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.
a.
Attempting to forecast growth in terms of a
percentage becomes a guessing game that few people are able to predict
accurately.
b.
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.
a.
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.
a.
When growth goals exceed carrying capacity, the
result is either anemic or unprofitable growth.
b.
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.
a.
Using a P&L to record results creates
multiple issues including:
i.
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.
ii.
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.
