At its most basic, to make an expense forecast you can simply take last year’s costs, add a percentage increase (say, 4%) to that number, and you’re done. There’s a bit more to it than that, though historical projections are a part of it.
First, recognize that it’s impossible to separate expenses from revenue growth and your budgeting process. In financial planning, it’s common to look at expenses as a percentage of revenue. That’s why, to forecast expenses, the first thing you’ll need to do is forecast revenue.
Of course, there are a couple different high-level approaches to revenue forecasting: the top-down approach, and the bottom-up approach.
The top-down approach is all about the leaders of the company creating (realistic) revenue targets, then communicating exactly how to achieve these goals to individual departments.
A bottom-up approach goes the other direction — department heads would create their own plans, justifying each expense in terms of how they’ll match the revenue goals set by leadership.
The first thing to do is determine how much you’re going to spend each month. Consider all costs. How much are you setting aside for marketing? What about hosting costs?
Since certain expenses may depend on your headcount, you also need to work your headcount models into your expense forecasting — for example, if you know each new employee will require a $1,500 laptop, you can put that on the list.
But you also need to break things down by department — depending on the overall business strategy, some departments might be planning major expansion in the upcoming months or years, while others business units could be cutting back or closing down completely.
In order for an expense forecast to be as accurate as possible, finance teams need to look at each of these individual components and project them out individually.
In order for an expense forecast to be as accurate as possible, finance teams need to look at each of these individual components and project them out individually.
The last step is to review your forecasts. This can help you make future forecasts tighter, leading to less waste on variances. Do this at least once a month, using the insights to aid in creating new budgets. So, that’s a general outline of how to forecast expenses. Let’s get a bit more granular by looking at how to forecast operating and payroll expenses.
How to Forecast Expenses
Your operating expenses include day-to-day line items, which you’ll find on the income statement. For SaaS companies, they include salaries, marketing costs, and hosting costs. Operating expenses are divided into two types: fixed and variable.
Fixed expenses like rent and depreciation and amortization are easy enough to forecast, as they generally won’t change from month to month.
However, some expenses do change from month to month — these are your variable expenses, which are tied directly to how many sales you make. Variable expenses include your marketing costs, travel costs, and commissions. Notably for SaaS companies, they include your hosting costs, known as cost of revenue or SaaS cost of goods sold.
Once again, since variable expenses depend on sales, the first thing you’ll want to do is forecast revenue. Your SaaS revenue forecasting methods can (and should) be a lot more in-depth than simply estimating a “reasonable” growth rate. If you have a good amount of historical data, you might use a sales capacity model, which maps out the number of sales reps you’ll need to hit specific goals.
If you don’t have a lot of historical data, you could use the ARR snowball method, which builds off of short-term revenue trends. Of course, this method is more dependent on assumptions than the sales capacity model, so make sure you get those down pat.
So, you have your estimate of future revenue — how do you get your projection of variable expenses? The answer is calculating historical operating expenses as a percentage of revenue.
