Profitability Forecasts: What They Are and How to Create Them

Long-term success isn’t just about increasing sales—it requires making investments that generate more income than expenses over time. Profitability forecasts help businesses plan sales strategies, capitalize on market trends, and mitigate risks. For example, an electric vehicle manufacturer anticipating a 20% sales increase from October to December might need to adjust profit expectations due to a 10% rise in supply chain costs.

This article explores how profitability forecasts work, how to calculate them accurately, and how financial management software simplifies the process, benefiting businesses of all sizes—from startups seeking funding to established companies planning for growth.

What Is a Profitability Forecast?

Also called a profit and loss forecast, a profitability forecast predicts how much profit a business will make over a given time period or by a specific date, providing valuable insights into a company’s future financial health and performance, for both its leaders and investors. To create a profitability forecast, a business must predict its expected revenue and expenses for a given time period, which, in turn, reveals the net profits or losses they can expect to achieve during that time frame. While no forecast is 100% accurate, companies can make realistic predictions about their future revenue and expenses by drawing on historical business data, current market trends, and socioeconomic markers to inform their calculations.

Detailed profitability forecasts can help companies achieve a number of strategic outcomes. For instance, they empower decision-makers to predict whether their investments will be successful enough to help their business be profitable over time. Companies also use profitability forecasts to assure investors of their financial viability—and that applies to growth-hungry companies looking to secure venture capitalist funding to fuel expansion, public corporations sharing their quarterly financial projections with investors, and every type of business in between.

Key Takeaways

• Profitability forecasts help businesses estimate how much profit they’ll make over a given time period, often a month or a year.
• To create a profitability forecast for a specific analysis period, businesses must subtract their total anticipated expenses from their projected sales revenue.
• Financial management software simplifies profitability forecast calculations by accelerating and eliminating human error from labor-intensive data analysis processes.

Profitability Forecasts Explained

A profitability forecast looks beyond a business’s revenue to reveal how efficiently it can expect to grow. It combines revenue-generating activities, such as sales, with business costs, including inventory, manufacturing, and business overhead, to give decision-makers a realistic view of their future financial performance. For example, a furniture manufacturer that wants to estimate its profits ahead of a global expansion would need to combine its projections for sales growth in new markets with the anticipated cost of serving a larger and more dispersed customer base. These expenses might cover the construction of new warehouses, international shipping and logistics costs, and employee salaries for in-country customer service teams.

Profit and loss projections can be calculated using quantitative methods, such as data analytics; qualitative measures, such as market research and customer sentiment surveys; or both. Businesses should adapt their choice of approach to their unique conditions and ambitions. For instance, a long-standing local grocery store is more likely to predict its profits based on historical sales figures than a new technology business that has limited data on the performance of its products and services on the open market.

Profitability Forecast vs. Cash Flow Forecast

Cash flow is a measure of a company’s net cash inflows and outflows. While a profitability forecast tells businesses how much profit they can expect to make over a given period, a cash flow forecast tells companies how much cash will move in and out of their business during that time and what will be left in the bank. This information is captured in cash flow statements, which break down cash inflows and outflows from a company’s operating, investing, and financing activities.

Profitability forecasts and cash flow forecasts are complementary. The former type of financial forecast tells business leaders if they’re building a sustainable operation that can grow its revenue and reduce its expenses over time, while the latter indicates how much money their company needs to meet its sales objectives while covering its expenses. Together, these financial forecasting methods empower leaders to develop a pragmatic growth plan that is based on realistic expectations about the future.

Why Create a Profitability Forecast?

A company’s ability to predict and prepare for all eventualities is essential to its viability. Whether the goal is to drive growth, launch new product lines, or tackle economic difficulties, business leaders need a clear picture of their future costs and revenues to make well-informed decisions that bring them closer to their goals in a sustainable way. An accurate profitability forecast provides companies with this level of clarity and allows them to match their sales and investment strategies to their broader business goals without putting their financial future in jeopardy. A profitability forecast can fuel better business judgments by helping decision-makers who need to:

• Plan resources: Consider the case of a popular restaurant chain that wants to open a new location to capitalize on positive consumer sentiment. A profitability forecast could help the business predict its expected sales in the new location and ensure that sales would offset the costs of building and running a new restaurant, such as renting the space, buying new equipment, hiring and training staff, and paying for insurance and utilities.
• Identify trends and seasonal changes: Profitability forecasts give businesses a big picture view of their sales data so they can adapt to shifting market conditions or seasonal changes in customer behavior. For instance, the restaurant above might discover that sales of its most popular dish dropped consistently over the past three months, while sales of a new menu item skyrocketed. It could then adjust its profitability forecast to account for the likely impact of this continuing trend on its sales and operating costs.
• Forecast potential issues before they arise: When faced with financial challenges, such as an economic downturn or a sudden spike in inventory costs, a company can factor its historical revenue and expense data into a profitability forecast to determine which strategies have helped them overcome these issues in the past by maximizing revenue and minimizing expenses. If the restaurant above learns that its raw-ingredient costs will temporarily rise 15% due to a scarcity of supply, for example, historical data might reveal that the most effective way to mitigate losses is to raise the price of dishes by 8% and temporarily operate on smaller margins, rather than raising the price of menu items by a full 15% and risk losing customers.
• Provide valuable information to potential investors: Investors aren’t donors; they expect that the money they invest in a business will deliver financial returns. To that end, potential investors will generally ask to see a company’s profitability forecast before investing to make sure the business is viable, has a clear understanding of its financial prospects, and will ultimately convert their investment into monetary gains.
• Apply for a business loan: Just as investors want to know that they’re investing in a viable company, banks and lending institutions want to know that the money they loan to businesses in their community won’t be lost. In addition to assessing a company’s profitability forecast, banks may also ask for proof that its founders have the liquidity to cover their living expenses and pay off any other debts, before approving the loan application.

How to Calculate a Profitability Forecast

Companies need to define a time frame for their analysis and subtract their expected expenses from their expected sales during that period. In practice, however, businesses must keep two important points in mind, to make certain their profitability forecasts are accurate and serve their best interests. First, they must base their forecasts on reliable information. A company’s historical data on sales, the cost of goods sold, operating costs, and other business expenses serves as the basis for its future decision-making, making it crucial that these figures be accurate. Second, companies need to regularly review and adjust their profitability forecasts to match their changing goals, shifting market conditions, and other realities that can affect their financial outlook, from seasonal swings in customer demand to inflationary pressures that can raise their operating costs. Keeping these principles in mind, companies should comply with the following three steps to create a profitability forecast.

1. Review the Sales Forecast

The first step in creating a profitability forecast is to predict the business’s expected sales revenue. In the case of a company that sells physical products, this would involve estimating how many units it will sell and multiplying that figure by each item’s price. By contrast, a service-based company, such as a software-as-a-service IT vendor, would estimate its total revenue for software licenses over the period in question.

Established businesses can base their sales projections on historical data—in addition to current market conditions and other relevant data points—but startups and young companies rarely have this luxury. Instead, these businesses may need to collect qualitative data to gauge customer demand for their products and services, so they can make realistic predictions about future sales. Another useful tactic for entrepreneurs is to create one conservative profitability forecast and another more aggressive forecast that reflects their dream scenario—and then find the middle ground between these two outcomes.

2. Tally Expenses

Compared to the inexact science of revenue predictions, calculating expenses is a simpler proposition, especially for businesses that regularly track and record their costs. Business expenses fall into two categories—fixed and variable—both of which must be included in a profitability forecast calculation. Fixed expenses are recurring costs that rarely vary over time, such as rent, utilities, employee wages, and marketing costs. Variable expenses, on the other hand, refer to costs for raw materials, inventory, and logistics, all of which are directly linked to how many products a company sells.

Though tallying expenses is straightforward, companies must be careful to account for every business-related cost in their calculations to guarantee the accuracy of their profitability forecast. Underestimating future expenses can have major implications for finances and long-term viability. To avoid this situation, many companies lean to the conservative side when calculating their variable expenses, or they might add a small percentage to their total expense tallies to account for future increases in the price of doing business.

3. Subtract Expenses From the Sales Forecast

Once they’ve estimated their sales and expenses for the analysis period, all that’s left is for the business to subtract the latter from the former to complete their profitability forecast. To gauge whether their projections are realistic, companies can sense-check them against historical profit forecasts. It’s also good practice to regularly revisit and update profitability forecasts, particularly for companies that must constantly revise their business priorities and strategies to keep up with customer demand.

Financial Management Software Solves Forecasting Headaches

Profitability forecasts are a valuable tool for businesses, but the data collection, analysis, and calculations required to create an accurate forecast are time- and labor-intensive when executed manually. NetSuite financial management software accelerates these processes by orders of magnitude. The cloud-based digital solution reduces forecast cycle times, allowing companies to continually review and update their sales and cost projections with ease.

The platform, powered by artificial intelligence (AI), also provides businesses with real-time visibility into their financial performance, improving the quality and reliability of their profitability analyses. Seamless integration with other core business applications, such as inventory, customer relationship management, and commerce solutions, allows users to draw on a consolidated view of their entire operation to inform their future sales and investment strategies. Beyond making profitability forecasts more efficient, NetSuite’s AI and automation features eliminate calculation errors from the process, thereby facilitating more accurate budgeting and revenue planning. What’s more, companies can steadily track their financial performance against their goals, giving themselves more time to course-correct or revise their profitability and cash flow forecasts when conditions change.

Businesses don’t become financially viable by luck, and they certainly don’t stay in that position without constant analyses and adjustments that keep them profitable, even as their customers and the world around them change. Profitability forecasts are integral to a company’s long-term financial health, helping them understand their future revenue and expenses so they can capitalize on new opportunities, while mitigating potential risks along the way.

Profitability Forecast FAQs

Is a profitability forecast the same thing as a profit and loss forecast?

Yes, the terms “profitability forecast” and “profit and loss forecast” can be used interchangeably. These analyses help companies estimate their future revenue and expenses over a set period of time, providing them with a valuable indicator of their financial outlook that can help inform business strategies.

What is a good profit margin for a small business?

Profit margins vary significantly among industries. For instance, retailers generate an average net profit margin of roughly 7%, while healthcare companies have an average net profit margin of over 13%. Given this variability, small businesses should benchmark themselves against similarly sized competitors in their industry to see how they fare.

What does “profit rich but cash poor” mean for a business?

A business is said to be profit rich but cash poor when it records high profits but struggles with cash flow issues. Despite having a strong profitability forecast, a company may not have the liquidity to cover its current debts and expenses. This situation can occur when a company overextends itself on capital expenditures or doesn’t collect customer payments in a timely manner.