All accounts are expressed as a ratio of sales in the financial statement analysis technique known as the percentage of sales method. In other words, the amount of cash, inventory, accounts receivable/payable, net income, and cost of goods sold is calculated as a percentage of revenue for each line item on the financial statement.
Percentage-of-Sales Method for estimating Bad Debt Expense
How to use the percentage of sales method
To create a business financial forecast using the percentage of sales method, you don’t need a lot of data. Heres what you need to do:
1. Find your numbers
Knowing the sales and expense data that your company generates is necessary before you can forecast the financial health of your business.
2. Determine what you want to forecast
A financial statement’s accounts that are more likely to be directly impacted by sales include These include:
Decide which specific accounts you want to include in your company’s financial forecast and create a plan to include them.
3. Calculate the percentage of sales to expenses
Examine the balance of each line item on the financial statement of your business and determine its percentage in relation to overall sales. You can do this by following these steps:
(Expenses/sales) x 100
Heres what this looks like using sample numbers.
This illustrates that in this example, 25% of your sales revenue is allocated to your cost of goods sold account. This number can now be used as a planning and forecasting tool. For instance, you might want to look into why your production costs have risen more quickly than your revenue if the percentage is significantly higher the following year. This data can inform your budgetary decisions.
What is the percentage of sales method?
A forecasting model that bases financial projections on sales is the percentage of sales method. Accounts receivable and cost of goods sold are two examples of financial statement items that are represented as a percentage of sales. Companies then use this data to assess their financial future.
The percentage of sales approach connects sales data to a company’s income statements and balance sheets. It’s one of the most effective ways a company can come up with a thorough financial outlook statement. Although a company cannot get exact numbers in this manner, it is still a useful way to understand the organization’s near-term financial outlook. You need to be aware of the financial line item you wish to analyze and your company’s sales data in order to make a financial prediction using the percentage of sales method.
Examples of the percentage of sales method in use
Here are a few additional real-world applications of the percentage of sales approach:
Example: Billys Brownies
Famous online bakery Billys Brownies sells products directly to customers. The management team wants to know if they need to increase the price of their brownies because the cost of flour and eggs is rising. The team decides to use the percentage of sales method to determine this.
First, they prepare in-depth financial statements. Each line item is associated with a percentage determined by the formula for calculating the ratio of sales to expenses. For instance:
(30000/100000) x 100 = 30%
Management would want to know why baking brownies has become more expensive if the percentage was 25% last year. It might be due to rising flour and egg costs, but it might also be due to a shift in the supply chain. Perhaps the new industrial kitchen is farther away from the delivery trucks.
Ultimately, businesses want revenue to increase proportionately to costs. In the absence of this, the management team can identify the costs that are rising and determine whether any cost-cutting measures are necessary.
Example: Sandras Loan Company
Businesses can predict future “bad debts,” or unpaid receivables owed by customers, using the percentage of sales method.
Sandras Loan Company, for instance, observes that 10% of sales in the past were used to finance bad debts. The amount of unrecoverable debt recorded in its ledger rises as sales do. Using the percentage of sales method, Sandras management team would account for a planned 10%, or $100,000, in bad debt-related expenses if the company expects to report $1 million in sales the following year.
Example: Pizza Planet
Pizza Planets’ financial statement indicates that it generates $2,000 in monthly sales. Due to the upcoming opening of a school close by, the proprietors anticipate a 50% increase in business next month, bringing in $3,000 in revenue.
Using the formula for the ratio of sales to expenses, the owners of Pizza Planets can determine that a balance of $200 in the company’s available cash account equals 10% of current sales.
(200/2000) x 100 = 10
Pizza Planet can apply the same formula, substituting $3,000 for the sales information and variable X for the amount of available cash, to forecast how much cash will be available next month after the school opens. It looks like this:
(x/3000) x 100 = 10
The group can now calculate X to forecast how much money will be available in the following month. In this case, its $300.
Advantages of the percentage of sales method
The advantages of using the percentage of sales method include:
Disadvantages of the percentage of sales method
A rough estimate, not a detailed blueprint, of a company’s financial future is provided by the percentage of sales forecasting method. There are drawbacks to this approach that you should be aware of. These include:
What is the percentage of sales method example?
For instance, if the historical cost of goods sold as a percentage of sales has been 42%, the forecasted sales level will also be 42%. Some balance sheet items, such as accounts receivable, accounts payable, and inventory, can also be forecasted using this method.
What is percentage of sales method in marketing?
The cost of goods sold, inventory, and cash are just a few examples of the financial line items that are calculated as a percentage of sales in the percent of sales method of financial forecasting. These percentages are then used to project the future value of each line item using estimates of future sales.
How do you find the percentage of sales ratio?
The percentage of sales approach is used to determine the amount of financing required to boost sales. Using the technique, a balance sheet and an income statement can be produced. Forecasted Sales = Current Sales x (1 + Growth Rate/100) is the formula to determine the anticipated net income.