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How to build a financial plan that’s more than a guess

Throughout my corporate career, in all my roles, I was required to talk financial results to somber men many years my senior. This was as terrifying as it sounds because, if you imagine yourself in that position, you'll probably realize that you're not the only person relying on you sounding confident and coherent while explaining a complex issue simply enough to make your point, but not so simply as to offend. To explain why we were behind on the plan but that we should not be fired, or that we were over on the plan but that they shouldn’t increase it in case we couldn’t hit the level consistently, could lead to getting fired. And saying that we were on plan must be wrong because no one is ever on plan could—you guessed it—get you fired.

I exaggerate (a little), but you get the picture. In corporate, you don’t get to pull a number out of your wish list and hope to meet it. You don’t get to exclaim, in horror, that you missed a target and simply promise to try harder next month. You don’t get to exceed the number and not see expectations soar.

As entrepreneurs, we do annual planning, but it’s often little more than lip service to the idea that we, as successful business people, should have a plan. There is no one monitoring our expectations or comparing our results back except us, and this buys us some leeway in our guesstimating.

But what if I told you real planning could: 

  • Make you money
  • Save you time
  • Lead to better decision making

A true plan turns into KPIs for monitoring, leading to quicker action on both good results and misses. A true plan allows you to move quickly to investigate variances more often. A true plan provides you the data you need for CEO-level decisions around offers, clients, and your team.

Methods of Planning

There are a variety of methods that can be used for both cost and revenue planning, and you will ultimately choose what works best for you and your business. I’ll go in the order we see most frequently used in the entrepreneurial space rather than my preference, as I tend to use a mix of these.

Top Down

In the corporate world, it is not only sh*t that trickles down but it's also the plan. The board wants to give a number to the shareholders, so the CEO needs to hit this so it gets divided down into departments, and then within departments, and down and down until the person who is doing the actual money-making activity is given a target and simply left with figuring out the how, while their job and bonus are linked to achieving it. Seems unfair right? 

In the entrepreneurial space, top-down planning happens when you decide you want to make 500k because it has a nice ring to it, or that this is the year for seven figures and then you spend the next 12 months trying to hit it with everything you’ve got. You, as the CEO, have simply given a target to yourself as the money maker. Seems unfair right?

Incremental

Another favorite in both the corporate and entrepreneurial spaces is the “last-year-plus-a-bit” methodology. For some unknown reason in both spaces, it always seems to be 20%.

This method is at least grounded in some reality, unlike the wishful thinking often associated with top-down, but it assumes that last year is indicative of this year. It assumes no changes. 

The other error I see creep into this methodology is that revenues get the last year plus a percentage treatment, but somehow costs miraculously don’t increase, so we see a bumper increase in profits.

Zero-Based

Now we’re on to the more technical type of planning that we see less of in the entrepreneurial space. Zero-based planning assumes a zero starting point. Each item is looked at with a clean slate. What is needed this year? What are the revenue-generating activities this year? What can we achieve this year?

I am a fan of this approach, as it encourages new ideas and innovative solutions. It frees you up from the norm or the shoulds, but it is definitely more difficult to do. That's because you’re starting with a blank page, which can be overwhelming and time consuming, so we don’t see it much.

Bottom Up

We often associate this more with cost than revenue. Imagine corporate departments ruthlessly clinging to how much they can spend this year in case it gets taken from them next year. It often creates an understatement of revenue and an overstatement of costs as political expectation management takes over.

So how does this benefit us in the entrepreneurial space where we don’t have departments to present the numbers to sum up to the whole? You definitely have department heads; you’re just probably filling several if not all of those roles. 

So you, as the head of each of the departments, should be working out what you need as objectives for the year, by department, to meet your vision as CEO. 

What do you need to invest in marketing and why? In systems and why? In people and why? If you have a team, they can present what they think it will take for their area. But you have the secret sauce that could make this more useful than the political catfight in corporate. As an entrepreneur, you do not have people protecting their “share” of the budget, because its all your share.

I like this method, as it focuses on why you need to spend as much as what you spend, which we do less of in our revenue-focuses culture.

Deciding on a number

We humans operate in a weird performance v anxiety paradigm. If there is not enough stress, we become bored and stop achieving. If there is too much stress, we freeze up or burn out and results suffer, so we need an optimal stress level for our brains to be revved up and ready to go. 

If you’ve made 300k a year for the last three years, chances are a plan to make 300k again this year won’t have you leaping out of bed at full throttle. But if this year’s plan is 1million, the anxiety over being able to hit it will render you incapable of seeing the how. So how do we get to the optimal level of stress with our plan?

I like to think in terms of three levels:

  • I’d be happy if I achieved this. (Notice—HAPPY, not satisfied.) This feels attainable but tough.
  • Better – I’d be thrilled to get this much, but I feel it's just out of reach.
  • Best – I would do cartwheels naked down Main Street if I made this. It’s a leap, BUT it is still something you can imagine. Maybe it’s 100k, 200k, and 500k. It’s not 100k, 200k, and 10 million

I like to do a combination of the planning methods about to give a baseline for good, and then decide what stretching into better and best would look like.

Assumptions

If you take only one thing away from reading this ode to financial planning, let it be this: For the love of everything, document your assumptions.

I know that when you are in the throes of planning, if done correctly with the right amount of detail, you feel like the numbers have been tattooed on your eyeballs never to be forgotten. You will never forget that you used a ratio based on an XYZ similar business of a friend of a friend as your best guesstimate. But in six months' time, or nine, will you remember every number and every reason?

This may seem like overkill, but here’s why it is vital. How will you know why you were off in that line of the plan, and how will you be more accurate next time if you have no idea what the basis was? Why did you pick 17% of sales revenue for that cost? How come it’s 5%? Did you miss some cost or misallocate something? Are you just a cost-management genius? 

The best way to do this is to ask what drives the number. For example, if revenue is driven by leads and conversions, how many leads are you assuming you need to make the required conversions and to meet the revenue target. For costs, if leads are driven by paid traffic, what is your expected cost per lead. For each driver, document what you assumed.

Assumptions tell you if the plan was wrong based on new information, or if the driving activity needs attention right now.

It is important to note here that these assumptions are just data. And you are unlikely to ever be exactly accurate. The goal is to get closer, to get a better understanding of the drivers, and to be more on track next time.

The Reality Check

Overall Review

One of the quickest ways to do a simple reality check on your plan is to calculate your profit margin (profit/sales).

If this has a significant jump, you’ll want to go back and check to see if you did the classic entrepreneurial optimist move of increasing revenue without the matching costs. If your profit margin has been a consistent 15% for three years and suddenly it is 50%, you better have highly detailed notes around those assumptions and changes to refer back to, and not just wishful thinking.

Cost Check

This is an area where we entrepreneurs are primed to go off course. There is always the newest app, software, or platform being launched to tantalize us. When planning, each cost element needs to come with a value proposition. In other words: What does the spend bring to the business? Is there an alternative? And why are we using this option?

Breaking the plan down for the year

Knowing at the end of the year that we missed or exceeded the plan is too late. If you were far exceeding your numbers in one area, you need to know that info asap so you can go all in or replicate the results in other areas. Similarly, if you are losing money on something in January, losing it for 12 months before you make a decision is reckless.

Run rate

By far the simplest method of taking an annual number down to a monthly, weekly, or daily target is to assume your revenue is earned in a regular way. So you sell and deliver one website each month, thus monthly revenue is the year divided by twelve.

Now, this type of revenue generation is rare in small business because we take vacations, our clients take vacations, etc., so we have natural peaks and valleys. Maybe the established passive income stream of a membership or evergreen course would best fit this model. But a membership where the focus is growth would not.

Seasonality

One step up from the run rate is seasonality. This does require some historical info, like knowing that your clients don’t buy in February because of Maria Forleo! Or it could be as simple as we dip in August because I take the full month off for vacation.

You simply look at that info and assign the total as appropriate. Maybe February is zero, so it is the total divided by eleven, for example.

Activity Based

A great example of this would be Marie Forleo’s B School or Tribe launches. They do a massive launch to bring in most of their revenue in February and April, respectively. Sure, they have other things going on, but this is launch-based. 

Parts of your revenue may be similar. Maybe you have an annual launch of a signature product, or you have material affiliate income on other people's big launches that creates spiky P&L.

Your breakdown could be X for launch month and the remaining revenue over the other months.

Ongoing Monitoring

In the same way that you forget your planning assumptions, you will forget your revenue drivers from day to day or week to week. Tell me three weeks ago on Wednesday how many sales you made and whether they were on target and why? 

We have so many spinning plates as entrepreneurs, we really need to give our brains a break from being our (unreliable) data warehouse and make some notes while things are fresh. This is always quicker than having to go back and investigate.

Daily and weekly, you may simply want to note the revenue and what happened that day. Monthly, I would suggest you do a more detailed review of both revenue and costs as if you were going to present it to an investor so that later you, as the CEO/Owner, have the level of info should you ever need to refer back. That way, you have a process that keeps you sufficiently in the loop when you are ready to hand it over.

The most important thing to remember

It can be easy to feel like planning is a nice thing to have when there is no boardroom table of scowling directors grilling you on the ins and outs of your results, but planning is a tool that will save you time and make you money if used correctly.  

It can feel daunting at first, but to make CEO level decisions—especially when others rely on you for their income—you need quality data.

To get started: 

  1. Track your actual numbers at the most detailed level you have. 
    1. revenue, by service and client, and 
    1. each separate cost line. 
  2. Compare the month with its plan (if you did not have a monthly plan, use run rate to keep it simple).
  3. Now see if you can comment on any of the discrepancies.

This will highlight where your plan needs more focus or tweaking. Maybe it needs a monthly target, or maybe it needs more than a top-line cost or revenue number. Then you can begin to adjust accordingly before you try again next month.

Just because your plan on January 1st was at too high a level does not mean you cannot improve it as you go through the rest of the year. This process will help you to be much more focused on 2019 results before the Q4 panic, and it will prepare you to make a much more meaningful plan for 2020.

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