I’m well into my business plan marathon again this year, in Houston today looking forward to judging the Rice Business Plan Competition, one of my favorites.
Regarding business plans, instead of just complaining (again) about unrealistically high profitability projections, today I have some specific suggestions. And this has nothing whatsoever to do with the six excellent plans I’ve read for my part of the judging today.
But, as my mother used to say: “if the shoe fits, wear it.”
The underlying problem is that projecting high profits doesn’t usually mean you have a great business plan. It almost always means that you’ve underestimated expenses or direct costs. It’s usually a bad thing, rarely a good thing.
So here are those concrete suggestions:
- Compare your projected profitability (net profits or pretax profits as percent of sales) to standard industry profiles. The most well-known source in the Annual Statement Studies published by Risk Management Associates (RMA). These will give you standard profitability rates for more than 700 common types of business. I searched the site for information business, narrowed it down to software publishing, and I was offered a download for $120. Oxxford Information Systems competes with RMA with more profiles for more different types of business. And Business Plan Pro bundles the Oxxford Information profiles with a searchable database linked to the ratios table [disclosure: I'm the conceptual author of Business Plan Pro and my company publishes it.] And there are other competitors in that market. Standard profitability isn’t that hard to find.That doesn’t mean that I recommend your projected profits always match some standard industry profile. Not at all. What it does mean, though, is that you should know what profits are reasonable for similar industries, and don’t project huge profitability that’s 5 or 10 times higher, in percent of sales terms, than the standards. That kills credibility.
- Compare your projected profitability to results of publicly traded companies in your industry. You don’t need an exact match, but you should know how different your projections are, and you should satisfy yourself on why they’re different. The publicly traded companies tend to be larger and more established than new startups. Sometimes a startup is so new and innovative that it is much more profitable than industry leaders; but that’s rare. If you don’t know where to find financial reports of publicly traded companies, start with Yahoo Finance.
- Do a good web search to see if you can find comments on blogs or in interviews where entrepreneurs talk about actual profits in real businesses like yours. Maybe you’ll find somebody who might be a competitor. People give a lot of information away these days, in blogs, and on the web.
- Try to find somebody with actual experience in a similar company. Use social media, use your mentors, talk to the nearest business school or chamber of commerce. Get somebody to tell you, from real-world experience, what kind of profits are likely.
- If all else fails, remember that across the real world of business, normal profits run about 5, 10, maybe 15 percent of sales. If you’ve done your best and it still shows 30 percent or more, take a good look at your payroll, headcount, and marketing expenses. When it doubt, add marketing expenses to take your projected profits down to a credible level.
Is this you? Does your business plan project profits way above standard levels? That doesn’t make your plan look better. First, make it credible. Only then are the numbers really interesting.