The Percent Of Sales Method Explanation

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Defining the percentage of sales method

Let’s presume you work for quite a while and you’ve accumulated information for years or, at least, months, which show your sales and expenses. Using these data, you can roughly plan the numbers and volumes of sales in the future periods and predict the expenses – given that no serious factors contribute to fluctuating of the both, so your business is considered as being stable.

Using the percentage of sales, it is possible to plan what you will earn and how much of that you will be able to spend (given that you do not spend more than you earn, living in credit). So, it allows a business owner or runner to find out (when they want to spend something), how much time has to pass before they can buy it given the level of sales. It shows as well what they spend and earns on a monthly basis. 

To build a more reliable cash flow model and make various estimations and business decisions, they can take into account additional factors like seasonal fluctuations, operative expenses, or future plans. But actions like these – the inclusion of additional factors – are based on sale percentage analysis and are additional in building business plans. While the sale percentage parameter itself only operates with two indices: revenue and expenses.

Well, that depends. If a year before that, the number was 25% and now turned 30% that might mean that the cost of your raw materials grew or that other expenses were bigger. Or maybe your supply chains have become longer and more expensive. In either case, you should make an analysis of the exact numbers you have, taking them from the ledger of your enterprise. As a result, this can be a managerial decision to increase the cost of your product, change the formula or suppliers, or, for instance, change the processes in your enterprise or cut down possible expenses. 

Using this method, you can define what will be in the future. Given that you’ve been spending $30,000 during the previous year and made $100,000, doing the same this year, you will have $70,000 revenue, which you can spend for the needs of your enterprise.

On the example of some credit institution, that can be as follows: if you have a 10% booking of overdue debt in your volume of lending (to cover for the expenses), increasing your lending volume from 1 million to 2 millions in the next period, given that the ratio stays, you will have to book not $100,000 as overdue debt but already $200,000.

Sale percentage calculator

For example, let’s say, you had $100,000 sales revenues last year and had $30,000 expensed for a year. The formula used to calculate the sales percentage is as follows:

Expenses/sales* 100%

Thus: 

$30,000/$100,000 * 100% = 30%.

What does 30% tell you?

Pros and cons of the percentage of credit sales method

This method has a number of identified pros and cons.

Pros:

  • It is a simple method that allows making quick business estimations if you want to promptly receive a general picture of how you’re doing
  • Easy to define cash flows
  • Clear budget that is easy to plan, relying on the calculated cash flows
  • Focus on profitability.

 

Cons:

  • The calculations require some figures from the past: they do not work for startups, which did not generate any inflows and outflows of cash yet
  • It only allows rough estimations, relying on the previous numbers, not taking into account their possible changes and fluctuations. You miss variables, which may be crucial
  • It gives only a high-level picture, while it is required to dig into the details for a more comprehensive business evaluation
  • Short-term focus: you can’t take numbers of 10 past years and directly apply them for the 10 upcoming years, without losing the entire preciseness, even a rough one. It is best workable for weeks, months, or up to 1 year in most cases.

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