As I’m winding up my series of posts on standard business plan financials – this is the 20th since last month – I want to focus on why? Why bother to project your business plan financials ahead of time? Aren’t they going to be wrong anyhow? Aren’t they going to change? Some people will suggest that you don’t both with this part of planning. And that’s terrible advice.
For your own business, whether you have to show anybody else a business plan, or not, simple financial projections, done right, are a powerful tool for managing your business better. They give you a way to lay out in an orderly manner how you expect your sales, cash, spending, and capital to go, based on the meaningful assumptions for your business, whatever they are. Obviously what drives your business numbers depends on the exact nature of your business. For some it’s web traffic, downloads, or subscriptions; for others it’s store traffic, or leads, or pipeline, or unique visitors; you know what it is for your business. And furthermore, if you’re one one of those businesses that is using a business plan to show investors for due diligence, or as part of a bank loan application. I like how Martin Zwillig explains the use of business plan financials in a post for the gust.com blog:
Why? For you to make decisions and manage the business – because we are all mere mortals and can’t possibly keep all these numbers and calculations in our head – to decide whether and when the business is going to be profitable given rational projections of costs and income (these assumptions are referred to as your business model). Secondarily, it will be required by potential investors to validate how much money you need to get started, and how much return they can expect on their investment.
And for me, in my experience, it all comes alive with the plan-vs.-actual analysis. I say often business plans are always wrong, but also vital, and extremely necessary. Of course they’re wrong because we’re human so we can’t predict the future. But they’re vital because you track the direction and the details of what went differently, and you manage that as steering. When sales are better than projected, you figure out why, what’s working, and put more resources into it. When sales are worse than planned, you have your assumptions laid out so you can identify what went wrong and adjust. Did marketing programs not work, or did you not execute? Tracking the money will help you know. How do I have to cut to stay solvent? Having projections is vital.
I also advocate – strongly – taking the extra time to learn what a business owner needs to know about financials to make those projections match standard practices. I insist that the basic standard definitions are not that hard to learn (it’s all in this post), and keeping your projections in line with standards makes them instantly recognizable to people who expect standard financials. Fine points like timing, working capital absorbed in inventory and accounts receivable, and funding assets re critical to actual real cash flow in the real world. So you don’t just guess at standards, you follow them.
And here – in that illustration above – is a cool and intriguing benefit of doing the business plan financials right. When you have proper financial projections, you work in a delightfully closed system that helps you pull it all together. If you have the right conceptual linkages between sales, costs, expenses, profits, assets, liabilities, and capital, then your projected balance will balance and you will be both financially and mathematically correct. And that’s makes the whole projection effort easier and more interesting. Just as one example, for more than 20 years now, at Palo Alto Software we’ve used collection days (how many days, on average, you wait to get paid by your business customers) as an input variable to help solve the math for cash in the bank, which is a number we derive from the inputs. And it has to be right, because we’re using algebra in the background (of course it’s only as right as your assumptions, but that’s where plan vs. actual comes in; and the balance will always balance.)