Article

Percentage of sales method: What it is and how to calculate it

The percentage of sales method allows you to forecast financial changes based on previous sales and spending accounts. Here's how to work through it.

By Donny Kelwig, Contributing Writer

Published November 22, 2021
Last updated November 23, 2021

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.

That’s where the percentage of sales method comes in handy. The percentage of sales method allows businesses to make accurate assessments of their previous sales so they can comfortably project into the future.

In this article, we’ll discuss what the method is, how to use it, show an example, and illustrate some of its benefits.

What is the percentage of sales method?

The percentage of sales method is a forecasting tool that makes financial predictions based on previous and current sales data. This data encompasses sales and all business expenses related to sales, including inventory and cost of goods.

The company then uses the results of this method to make adjustments for the future based on their financial outlook.

While these numbers are only useful in the short term and the process needs repeating, the percentage of sales model allows businesses to make educated decisions about the direction their companies are headed.

The benefits of percentage forecasting

Business forecasting may not perfectly predict your company’s financial future, but it can give you a strong sense of where your company is headed and any changes you may need to make. Here are just some of the benefits of business forecasting:

  • Developing structured plans: With an idea of how much revenue you stand to gain or lose in the coming period, you can create a detailed plan for how to increase or achieve that revenue.
  • Creating accurate budgets: Knowing the exact accounts your money is leaving from and coming into allows you to create a more accurate budget. Having a budget at the beginning of the month is a great start, but knowing whether or not you have stuck to that budget by the end of the month is far more important.
  • Analyzing expenses and revenue: When you know your revenue is exceeding your expenses, you can start planning for business improvements, employee raises, and other additional expenses that might benefit the company and further increase revenue down the line.
  • Evaluating market trends: Insight into how customers are paying for products and what products they are buying allows you to reconfigure your sales strategy and make sure you are putting your best foot forward.

Percentage of sales method formula

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.

How to calculate step by step

1. Locate and determine your current numbers: Before doing any calculating, you need to have your current finances ready and available. These numbers will serve as a baseline for future budget comparisons and will give you a sense of what your business is looking like financially.

2. Choose what you want to forecast: Not every business expense or account is influenced by sales. Of course, if you are seeing high expenses in areas that are not backed up by revenue return, those are worth looking into through a budget analysis, they’re just not applicable to this formula.

Some accounts you may want to forecast include:

  • Cash
  • Accounts receivable
  • Accounts payable
  • Fixed assets
  • Cost of goods sold
  • Net income

3. Write out the balances of each account and their percentage in relation to revenue: Depending on the size of your business, this can take some time. The hope in this step is that you will end up with positive percentages in every account. If not, it means you have a negative net income. We’ll go into this further in the walk-through example.

4. Calculate the forecasted sales: Your company should have an ideal increase forecast based on current sales and realistic KPI goals. Let’s say you expect sales to increase 20 percent. Using the following formula, you can determine the approximate value of your forecasted sales:

If your current sales are at $75,000 and you expect a 20-percent increase, your formula would look like this:

75,000 (1+20/100) = 75,000 (1.2) = $90,000

If your sales increase by 20 percent, you can expect your total sales value in the upcoming quarter or year to be $90,000.

5. Apply your new sales value to the percentages calculated in step 3: By taking the percentage of revenue relevant to each account and applying it to your forecast number, you’ll be able to see approximately how much money will be gained or lost in each account.

Let’s walk through the entire process in action.

Percentage of sales method example

We’ll walk through an example with a positive net income, but we will also point out spots where problems could occur and lead to a negative net income.

Using the five steps, let’s look at Liz and her pet boutique.

Step 1

Liz looks through her records for the month and calculates her total sales at $60,000. It’s been a decent month and she’ll break even, but she wants to know what the following month might look like if sales increase by 10 percent.

Step 2

In order to forecast her sales, Liz needs to decide what accounts she wants to look at. We’ll dig into the accounts we listed above:

  • Cash
  • Accounts receivable
  • Accounts payable
  • Fixed assets
  • Cost of goods sold
  • Net income

Step 3

Next to each account, Liz writes down the balance:

Cash:
Accounts receivable:
Accounts payable:
Fixed assets (rent, etc):
Cost of goods sold:
Inventory:
Net income:

$5,000
$6,000
$8,000
$10,000
$11,000
$15,000
$20,000 (this also includes credit sales)

Next, Liz needs to calculate the percentage of each account in reference to her revenue by dividing by the total sales.

Cash:
Accounts receivable:
Accounts payable:
Fixed assets (rent, etc):
Cost of goods sold:
Inventory:
Net income:

$5,000 → 8.3%
$6,000 → 10%
$8,000 → 13.3%
$10,000 → 16.6%
$11,000 → 18.3%
$15,000 → 30%
$20,000 (this also includes credit sales) → 33.3%

Step 4

Just as we showed earlier, Liz uses the forecast sales equation to determine what a 10 percent increase in sales would mean:

If Liz’s current sales are at $60,000 and she expects a 10 percent increase, her formula would look like this:

$60,000 (1+10/100) = $60,000 (1.1) = $66,000

If her sales increase by 10 percent, she can expect your total sales value in the upcoming month to be $66,000.

Step 5

Liz’s final step is to use the percentages she calculated in step 3 to look at the balance forecasts under an assumption of $66,000 in sales.

Cash:
Accounts receivable:
Accounts payable:
Fixed assets (rent, etc):
Cost of goods sold:
Inventory:
Net income:

$5,000 → 8.3% → $5,478
$6,000 → 10% → $6,600
$8,000 → 13.3% → $8,778
$10,000 → 16.6% → $10,956
$11,000 → 18.3% → $12,078
$15,000 → 30% → $19,800
$20,000 (this also includes credit sales) → 33.3% → $21,978

It’s important to remember that a forecast is not a guarantee, but it does give Liz an idea of what she might be bringing in and lets her know that if she wants to invest in a new paint job for the storefront, she’ll have an additional $1,978 to do so.

Other percentage methods

The percentage of sales method, while useful, doesn’t cover every financial aspect of a business. Because of this, there are two additional methods we want to look at when calculating financial health: the percentage of credit sales method and the percentage of receivables method.

Percentage of credit sales method

Credit sales carry a great deal of risk despite their convenience, including processing fees. One of the largest risks is bad credit expense. Bad credit expense refers to purchases that go uncollected due to credit card complications on the customer end.

Larger companies allow for a certain percentage of bad credit in their financial analysis, but many small businesses don’t, and it can lead to unrealistic projections and unforeseen loss.

To calculate your potential bad debts expense (BDE), simply multiply your total credit sales by the percentage you anticipate losing.

Let’s look at Liz again.

With a revenue of $60,000, she’s not running a corporation, but she should still expect to run into a small amount of bad debt expense. By looking over her records, she finds that for the month, her credit purchases come to $55,000 (with $5,000 cash).

She estimates that approximately 2 percent of her credit sales may come back faulty.

Therefore, her BDE formula looks like this:

BDE = 2% x $55,000

This leads to a total BDE of $1,100.

This number may seem small, but it’s crucial when you remember that she’s hoping for an increase of sales next month of $1,978. With a BDE of $1,100, she might be looking at merely an extra $878, which significantly impacts any new purchases she might be looking to make.

Percentage of receivables method

The percentage of receivables method is similar to the percentage of credit sales method, except that it looks at percentages over smaller time frames rather than a flat rate of BDE.

This method is widely considered more effective and referred to as ‘accounts receivable aging.'

For this method, rather than taking the percentage of potential BDE from the entire period (let’s stick with a month, for ease), the percentage of receivables method breaks down the percentages into smaller time frames within a period and only focuses on the amounts unpaid from that period.

For a month, this might look like this:

This method is seen as more reliable because it breaks down the probability of BDE by the length of time past-due. There is a lower chance that recent purchases won’t be settled by the credit card companies than purchases over a month out. This allows for a more precise understanding of what money may be lost.

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