a sales director, will oversee this sales team over the next year to determine success.
As you implement the sales tool, give access to key people in your organization so they can make decisions, such as a plant manager, line leader, finance team, and you as the owner.
Consider another driver: It might be the case that you want to improve the ingredients of your food products to make them more sustainable and nutritious. To do that, your procurement team needs to find the appropriate vendors to find the right ingredients. Vendor management software can help in this regard to automate processes and give your procurement specialists the tools they need to make strategic decisions down the road.
Step 5: Revisit and update your driver-based model
Driver-based forecasting is only as good as the people making the decisions behind it. Always revisit the strategy and make tweaks if you need to. For instance, you assumed that hiring five new sales reps would land you at least 20 more contracts in a one-year period with the goal of increasing recurring revenue by $1 million a year. If your company only earned 10 more contracts in that timeframe, determine what went wrong and make changes.
Common pitfalls and keys to success for driver-based forecasting
Driver-based forecasting can help you succeed, but your team may need to get past some common pitfalls of this model.
You might think applying a one-size-fits-all approach to your entire business could work, but selective forecasting, where you examine particular historical data before making informed estimates that can predict future trends, might be more appropriate when you talk about who brings in the sales and revenue versus the operations of your business. Driver-based forecasting focuses on key business drivers as opposed to complete or selective historical data.
Another pitfall comes from becoming too attached to your driver-based strategy. If something doesn't work, you'll have to be agile and flexible enough to make changes.
Try not to rely on overly detailed forecasting models. Maintain only one or two key metrics for the forecast based on historical data, materiality, and measurability. If you need more detailed data, you can discover insights from processes and documentation within your company as a whole. For example, one key metric is revenue. How you achieve more revenue comes from internal processes, such as discovering opportunities for upselling with current clients thanks to sales staff and account managers who gain insights from current clients in the course of contractual work.
Need more information on how you can employ driver-based forecasting with your small business? Software Advice has some resources for further reading: