What Is the Percentage of Sales Method?

The percentage of sales method is a financial planning tool used to forecast future financial performance. It estimates how financial line items, such as expenses, assets, and liabilities, will change in relation to projected sales revenue. This method provides insights for informed decision-making.

Understanding the Percentage of Sales Method

The percentage of sales method is a forecasting model that projects future financial data by expressing financial accounts as a direct percentage of sales revenue. Many operational financial items tend to move in tandem with sales volume. This method relies on analyzing historical financial statements to identify consistent relationships between sales and accounts, such as cost of goods sold or accounts receivable. This approach assumes these historical relationships will continue, providing a straightforward way to create projections.

How to Calculate the Percentage of Sales Method

Calculating forecasts using the percentage of sales method involves several steps to project figures based on anticipated sales. The initial step requires identifying the historical relationship between sales and the financial items to be forecasted. For example, if a company’s cost of goods sold was consistently 60% of its sales, that 60% becomes the historical percentage for future projections.

The next step is to project future sales for the forecasting period. This sales forecast serves as the foundation for all subsequent calculations, as other financial items will be scaled based on this projected revenue. Once the future sales figure is established, the historical percentages are applied to these projected sales to forecast the corresponding financial items.

Consider a business with historical sales of $500,000, where the cost of goods sold (COGS) was $300,000, and accounts receivable (AR) was $50,000. This means COGS historically represented 60% ($300,000 / $500,000) of sales, and AR was 10% ($50,000 / $500,000) of sales. If the company projects sales to increase to $600,000 next year, the forecasted COGS would be $360,000 (60% of $600,000), and forecasted AR would be $60,000 (10% of $600,000). This process is repeated for all income statement and balance sheet accounts that are expected to vary directly with sales.

Common Uses of the Percentage of Sales Method

The percentage of sales method is applied in financial planning activities due to its simplicity and efficiency. A primary use is forecasting financial statements, including both the income statement and the balance sheet. By projecting sales, companies can quickly estimate future revenues, expenses, assets, and liabilities, providing a preliminary view of their financial position and performance.

This method is valuable for budgeting, particularly for variable costs that fluctuate with sales volume. It allows businesses to create initial budgets for items like raw materials, production costs, and selling expenses, which are tied to sales activity. This helps in allocating resources and setting financial targets that align with projected sales levels.

The percentage of sales method assists in analyzing capital needs. By forecasting assets and liabilities, businesses can identify gaps between their projected asset requirements and available financing. This helps in estimating the funding necessary to support anticipated sales growth, informing decisions about debt, equity, or other external financing.