Predicting Financial Results – It’s All About the Data

by | January 7, 2015

Blog written by Michelle Bomberger, Equinox Business Law Group

How many of you ended the year surprised by your business results?  How many of you could have readily predicted what the results would be?   It’s very common for small business owners to not have the tools to predict revenue and find themselves surprised by their year-end results.   Why is this?  We hear over and over the importance of both strategic and financial planning and some of us spend the late part of the year putting together such plans.  However, I think two things stand in our way of success in executing our plans.  First, the planning has to be based on some assumptions; and second,    we must have actionable steps to affect the plans.

After almost 10 years in business, I feel I’m finally understanding the business dynamics.  This is due to a number of things:  1) Scale: With 5 of us at Equinox, I must better understand the drivers of revenue so as to cover the costs; 2) Historical data: We’ve been around long enough at our size to see trends; and 3) Profitability:  A need to focus our efforts where they have the biggest bang for the buck – to maximize efficiency.  Up until recently, our annual projections were based on some percentage of growth over the prior year.  My CFO husband and my business coach consistently have asked, “Where is this new revenue coming from?”  And year after year, we use a set of somewhat arbitrary assumptions to determine what percentage of growth will come from current clients versus new clients and what amounts will be spent.   I was always baffled by how we can say that a certain number of new clients will come in the door and they will spend on average X dollars.   And yes, this is still more of an “art” rather than a “science” in my opinion – but with the historical data we have, we can now see trends in the business.   We can also begin to understand our leading indicators of revenue and predict whether a particular month or quarter will result in higher or lower numbers.   For example, if we received an unusually high number of prospective client calls in December, we assume it’s more likely that December and possibly January will have higher revenues due to the conversion of these prospects to clients.  The only way to use this information, though, is to have the data and know what it means to the business.

A first step is to consider what defines “success” in your business.  Most businesses are focused on the financial figures of revenue and profitability.   If that’s the case, then you want to know the factors that influence revenue and profitability in your business.  Note that these factors might differ from other businesses – even from other businesses in your industry.   Your business may be connected directly to one key customer or referral partner, so you must consider what actions on their part impact your business positively or negatively.   In retail or restaurants, consumer confidence data or actions by competitors might affect your business more heavily than in a commercial manufacturing context.   Similarly, businesses that rely on commodities as inputs such as oil will monitor cost of goods sold and understand the impacts of price changes on their bottom line.  These factors – often called Key Performance Indicators or “KPIs” – can be leading or trailing and are the baseline assumptions you need to build into your planning.

Once you have determined what KPIs you plan to monitor, you must track them month over month and year over year; analyzing them for trends.   Just because you think these factors are relevant to your goals does not necessarily mean they are in fact the drivers you thought they were.  Analysis of the data trends will help you understand how the factors interplay to move your business.   In our example above, the number of prospective client calls is assumed to drive future revenue.  However, if we see a spike in prospective client calls and no resulting revenue increase, we’ll need to dig a little deeper.  It might turn out that prospects that come from certain referral sources take longer to decide or convert or possibly a high percentage of prospects from other referral sources aren’t qualified prospects for our services at all.  We have to take action and dive a little deeper to really understand what factors are important and then sort out its relevance.  From there, we can use it not only to predict our results but also to proactively make business decisions about where to exert our efforts.  This is what I call using the KPIs to manage the business.  Tracking the data alone is not going to help your business.  Taking action to understand the data and what it means and then managing your business based on this data will drive results.

I know that this type of data analysis is foreign to many business owners.  It’s something that’s not taught (I can attest to this as a business owner and MBA) and it requires discipline to stick with it.  You may even need to enlist help from a CFO or coach to determine your KPIs and to keep you accountable for implementation.  As daunting as this may seem, you’ll find a huge benefit in knowing what factors move your business in a positive or negative way and taking the time to understand the metrics will have a dramatic impact on your ability to predict and even control how your business performs this year.