White Squires
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Current Business Issues

As sure as day follows night, this economy will turn around, but for now, CFO's are driving changes in their businesses to deal with the downturn. But this requirement to rightsize the business, has to be balanced with the need to manage its exposure to risk. Call us today to find out how White Squires can help you get the balance right.

 

Weathering The Storm

Brendan Sheehan - 2nd April 2009.

When the economy is contracting sharply, the most important thing that can help you make good decisions is knowing what your revenue is going to be for the next 3 to 6 months.

Profitability is a very simple equation; Revenue – Costs = Profit. If you know what your revenue is going to be and you know what you need your profit margin to be, then working out the amount you have left to spend is a pretty straightforward calculation. Once you have a handle on how much you can spend, its a lot easier to work out how to spend it. Yet despite the importance of the revenue number, very few Professional Service Firms use anything more than guesswork to do their forecasts.

A $100,000 client fee multiplied by a 50% probability that it will be billed in May, does not mean that your revenue is going to be $50,000 in May. It means that it is either going to be $100,000 or zero. That's a huge difference, and yet this “sticking your finger in the air” approach is the way that many businesses forecast, with potentially disastrous results:

  • Underestimating revenue can ripple through the supply chain and cause project staff and support staff to unnecessarily lose their jobs; which can then lead to under-capacity issues later on and possible loss of clients and market share;
  • Overestimating revenue can cause profits to be wiped out, and serious cash-flow difficulties later down the track; which can anger owners and shareholders and cause management to lose their jobs as a result;

Revenue forecasting based on probability estimates is not the way to get accurate numbers. A more effective way is to use a combination of top-down and bottom-up forecasting, which is similar to how an investor uses a combination of Chart Analysis and Fundamental Analysis to evaluate the price they should pay for a share.

Top Down Forecasting

A top down approach involves using a combination of ratio analysis and trend analysis to forecast the revenue numbers at an organisational level. If you look back at the historical productivity (ie. the revenue per fee earner) of the firm over the past number of years you will detect trends in the way that revenue is generated (for most Professional Services Firms there will probably be peaks around tax time and corporate fiscal year ends). When you have large amounts of data, a well diversified range of clients and a counter cyclical service offering, this historical analysis can be a very accurate indicator of future revenue. When you have finished you will have a very accurate version of the revenue forecast by Service Line and by Geographic Region.

Bottom Up Forecasting

A bottom up approach involves looking at the detail. Every manager that is responsible for forecasting revenue needs to look critically at every project to decide if it will, or will not generate revenue in a particular month. If it will be billed, then include it in that month's forecast. If it will not, then don't include it. Only when the manager is 100% certain that revenue is going to fall in a particular month should they submit the forecast.  When all the bottom up data has been compiled it will create an alternative version of the truth, analysed by Service Line and Geographic Region.

 

You can now carry out a Gap Analysis on the results from the two versions of the truth. You may need to fine tune the top down numbers and you will likely need to go back to the managers to scrutinise their projects and pipelines again, but eventually you will have a very clear understanding of the revenue gap that needs to be filled. Armed with this kind of information you can start to make operational decisions well in advance of the market, rather than waiting to react until after the forecasts have been missed.

This approach to revenue forecasting is the kind of forward-looking analysis that determines the success of a business in volatile times. Technology can certainly help by using Business Intelligence tools to analyse data and by having a good project management solution to track the status of projects, but the accuracy of revenue forecasts are only as good as the process behind them.

Just as weather forecasting is more than sticking a finger in the air, revenue forecasting is more than a probability estimate, and the top-down / bottom-up approach will give you far more accurate information to help you guide your business through the economic storm ahead.

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Once you have invoiced the revenue the next step is to make sure that you collect the cash. And that's the topic of our next article, “Show me the Money”.

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