The Percent of Sales Method: What It Is and How to Use It

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. Those percentages are then applied to future sales estimates to project each line item’s future value.

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For the sake of example, let’s imagine a hypothetical businessperson, Barbara Bunsen. She operates a specialty cake, army bed, cinnamon roll shop called « Bunsen’s Bundt, Bunk Bed, Bun Bunker » or « B6 » for short. We’ll use her business as a reference point for applying the percent of sales method. Joist helps manage sales, streamline operations, and create detailed estimates and invoices. These capabilities contribute to a clearer understanding of your financial situation. One of your goals as a business owner is to increase your sales percentage to grow your business and stay competitive.

Percentage of Receivables Vs. Percentage of Sales

This could happen because of a number of supply issues or environmental changes. Material prices or utility rates could have gone up uncontrollably during the year for example. From there, she would determine the forecasted value of the previously referenced accounts. 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.

Example of Bad Debt Allowance

• But, using it along with other techniques can provide an even clearer picture of your business’s financial health.
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• 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 5,000 comes at a discounted price.
• Adopting smart strategies can improve your sales performance and boost your revenue.
• This more selective approach tends to yield budgets that more closely predict actual results.
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But you need to link these to implement the percentage of sales method. Next, Liz needs to calculate the percentage of each account in reference to her revenue by dividing by the total sales. Liz looks through her records for the month and calculates her total sales at $60,000.

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And second, it can yield high-quality forecasts for those items that closely correlate with sales. The goal for management is to ensure costs increase proportionately to revenues. With this information, management can look further into which costs are causing this relationship and implement effective cost cutting procedures. Management typically performs this analysis on each account to track the company’s financial progress year over year. By no means is meant to be hailed as a definitive document of every aspect of your company’s financial future. Following a few simple steps, you can forecast future revenues and expenses to ensure your business stays on track.

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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. She estimates that approximately 2 percent of her credit sales may come back faulty. The company then uses the results of this method to make adjustments for the future based on their financial outlook. First, Jim needs to work out the percentage that each of these line items represents relative to company revenue. For the percentage-of-sales method, you need the historical goods sold sales percentage and the other relevant percentages based on past sales behavior.

• By no means is meant to be hailed as a definitive document of every aspect of your company’s financial future.
• With this information, management can look further into which costs are causing this relationship and implement effective cost cutting procedures.
• 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.
• The goal for management is to ensure costs increase proportionately to revenues.
• 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.
• While it offers a good starting point, it’s essential to use this method alongside other forecasting techniques.

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. If your sales increase by 20 percent, you can expect your total sales value in the upcoming quarter or year to be $90,000. 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 percentage of sales method 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. Now Jim has the percentages, he can estimate his sales for next year, and apply them to each line item to get a rough idea of what each of them will look like. Say for example that Jim believes he can increase company revenue (sales) to $400,000 next year.

Two Different Ways to Measure Bad Debt Allowance

Let’s look at a practical example to help you understand how to apply the percentage of sales method. This method is helpful for contractors who need to make financial projections based on past performance. It’s especially useful for predicting the resources needed to handle upcoming projects and expenses. 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.