At a recent dinner with a friend who’s the CFO of a mid-sized company, the topic of budgeting came up. I asked him how his company sets its annual revenue targets and he said, “We look at what we did last year, come up with a reasonable growth rate and that’s our number.”
I know from speaking with other CEOs and sales leaders that this is a pretty common way for SMEs to set their sales targets. Unfortunately, it’s also a very bad way to do so—in fact, it’s one of the main reasons so many firms miss their targets. This method skips an essential step: considering a number of variables before you set your targets. If you leave out this step, you might as well just pull a number out of a hat.
Sales targets set the course for your company because they’re the basis for budgets for everything from marketing to expansion plans. Yet many firms don’t take the time they should to carry out the target setting properly. The biggest reason companies fail is that they don’t understand what’s involved in hitting sales targets. What is a sales rep truly capable of generating? Is the number you’ve written down realistic? By taking the time to set targets properly, you’ll avoid setting a number that’s too high—or, just as bad, too low.
Failing to achieve an inaccurate sales target can damage your business more than you might expect. For most SMEs, cash flow is king. Arbitrarily picking a number by taking last year’s results and adding a reasonable growth rate exposes you to the risk of major upheaval—or worse—if you fall so short of your targets you cause a cash-flow crunch. And even if the outcome isn’t that drastic, badly crafted targets can erode management’s credibility with your salespeople. What’s worse, badly crafted targets can kill your sales team’s motivation by burdening them with unrealistic expectations.
Read: Building a Super Sales Culture about how Robert Herjavec fuelled fast growth by putting sales at the very heart of his company
You can avoid these unhappy outcomes by instead using a zero-based forecasting method that I call Smart Sales Budgets. This requires more work than the arbitrary method described above; but it’s worth the effort and becomes much easier in the second and subsequent years.
Here are the factors you should review before setting your targets:
Recurring revenue: This is the portion of your firm’s revenue that is predictable and stable, because your clients pay it automatically, and that you can count on in the future with a high degree of confidence. The classic example is subscription fees in a business with a high customer-retention rate.
Revenue from well-established clients: The next best thing to recurring revenue is revenue from clients that you’ve had for at least three years that has grown consistently and that seems highly likely to continue.
Economic factors: Although many companies look at these factors last, they’re actually one of the first things you should consider. What’s going on in your industry that will affect your revenue? Is there new competition; is the economy expanding or contracting; and are interest rates going up or down? How will these economic factors affect your revenue targets, and is it reasonable to assume, given the current environment, that your sales reps will perform better or worse? Be brutally honest in this evaluation.
Revenue per rep in the previous year: Calculating this will give you an idea of what you can reasonably expect an average rep to generate in terms of revenue. Even more important, you’ll get a handle on the enormous differences in performance that you’re likely to see among your reps. Here’s an example:
- Outperforming reps: 3 people averaging $400,000 in revenue each
- Seasoned reps: 4 people averaging $300,000 each
- Underperforming reps: 2 people averaging $150,000 each
- New reps: 2 people averaging $75,000 each
In this scenario, the average is $259,000 per rep. But this figure doesn’t reveal much because sales performance varies so widely among your reps. Instead, when you’re setting targets, you need to look at whether they’re realistic given your current mix of reps. If, say, you wanted to boost your revenue by 20%, what mix of reps would that require if you assume that you’re likely to lose a couple of your veterans due to turnover? How many newbies would it take to make up for the resulting loss in revenue and boost the total by 20%? This analysis will give you the information needed to decide whether to scale back your target or, as per the next point, to ramp up your hiring.
Hiring plans: After you’ve completed the above, you’ll have a reasonable idea of the revenue targets you can achieve. If the number is lower than you’d like, you’ll need to look at hiring more salespeople to make sure you hit that target. To calculate how much business new reps can bring in, you must factor in:
- Ramp-up time: How long will it take them to bring in revenue? Base this estimate on your firm’s past experience, because this factor can vary greatly from one company to the next depending on the length of the sales cycle.
- Revenue target: New reps are highly unlikely to bring in the same revenue as a fully ramped-up salesperson. Again, past performance is the rule of thumb.
- Timing: When do you need to hire people so they bring in the numbers you need?
Support for your sales team: Before setting a target, you should assess how productive your reps are and what you could do to make them more productive by investing in tools such as the following:
- Customer relationship management software
- Sales training and coaching
- Lead generation and nurturing from your firm’s marketing efforts
- Marketing collateral
- Public relations
There’s no one-size-fits-all formula for how much each of these will contribute to your sales effort. But the more of these tools you adopt, the more quickly your new hires will get up to speed and the more your entire team’s performance will improve. To take one example, half the battle for sales reps at SMEs is that no one has heard of the company they’re selling for, and a smart PR campaign can make it far easier for them to land business.
Best case, worst case and most likely case: Based on your analysis of the above variables, create a “best case,” “worst case” and “most likely case” for revenue. Take your time here, because understanding the role the various factors play in your sales results will alert you to possibilities you should prepare for. For example, how would your numbers be affected if your top three reps were to jump ship, and how would you rebound from that?
You should, of course, use the most likely case to set your sales targets. But it’s also worth taking the time to come up with realistic numbers for the two extremes. Study the worst-case scenario to determine whether you could live with it and still make a profit. And use the other two cases in tandem with each other, setting sales targets based on the most likely case and bonuses based on achieving the best case.
Matthew Cook has 17 years of sales and sales management experience, primarily in the financial services and staffing industries. He is founder of SalesForce Search Ltd., which was No. 4 on the PROFIT HOT 50 ranking of Canada’s Top New Growth Companies in 2010, and No. 19 in 2011.
More columns by Matthew Cook