Friday, May 27, 2005

Sales Forecasting

This post addresses a key question for start-ups, how do you model and forecast sales?

Forecasting Revenue
A key mistake start-ups make in raising money relates to how they model future revenues. This post explains a bottoms-up approach to forecasting revenue. My favorite bottoms-up forecasting method is the productive sales rep model. In this model, future bookings are NOT a function of market share, size, and penetration rates ($500m market x .005 penetration, or $2.5m) but rather of how many mature sales reps are in the company and the expected sales rep quota and productivity. A top-down approach is simply too hard to handicap and fails to ensure that a company matches an investment in sales resources with projected bookings and revenue.

First Model Bookings
Bookings = mature reps x quota per rep x productivity
Bookings = purchase orders
Mature reps = the number of reps with sufficient market and product experience to be effective (typically six months with the company)
Quota = bookings quota per year (typically $1-2m per rep in a start-up, and $2+m per rep in a mature company)
Productivity = percent of total quota achieved, on average, by the sales force

Therefore, for a start-up, with two mature reps entering the year, one rep joining in January, a $1.5m quota, and an expectation of 75% productivity, bookings would equal:

2.5 (mature reps) x $1.5m (quota) x 75% (average productivity as % of quota), or $2.8125m.

Then Assume Bookings Mix and Revenue Recognition Policy
To get to revenue, we then need to assume 1) a revenue recognition policy and 2) a bookings mix across license, maintenance, and professional services. This mix is typically 70% license, 15% maintenance, and 15% professional services.

Wrt revenue recognition, license revenue is recognized at the time of sale, while maintenance and professional services revenues are recognized pro-rata over the course of the year/project. For example, assuming the bookings mix above a $1m purchase order (booking) on April 1 would contribute the following revenue in the year:

License revenues: $1m x 70%, or $700k
Maintenance revenues: $1m x 15% x 9/12, or $112.5k
Services revenues: $1m x 15% x 9/12, or $112.5k.

While there were $1m in bookings, revenues would be $925k, with the $75k difference on the balance sheet at year-end as deferred revenue.

I have a good worksheet I am happy to share if people are interested. The key issue is make sure that sales projections are tied to tangible investments in sales resources and are based on reasonable assumptions of sales rep productivity, time to maturity, and quota. Finally, think through how bookings translate to revenue. A sophisticated approach to the problem will go along way in gaining credibility with a prospective investor.

7 comments:

  1. It would be great if you could post the worksheet.

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  2. Great post, but...

    This model only applies to sales-team style products and companies. What about Google Ads or Basecamp, say? The customer interacts entirely over the web and no reps are involved. I am deliberately excluding corporate accounts of course, but that long tail sure is big.

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  3. Richard,

    I completely agree this model is germaine to enterprise sales.

    I would be delighted to see a post or thoughts on how to model consumer Internet sales, ie without a sales force.

    This appears to be a real challenge and especially difficult if you are trying to match expenses to projected revenue.

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  4. I agree. I am starting that kind of business and I'd love to see how others have modelled their sales. Maybe I will work something out once I have more experience.

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  5. Will,
    Thank your for clarifying how to properly forecast sales. I work with entrepreneurs and their idea of forecasting sales is often ridiculous and always circular. When building projections, they inevitably end up saying something like, "Well, I know sales will be $500 million in year three, so how I do model that?". As a former distressed company consultant with hard-core modelling skills, it kills me to see the methods often used in modeling. Kills me!

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  6. I'm currently working on a forecast for a start-up and I'd like to check out your worksheet. I'm sure it would provide some useful tips, in addition to the good stuff you've already posted. Thanks.

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  7. I think this is a pretty good description of an enterprise sales model. Does anyone know of a link to a good channel sales model?

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