Most business owners feel one of two ways about projections. Either they feel projections are worthless because they cannot predict the future, or they feel projections are a mechanism to make radically optimistic assumptions that are not grounded in reality. These attitudes lead to meaningless planning activities for the future.
What if there was a way to make planning for the future and financial forecasting meaningful? Better yet, what if engaging in such activities could actually create a strategic competitive advantage for your business? Yes, what if projections became a way to beat your competitors?
When done correctly, forecasting is one of the most value-added activities a business owner can do. Here are four secrets to make this activity meaningful for the future of your business.
1. Lead Sources and Conversion
I have seen far too many business plans and financial projections that jump right in and make generic and un-founded assumptions about sales growth. For example, one small company had planned for their sales to grow by $5,000/month. While this may initially sound good, it leaves a good set of projections wanting. How many additional leads per month will be required to meet that growth? What will be the source of those leads? Will your conversion rate of leads into paying customers improve or decline? What are the costs of these activities and is it becoming more or less expensive to acquire customers?
Here is an example of why this is so critical. A small company was excited to release their new product and begin to see their sales grow. They assumed they would quickly scale to over $25,000 per month in sales. This may seem reasonable, but let's figure out what it really will take to get there.
You see, they planned for all of their leads to come through their website. They made a fairly conservative assumption that 1% of their website visitors would make a purchase at a price point of about $20. We can use a little math to figure out how many monthly website visitors they would need to achieve $25,000 in sales.
First, they would need 1,250 customers ($25,000/$20 per customer) to reach their goal. At a 1% conversion rate, this means they would need 125,000 visitors per month to hit their revenue target. This number was overwhelming and surprising — and fostered a very healthy strategic conversation about the viability of the new product. They decided to move forward, but empowered with better information to scale their website visitors over time and accept lower but more realistic revenue growth.
2. Scale Expenses with Revenue
Nothing is more frustrating than to look at a business plan forecasting sales growth but no growth in salaries and wages, insurance, and other expense line items on a profit and loss statement. These expenses may not be truly variable, meaning they grow at the same rate of sales, but they will certainly need to grow to sustain the business. Rather than throwing loose assumptions into this section of the projections, find out how much things will really cost and scale those costs with the rest of your organization.
3. Don't Forget the Balance Sheet
I can spot amateur projections from a mile away — they don't forecast the balance sheet, only the profit and loss statement. Projecting the changes in your balance sheet is the only way to determine your sources of uses and cash — which should be one of the main reasons you bother to forecast. How much cash will you need? What will you do with cash flow excesses?
A fully sophisticated set of projections would include a statement of cash flows as well, although it requires no assumptions — it merely converts the net income from your profit and loss statement into cash flow via the changes on the balance sheet and other non-cash transaction, like depreciation.
4. Track, Measure, and Adjust
Nothing is worse than seeing a great set of projections completed and then set aside, never to be referenced again. If you go to the effort to create them, then here is the best way to benefit from them. Every month compare your actual performance to what actually happens in your business. Which assumptions did your performance validate? How many of your assumptions were incorrect, and, more importantly, should you update?
This process will teach you more about how to build a successful business than almost any other activity of which I am aware. In fact, my experience has been that those who track, measure, and adjust their plan faithfully for 12 consecutive months will know more about their industry than as much as 80% of their competitors. Now that's a strategic competitive advantage!
Projections will not be the most fun business owners have in their business. But the discipline to do it will reap significant benefits!
Ken Kaufman, Founder & CEO of CFOwise®, serves as the Chief Financial Officer for a dozen start-up, emerging, and medium-sized businesses. With almost two decades of experience and as an adjunct professor and published author, Ken focuses his professional efforts on helping entrepreneurs maximize cash flow, improve profits, and obtain clarity.