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Three Principles of Practical Business Planning

Business planning is often the difference between business success and failure. Still most companies fail to plan properly and even more fail to act on their plan.

This second article of a three-part series on successful business planning looks at three key principles to develop a successful business plan that will prepare your organization to respond effectively when things change.

Begin With The End

The first principle in planning is to begin with the end in mind. Start with an idea of where you want the business to be in five years. Think about the goals. These goals should be something that are aspirational, yet achievable and quantifiable.

An example of such a goal is "I'd like to grow my revenue by an average of X percent per year for the next five years." This is where a spreadsheet will be handy. Spend some time looking at your historical financials and look at how costs have changed when revenues have changed.

Then, put together a spreadsheet model that links your costs to changes in revenue. Some variables will be directly connected with revenue; others will change over time based on other metrics (such as the number of people you have).

Having a good understanding of your cost structure is a good example of how business planning in itself is beneficial. Look at things like human capital needs. What is your revenue per employee? When do you need to hire an employee? When are you at your optimal efficiency in terms of overall human resource utilization? Do the same thing with capital equipment.

Having a good understanding of when you need to buy a new truck, computer or piece of equipment as revenue grows is critical. Building a good spreadsheet model that links all of this as you change your revenue growth is key. 

All of this work should lead you to a forward looking profit and loss statement that maps directly to your existing accounting system's chart of accounts. This is the listing of how your revenues and expenses are laid out when you pull an income statement. This linkage will be handy as you move forward in time, allowing you to compare actual results to your budget.

Find Balance

The next piece will be to build out your balance sheet. This is where you keep track of your assets and liabilities and how they tend to change with changes in revenue.

Businesses tend to require more assets as they grow. Growing businesses almost always need ways of financing this growth — these are the liabilities and equity.

Building out a balance sheet can be more complex. There are also other important assets to track that have critical impacts on cash flow such as accounts receivable and inventory. 

You absolutely need to understand how your mix of assets and liabilities change with changes in your growth and how all of that impacts cash flow. We have seen businesses literally grow their way into insolvency because they didn't understand that growth requires assets and assets require cash. In the model, all of these elements are linked to the goal (revenue growth) either directly or indirectly.  

Go With The Flow

The final principle is the statement of cash flows. It begins where your income statement left off — net income. It then tracks changes in your assets and liabilities and ends up at the change in cash balance (your cash flow).

In addition to these three major components, you likely will want to build out other tabs in your model. Remember, spreadsheet real estate is cheap. You might want to have a tab that helps you track head count. When do you need to hire an additional customer service rep or manager? We frequently build a revenue model that helps rationalize how to achieve growth and to model things like pricing or market share changes. You might have others that track your accounts receivable, inventory and loan balances. 

Once you have this model built out, play around with it. Change the assumptions and check the outputs. Make sure it makes sense.

Then, take some extra time to focus on and build out metrics that are important for your business. Every industry has them. They are key ratios such as revenue per sales rep, gross margin percentage, various measures of capacity utilization, etcetera.

If you don't already have these metrics, spend some time researching your industry to get them. Often times industry associations are great sources for these, but also useful for what those metrics should be in terms of benchmarking and best-in-class performance. How does your business stack up? How are these metrics changing over time and why? 

The final part of the series will examine your business planning and look at how to execute it in the real world.