The Problem With Traditional Approaches to Assessing and Forecasting Future Revenues

I’ve worked with a few dozen lower-middle market companies in the last 4 years and I can pretty confidently say at this point that no one has figured out the secret to forecasting revenue. You can take a deep breath. It’s not just you.

But what I will say is that some do a much better job than others. There are a lot of approaches and ways to think about forecasting future revenue growth and every method has advantages and disadvantages, but none is perfect and each usually only tells part of the story.

In this edition of the newsletter, I want to share some of the common challenges with traditional approaches to assessing and forecasting future revenues. This will help you understand and inform your current approach and get a sense of what good looks like.

First, I want to set the stage by starting with “why does this even matter”?

The most straightforward answer to this question is that every investor, owner, CEO, and management team is basically trying to do the same thing: accurately assess their company’s capacity to generate sustainable revenue growth and hit their financial targets.

Revenue growth is the primary basis for long-term equity value. It’s what investors are buying and what CEOs and managers are trying to generate.

But as revenue advisors, we’ve seen time and time again that the tools these teams have to accomplish that goal are insufficient. Each of these compounds and leads to other issues, but the challenge facing stakeholders can basically be categorized into a handful of buckets.

1. The “science of growth” is not very well understood by investors, CEOs, and managers. This is largely because the assets (e.g. people, processes, data, etc) that create the revenues are intangible and difficult to measure, manage and report. Tangible assets like inventory and equipment are much easier to measure and report on. In fact, they show up on your financial statements and it's easy to quantify their role in revenue generation. This is both a challenge and an opportunity for companies that embrace this fact because intangible assets are hard for competitors to imitate, which makes them a powerful source of sustainable competitive advantage.
2. Management teams lack visibility into the capabilities of their revenue generating assets. This is a bit related to the first point, but this is more about understanding how well your revenue generating assets are positioned. The challenge is most companies don’t audit their revenue generating functions on a routine basis, the way that they do with lets say finance and accounting. There is a lot of gut feel and abstraction that takes place when evaluating the maturity and strategic readiness of these functions, so leaders can’t take corrective action that’s rooted in facts and data. This makes it difficult to build a management consensus on the “math” on how a firm grows and the capabilities that can create the greatest value to the firm.
3. Forecasting, resource planning, and capital allocation involve significant “guesswork”. In most organizations, revenue generating functions (e.g. sales, marketing, finance, product, etc) are disjointed and operate in silos. Their processes and operating practices very rarely are tied into one another and this results in poor information sharing. Of course this means that getting a holistic view of risks and opportunities across the revenue cycle is nearly impossible. This leaves executives without a financially sound method to prioritize investments, manage performance, and allocate resources effectively for optimal business growth.

The next logical question to ask yourself as an investor, owner, CEO or manager is, “How do we overcome these challenges”?

While there is no “easy” answer, I can share how we think about bridging the gap by doing a Quality of Revenue assessment or QoR. This a forward-looking analysis that objectively evaluates a company based on its capabilities and functional drivers of future revenue growth. Although our framework is proprietary, anyone can leverage these principles and apply them to their company.

1. Start by getting a holistic view of your company’s revenue generation potential. This means you need to not only evaluate how well you are positioned in key areas responsible for generating revenue, but also you need to understand the causal chain of events that lead to revenue generation. In the case of QoR, we’ve broken this down into 12 categories which includes things like strategy, culture, and operations, which all have been proven contributors to future organic revenue growth.
2. Gain an understanding of your company’s value creation gap. Before talking about the future, it's important to assess and gain a shared understanding of the current state. This means you need an objective and fact-based assessment of where the business is today, what’s working, what isn’t, and what’s holding you back. Doing this exercise will help you better understand the gap between the current state and the future state. You can then identify the ,root causes of underperformance, quantify these gaps, and develop a clear roadmap that is optimized for feasibility and return on investment.
3. Get a measurement of the factors that contribute to growth. To do this, you need to routinely assess the strategic readiness of your growth functions and assets. Think of this as a routine audit of the health of your strategy, alignment, and ability to execute. On a regular basis you need to benchmark and quantity these things so that they can be measured, managed and improved. Without a pattern of health check-ups, you have no clue whether you are making measurable progress towards your goals or not.

By acknowledging and understanding the challenge that most lower-middle market companies face in generating sustainable, predictable, and reliable revenue growth, you can start to develop internal control processes to address these.?

My belief is that companies that embrace this systematic and proactive approach to evaluating their revenue-generating functions can make more intelligent investment decisions, reduce risk, and create more enduring value for their companies.

Thanks for sticking with me. See you next week!