Financial Forecasting using Percent of Sales Method & How to Calculate Projected Retained Earnings

The percentage of sales method is sometimes referred to as an income statement approach because the only number being estimated (bad debt expense) appears on the income statement. This approach does not consider the balance in the allowance
for doubtful accounts because such balance is not used in the calculation of
bad debt expense. Each year, an estimation of uncollectible accounts must be made as a preliminary step in the preparation of financial statements. Some companies use the percentage of sales method, which calculates the expense to be recognized, an amount which is then added to the allowance for doubtful accounts. Other companies use the percentage of receivable method (or a variation known as the aging method). The reported expense is the amount needed to adjust the allowance to this ending total.

That also makes it handy for working out in the forecasted financial statements what’s performing well and what isn’t, and by extension setting financial goals for the company. Retained earnings refer to the value of income kept in the business after shareholders receive their portion. This is the amount of profit left after the company has paid all its liabilities and dividends to shareholders. Retained earnings are part of the company’s equity that can be used and added to net income to fund the company’s future projects.

Two Different Ways to Measure Bad Debt Allowance

The business could run into short-term cash flow problems if the ratio is too high. For this reason, it’s an important additional ratio to consider when running a percentage of the sales forecast. Since a company’s expenses and revenue A Deep Dive into Law Firm Bookkeeping could vary over time, higher revenue might not be the best indicator of a company’s profitability. Therefore, companies rely on the return on sales ratio as one of the more dependable figures for measuring yearly performance.

• That’s also the reason why it’s relatively easy to update with new historical sales data as it comes through.
• Most businesses think they have a good sense of whether sales are up or down, but how are they gauging accuracy?
• The process for determining the addition to retained earnings as a result of the increased sales is calculated by using the forecasted net income and the percentage of earnings that are kept in the business.
• However, if the situation has changed significantly, the company increases or decreases the percentage rate to reflect the changed condition.
• Tracking the ratio is helpful for financial analysis as the store might need to change its credit sales policy or collections process if the ratio gets too high.
• For each age category, the firm multiplies the accounts receivable by the percentage estimated as uncollectible to find the estimated amount uncollectible.
• Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.

Add these together to get $42,000 in total credit sales in the past three years. At the end of any particular year, the credit balance in this account will fluctuate, but only by coincidence will it be equal to the debit balance in the account Uncollectible Accounts Expense. To demonstrate the application of the percentage-of-net-sales method, assume that you have gathered the following data, prior to any adjusting entries, for the Porter Company at the end of 2019. So, I am sure now you know everything about how to calculate the percentage of sales. A good growth rate is whatever business owners and stakeholders determine to be so. Small businesses that made less than $5 million had a 6.1 percent sales growth on average in 2017, said Sageworks.

How To Calculate Average Sales

As you can see, when bad debts are written off (i.e., in X3 in our example) there is no impact on the income statement. That is
because the bad debt expense was recognized when the company recorded the
estimated uncollectable https://investrecords.com/the-importance-of-accurate-bookkeeping-for-law-firms-a-comprehensive-guide/ amount in the period of respective sales recognition. So, bad debt expenses are only recorded when the company posts the estimates of
uncollectable balances due from customers, but not when bad debts are actually written
off.

You look at the historical cost of goods as a percentage of its sales and use that figure for the forecasted sales. To calculate a percent of sales, divide the sales of a specific item by the total sales, then multiply by 100. Enter the total sales revenue and the sales of the item being analyzed into the calculator. The calculator will display the percent of sales the item is attributing to the total. Checking up to see how the actual figure is progressing against the predicted one helps to manage accounts receivable accordingly and tighten collection processes for businesses. This takes the credit sales method a step further by calculating roughly how much a company can expect not to be paid back from customers if they haven’t paid their credit sales after 90 days.

Tactics for Better Sales Forecasting [+5 Forecasting Models to Leverage]

Do not confuse earnings before interest and taxes (EBIT) with earnings before interest, taxes, depreciation and amortization (EBITDA). While these profitability ratios are similar, EBITDA does not exclude the cost of depreciation and amortization to net profit. For this reason, many investors feel that it is not a true measure of the operating cash flow and overall financial health. Return on sales is one of the most important measurements in testing the logic behind your budget and sales strategies.

• At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.
• To figure out a company’s market capitalization, you multiply the number of outstanding shares with their current market price.
• Normally, a higher rate is used for accounts that are older because they are considered more likely to become uncollectible.
• It helps provide the company with a detailed pro-forma financial statement showcasing the company’s short-term financial requirements.
• The percentage-of-net-sales method determines the amount of uncollectible accounts expense by analyzing the relationship between net credit sales and the prior year’s uncollectible accounts expense.