Why Revenue Based Forecasts Fail

Having been a part of numerous business planning and budgeting sessions for a number of industries, I have been able to see firsthand the failure of revenue based business models. When budgets, forecasts or entire business plans are developed based on the increase or decrease in revenue, the end result is often times an inability to reach revenue based goals. Those instances where the goals are reached or exceeded can be attributed more often than not to single point market contributions that may not be able to be continued or sustained.

Revenue is not a controllable key performance indicator, but rather a result of multiple controllable indicators. Basing a forecast or budgeting model on growth in revenue without making the proper determination of which indicators can have the most impact and utilizing them to determine possible growth goals will most often result in an inability to grow in a sustainable and profitable manner.

Assuming first that a forecast will by nature include growth in revenue and profitability, basing either growth on an increase in revenue without diving into what creates it will leave an organization with shortfalls, or the inability to consistently recreate any standard of sustainable revenue enhancement.

There are four basic flaws to revenue based budgets and forecasts:

1. Revenue is a product of multiple indicators and therefore cannot be derived without considering the impact and ability of the other indicators to produce. Revenue is always the sum of number of transactions multiplied by the average dollars per transaction.
   1. Attempting to forecast growth in terms of a percentage becomes a guessing game that few people are able to predict accurately.
   2. Top down forecasting (Revenue to COGS to Expenses to Profit) creates the inability to develop margin based indicators or track to results using anything but a P&L.
2. Revenue based forecasts do not take into consideration the impact of change in the workforce. Attrition, addition or reallocation of resources designed to create revenue streams will have an impact on the final number and must be taken into consideration when forecasting.
   1. Each member of a revenue production department will have an impact. Change in workforce, workforce efficiency or lack of individual non-revenue based goals/quotas will lead to a declination of margins or inconsistent ability to grow.
3. Revenue or revenue growth is not a sign of a healthy organization. Using revenue as an indicator without understanding the effect and nature of its growth can be detrimental to organizational profitability.  
   1. When growth goals exceed carrying capacity, the result is either anemic or unprofitable growth.
   2. Growing revenue without understanding its makeup can dilute gross profit margins and require unbudgeted expenses to attain.
4. Revenue based forecasts require a P&L to determine results and accuracy.
   1. Using a P&L to record results creates multiple issues including:
      1. Accuracy of the P&L. P&L is based on accounting which is based on accurate recording of events throughout the course of a specific time period. If there are adjustments in accounting in that time period or coming from previous time periods, the accuracy of the P&L will be impacted.
      2. Timeliness of the P&L. P&L statements record history not as it happens, but as it is accounted for and are not intended to be used accurately track critical variables. When the P&L statements have been completed, it is too late to impact the results of what has already happened and not enough information to adjust what will happen during the next period.

Revenue based forecasting models are perhaps the easiest to use and explain to departmental or divisional managers when it comes to providing forecasts. They are also innately more simplistic than other forecasting models based on critical variables and thus create less of a need to utilize additional time or resources. In this case, easier is not necessarily better. Taking the time to understand your carrying capacity, what your strengths and weaknesses are compared to your competition, developing real-time critical variable or KPI metrics that can be utilized to measure your success and more accurately forecast your future is definitely a longer and more difficult road, but at the end of it, you will have developed a blueprint to create better trained managers, more engaged employees and most importantly a path to repeatable and sustainable success.