In the two earlier postings on key causes for business plans to fail, we took note of the lack of a vigorous implementation process and poor understanding of the customer value proposition and market environments.
A third significant cause is poor financial planning. Entrepreneurs fail to plan six basic financial elements:
- sales projections
- cost of goods/services sold
- fixed costs
- costs of product or service development
- length of time to sustainable positive cash flow
- capital required
A first step to solving this problem is to make it the entire management team’s responsibility. Someone on the team is responsible for each of the functional elements that these financial plans support. It must not be the job of the finance person to make sales projections or know the costs of developments, and so on. The finance person will put the numbers together from the data provided by the functional experts.
A second step is to understand and enforce the notion that financial statements are not complicated. They involve nothing more than simple arithmetic and proportions. No one on the management team should be allowed to say, “Oh, I’m not a finance guy.”
For example, a projected Profit and Loss Statement (aka P&L or Income Statement) is nothing more than an projection of how many sales $s will come in, less how many $s will be spent that are directly connected with those sales $s (this s the cost of goods sold (COGS) – typically materials and direct labor), less all of the fixed costs of the business (rent, marketing, insurance, information systems, etc). After you have performed this arithmetic you will have either a profit or loss for the period of time involved.
A cash flow statement can be thought of simply as a view of the actual cash on hand at the beginning of a time period (week, month, quarter) and adding or subtracting all of the actual cash elements in a P&L (see above). Then, since you will be spending money on product development and other business development work you will subtract those, too. If you receive an infusion of cash from an equity investor or loan source, you will add that in as cash received. Now, at the bottom of this column of additions and subtractions of cash you will have a cash balance for the end of the time period. This then becomes the the starting balance for the next time period. You can easily imagine how handy it is to perform cash flow projections. Nothing worse than to discover that your bank account is empty.
Hopefully, these two brief excursions into financial statements and planning ave persuaded you that these are neither conceptually nor mathematically complex. And wonderfully, spreadsheet software makes this all very easy to do.
After you have assembled your first pass at projecting the six elements, take them out on a test drive, do the “do they pass the sniff test”, find comparable data from other companies, how do the projection compare with your earlier work experience?
Then, refine them. Get more data. Make some best case and worst case scenarios.
But, don’t get carried away with a useless drive for perfection. These are just projections! As you roll out your plan you will come back and apply the lessons of the real world to them. This s the real refinement.
So, examine your business plan for the rigor of your financial planning. Don’t be caught by a surprise cash shortage and also be ready to impress potential investors or partners with how well you have done your planning.