It also can’t consider other financial changes like future bad debts that might impact sales. Here are some of the reasons the percentage-of-sales method might not be for you. It’s also useful for risk management as it helps anticipate any financial challenges on the horizon, giving companies enough time to change course or correct any errors. That’s where the percentage-of-sales method can come in handy. Identify which financial elements to track along with your sales numbers. These elements show how sales affect your business’s finances.
Drawbacks of the percentage-of-sales method
Most businesses think they have a good sense of whether sales are up or down, but how are they gauging accuracy? With shifting budgets and different departments needing more or less from the company every month, having a precise account of every expense and how it relates to future sales is a must. When the percentage-of-sales method doesn’t cut it, there are a couple more ways to determine a business’ financial outlook.
- She decides she wants to put together a rough financial forecast for the future, so she opts to leverage the percent of sales method.
- Lenders also find this to be a useful metric for determining how much external financing a business can reasonably pay back.
- This could happen because of factors like inventory accounting methods or changes in material costs.
- The percentage of sales method provides a straightforward way to forecast financial figures.
How the percentage of sales method is used in financial forecasting
Frank had a holiday hit selling disco ball planters online and he wants to know what his expenses and assets will look like if sales keep going up. From there, she would determine the forecasted value of the previously referenced accounts. The method also doesn’t account for step costing — when the cost of a product changes after a customer buys a quantity of that product over a discrete volume point. For instance, if a customer buys a product from a business that has a step cost at 5,000 units, then every unit beyond those first credit note what is a credit note 5,000 comes at a discounted price. Well, one of the more popular, efficient ways to approach the situation would be to employ something known as the percent of sales method.
Divide your line item amounts by the total sales revenue amount to get your percentage. To calculate your potential bad debts expense (BDE), simply multiply your total credit sales by the percentage you anticipate losing. There are five basic steps to the percentage of sales method formula. We’ll go through each step and then walk through an example to see the formula in action. The percentage of sales method allows businesses to make accurate assessments of their previous sales so they can comfortably project into the future.
Other percentage methods
Organizing the data before calculating can improve the process’s efficiency and accuracy. She decides she wants to put together a rough financial forecast for the future, so she opts to leverage the percent of sales method. Now that she has the relevant initial figures, she can move on to the next step.
Benefits of the percentage-of-sales method
From sales funnel facts to sales email figures, here are the sales statistics that will help you grow leads and close deals.
By no means is meant to be hailed as a definitive document of every aspect of your company’s financial future. If you want a clearer, more accurate picture how to depreciate of where your company is headed financially, you’re better off carefully detailed, line-by-line forecast that considers other aspects beyond your sales level. To determine her forecasted sales, she would use the following equation.
The best part of this method is it doesn’t need loads of data to work, just the prior sales and a calculator (or software, if you want to make life easier). Especially when it comes to creating a budgeted set of financial statements. Bad debt expense represents the money that customers owe but are unlikely to pay. Estimating collection shortfalls is an important part of managing cash flow.
Say for example that Jim believes he can increase company revenue (sales) to $400,000 next year. Because the percentage-of-sales method uses common financial ratios and percentages, it’s a good tool for quickly comparing how a company is doing compared to its competitors or the wider market. In this article, we’ll explain the percentage of sales method and how to calculate it. We’ll also show you a real-life example, highlighting its benefits and drawbacks. Plus, you’ll get some tips for good practices for your business.