What the Percent of Sales Method Is and How To Use It

Do you ever feel unsure about your sales numbers? With changing budgets and different needs every month, it’s important to know where your money is going and how it affects future earnings.

That’s where the percentage of sales method comes in. It lets you look at past sales to make smart predictions for the future.

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.

What Is the Percentage of Sales Method?

The percentage of sales method predicts future finances based on current revenue. It looks at financial items like the cost of goods sold (COGS) and accounts receivable as a percentage of your total sales. This information about past sales data helps you predict future financial performance. 

Looking at these figures connects sales data to the company’s balance sheets and income statements. While it doesn’t provide exact numbers, it helps make estimates about a company’s short-term financial future.

How To Calculate Percentage Sales

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. 

Following a few simple steps, you can forecast future revenues and expenses to ensure your business stays on track.

1. Establish the Projected Growth and Latest Yearly Revenue Figures

Start by determining your most recent annual sales figures and estimate your growth for the upcoming year.

Let’s say John runs a service business specializing in residential renovations. In the past year, he made $80,000 in sales and expects a 25% increase in the coming year.

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2. Verify the Correlation Between Sales and Specific Line Items

Identify which financial elements to track along with your sales numbers. These elements show how sales affect your business’s finances. 

These typically include:

• Inventory: How much product you have on hand
• Accounts Receivable: Money customers owe you
• Accounts Payable: Money you owe to suppliers
• Cash Flow: Cash coming in and going out of your business
• Cost of Goods Sold (COGS): Costs directly related to producing the goods you sell
• Net Income: Your profit after all expenses are paid

Examine how these items change in response to sales variations. This analysis reveals which aspects of your business are most sensitive to sales changes.

In our example, John examines whether COGS is tied to his sales. While COGS is generally related to sales, it might not directly correspond to changes in sales volume. This could happen because of factors like inventory accounting methods or changes in material costs. But you need to link these to implement the percentage of sales method. 

3. Consider Bad Debt Expenses

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. 

John can do this using the percentage of credit sales method. Here’s how and why he does it: 

• What it is: Bad debt expense is the money that customers owe but will likely never pay.
• How he does it: John looks at his past sales on credit and notes how much was never paid back. He finds a common percentage of unpaid sales based on these past numbers.
• Why he does it: He applies this percentage to his recent credit sales to estimate potential uncollected debts. This ensures his financial records are accurate and reflect his business’s financial status.

RELATED ARTICLE — How To Calculate Bad Debt Expenses: A Comprehensive Guide

4. Assess Line Item Totals and Their Proportions Relative to Sales

Determine the balances of the line items and calculate their percentages relative to your sales. 

For John, the balances might look like this:

• Inventory: 20% of $80,000= $16,000
• Accounts receivable: 15% of $80,000 =$12,000
• Accounts payable: 10% of $80,000= $8,000 
• Cash: 25% of $80,000= $20,000
• Cost of goods sold: 30% of $80,000 = $24,000
• Net income: 50% of $80,000 = $40,000 

5. Calculate Forecasted Sales Figures

Use the estimated growth rate to calculate your forecasted sales. The percentage of sales formula is as follows:

Forecasted Sales = Current Sales × (1+Growth Rate/100​)

For John, the calculation looks like this:

Forecasted Sales = 80,000× (1+25/100)= 80,000 × 1.25 = 100,000

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6. Implement the Proportional Ratios of Line Items in the Forecasted Sales Figure

Apply the calculated percentages of each line item to the forecasted sales figures. The result will predict their future values. For John, the forecasted figures are all 25% higher:

• Forecasted Inventory: $20,000
• Forecasted accounts receivable: $15,000
• Forecasted accounts payable: $10,000
• Forecasted cash: $25,000
• Forecasted cost of goods sold: $30,000
• Forecasted net income: $50,000

While it offers a good starting point, it’s essential to use this method alongside other forecasting techniques. That will give you the most accurate financial picture.

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3 Benefits of Percent of Sales Methods for Financial Forecasting

The percentage of sales method provides a straightforward way to forecast financial figures. This helps businesses get a sense of their short-term financial outlook. 

Here are some key benefits:

1. User-Friendly. This method is straightforward. It doesn’t require extensive data or complex calculations. You can easily forecast your future financials with just your past sales data and a calculator (or software). This simplicity makes it accessible even for those with less financial expertise.
2. Realistic. This method uses actual sales data for forecasts, helping you create more accurate budget projections. It provides realistic sales expectations so you can use resources most cost-effectively. Although you should always use several methods, this gives you a good starting point. 
3. Effective Comparison. The percentage of sales method uses common financial ratios, like operating expenses and COGS. It makes it easy to compare your company’s performance against competitors or industry benchmarks. 

Drawbacks of Percent of Sales Methods for Financial Forecasting

Just like weather forecasters sometimes get it wrong, the percentage of sales method also has limitations. 

Here are some key drawbacks to consider:

Less Accurate for Fast-Growing Businesses

• Historical sales data can quickly become outdated for rapidly expanding companies.
• As these businesses grow, their sales patterns can change significantly.
• Past data can sometimes become a poor predictor of future performance.

Limited Scope

• The percentage of sales method focuses mainly on sales-related items.
• This method alone may not provide a complete picture of your financial health.
• It excludes expenses not directly tied to your sales, like fixed assets or other significant costs.
• Relying solely on this method can lead to an incomplete financial outlook.

Inadequate for Structural Changes

• The method may not work if your company undergoes significant operational or structural changes.
• Changes like a new product line, market expansion, or a major shift in business strategy can make historical sales data less relevant.
• This results in forecasts that don’t accurately capture the impact of these changes.

These drawbacks show why other financial forecasting techniques are needed. Use them alongside this method for better accuracy. Profitability ratios, for example, are an excellent tool for a more detailed and accurate financial forecast.

5 Pro Tips on Increasing Sales Percentage

One of your goals as a business owner is to increase your sales percentage to grow your business and stay competitive. Adopting smart strategies can improve your sales performance and boost your revenue. 

Here are five tips to help you calculate and increase your sales percentage like a pro:

1. Understand Your Customers’ Needs. To make more sales, you must know what your customers want. Ask open-ended questions to learn about their needs and pain points. This helps you tailor your offerings to meet their requirements and build trust, making it more likely they will buy from you.
2. Build a Rapport. People prefer to buy from someone they like and trust. From your first interaction, focus on building a relationship based on honesty and respect. Show genuine interest in their concerns and listen attentively to create a personal connection. These connections can lead to more sales and repeat business.
3. Communicate Value, Not Features. Instead of focusing on the technical aspects of your product or service, highlight its benefits to your customers. Explain how it can solve their problems, save time, or improve their business. Doing this shifts the conversation from price to value, making it easier for customers to see the worth of your offering.
4. Conduct a Thorough Follow-Up. Following up with potential customers shows your commitment to customer satisfaction. After your initial meeting or discussion, reconnect with them promptly. Send a thank-you email, address any outstanding questions, and keep the conversation going.
5. Set Clear Next Steps. Always end sales calls or meetings by setting clear next steps. This will keep the momentum going and ensure both parties know what to expect next.

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Brighten Your Financial Forecast With Joist

The percentage of sales method is a valuable tool for financial forecasting. But, using it along with other techniques can provide an even clearer picture of your business’s financial health.

This is where Joist can support your business. The platform offers powerful tools designed for contractors. Joist helps manage sales, streamline operations, and create detailed estimates and invoices. These capabilities contribute to a clearer understanding of your financial situation. With Joist, your business forecast is bright.