Percentage Of Sales Method

Updated on January 4, 2024
Article byRutan Bhattacharyya
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is The Percentage Of Sales Method?

The percentage of sales method refers to a financial forecasting model that enables a business to predict financial alterations based on spending accounts and past and current sales. One can utilize it to estimate a business’s annual sales growth. Moreover, it can help organizations prepare a comprehensive financial outlook statement.

Percentage of sales method

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It is one of the fastest to prepare a company’s financial forecast. Moreover, the technique can offer high-quality estimates for items that closely correlate with sales. Businesses utilize the results of this technique to make necessary adjustments for the future depending on the financial outlook. That said, one must note that businesses cannot predict fixed using this tool.

Key Takeaways

  • The percentage of sales method definition refers to a tool companies use to estimate assets, liabilities, and expenses based on their previous and current sales data. It allows organizations to estimate yearly sales growth and make informed financial decisions.
  • In the case of this method, every element of a financial document is expressed as a percentage of sales.
  • There are various advantages of the percentage of sales method. For example, it ensures the accuracy of budgets and allows businesses to focus on profitability.
  • Aging Of Accounts Receivable enables companies to evaluate their customers’ financial health.

Percentage Of Sales Method Explained

The percentage of sales method definition refers to businesses’ forecasting tools to predict multiple liabilities, expenses, and assets based on their sales data. This forecasting model enables organizations to prepare accurate budgets and take informed financial decisions. It connects a company’s sales data to income accounts and balance sheets. Although the method cannot provide accurate figures, it still offers businesses an effective way to understand their short-term future from a financial standpoint.

Companies can follow these steps to utilize the percentage of sales method and prepare a financial estimate based on the business data:

Step #1 – Find The Numbers

Before making predictions regarding financial health, businesses must accumulate data concerning their expenses and sales. Then, they can utilize their accounting documents to find the figures. Organizing the data before calculating can improve the process’s efficiency and accuracy.

Step #2 – Figure Out What To Predict

When preparing a financial prediction using this method, businesses must prepare a plan and select the accounts the final projection must include. Sales may directly influence specific accounts on financial statements. Some accounts that businesses may want to forecast include the accounts payable, inventory, accounts receivable, and COGS or cost of goods sold.

Step #3 – Write The Balances Of Every Account And Their Percentage With Respect To The Revenue

The time taken for this depends on a business’s time. In this step, businesses hope to obtain positive percentages in all accounts. However, the company’s net income is negative if that is not the case.

Step #4 – Compute The Forecasted Sales

A company must have an ideal increase prediction based on the realistic key performance indicator or KPI goals and the latest sales. Suppose a business expects its sales to surge 20%. It can use the formula below to determine its forecasted sales’ approximate value:

Forecasted Sales = Current or Latest Sales (Growth Rate/100 + 1)

Step #5 – Apply The Forecasted Sales To the Percentages Computed In The Third Step

Businesses can determine how much (approximately) they can earn or lose in all accounts by taking the revenue percentage relevant to every account and applying it to the forecast number.

Formula

The percentage of sales method formula is as follows:

Percentage Of Sales = (Expenses / Total Sales) x 100

Calculation Example

Let us look at his percentage of sales method calculation example to understand the concept better.

Suppose Panther Tees is a t-shirt retailer that sells t-shirts directly to consumers via its online platform. Since the cost of acquiring the products is increasing, the organization wants to determine whether it must increase the price of the t-shirts. Hence, Panther Tees used the percentage of sales method.

To start, the company prepares detailed financial statements. All line items correspond to a percentage computed utilizing the above formula. For instance —

  • The overall cost of goods sold in that year is $20,000
  • The overall sales recorded by the company is $80,000

Therefore, the COGS percentage of total sales is 25%.

If this percentage were 20% the previous year, Panther Tees’s management team would like to know why procuring the t-shirts costs more. The reason could be higher fabric costs or shipping charges. After identifying the cause of the increase in procurement cost, the organization must take the necessary measures to increase its margins. For example, they may change their supplier to bring down COGS.

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Advantages And Disadvantages

Besides the percentage of sales method formula, one must know its benefits and limitations. So, let us look at them.

Advantages

  • This model offers measurable organizational goals related to the core purpose, i.e., to earn profit.
  • The financial forecasting tool ensures that the company’s budgets are accurate. Moreover, it makes it easier for organizations to prepare for future expenses.
  • An organization following such a model can focus its investments on profitable projects while avoiding costs unrelated to sales.
  • This is the fastest way companies can develop a forecast.

Another key advantage of the percentage of sales method is that it helps develop high-quality estimates for items closely correlated with sales.

Disadvantages

  • Companies using this model may ignore the variables that have no instant impact on sales.
  • This method involves utilizing past sale data to estimate future trends. That said, this can lead to inaccuracies as one cannot say for sure if the sales behavior remains constant.
  • Some expenses may be fixed. Alternatively,  they may have a fixed component. As a result, they do not correlate with sales.

Percentage Of Credit Sales Method vs Aging Of Accounts Receivable

The meaning and purpose of the percentage of sales method and aging of accounts receivable can be confusing for individuals new to the finance world. To avoid confusion, one must clearly understand the critical differences between the two concepts. So, the table below highlights the distinct features.

Percentage Of Sales MethodAging Of Accounts Receivable
This financial forecasting tool helps businesses project future financial changes. Businesses use this method to roughly calculate the total number of accounts receivable a business cannot collect. In other words, it helps estimate the total amount of doubtful accounts and bad debt.
Companies can utilize it to develop a detailed financial outlook statement. It helps businesses gauge the financial health and reliability of their customers. 
This is based on the previous and latest sales data. It is based on the aged receivables report. 

Frequently Asked Questions (FAQs)

Who uses percentage of sales method?

Organizations wanting to use a forecasting technique that is free of cost and can offer a better chance of success for future sales opt for this method.

What is the percentage of sales method of working capital?

One can use the following formula to compute it: Working Capital As A Percentage Of Sales = (Working Capital / Gross Sales) x 100
For example, MaxGrip Tires, a tire manufacturing company, has working capital and sales of $100,000 and $180,000. In this case, working capital as a percentage of sales will be ($100,000/$180,000) x100, i.e., 55.56%

Why is percentage of sales method important?

This financial forecasting tool allows companies to evaluate their past sales accurately to project into the future easily. Based on the financial outlook, businesses can make necessary changes to increase profitability. This technique is popular among advertising companies owing to its straightforwardness and the ability to directly link advertising expenditures with revenue or sales.

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