ComplianceFinanceFebruary 08, 2021

Using your written business plan as a management tool

A business plan provides benefits beyond getting financing, dealing with vendors and suppliers, and familiarizing prospective employees with your business. It also serves as a roadmap for the operation of your business. This helps you chronologically organize business-critical events so you don't get ahead of yourself in business activities that have conditions precedent that must be satisfied.

A written business plan provides two important benefits with regards to managing your business. First, it helps you plan for the future. By this, we mean that it identifies the essential events that must occur and actions that must be taken to run and operate the business. Thus it serves as a timetable that provides concrete goals and deadlines.

Second, it identifies and analyzes the internal and external factors that might affect operations. Some of these factors are out of your control, including economic conditions, the weather, changes in technology, competitors, etc. It also includes issues unique to your business, such as staffing and hiring, management policies, estimated cash flow, etc. A written plan provides the mechanism to tie all these factors together and effectively manage them.

A written business plan also contains two important elements, the milestones of each which must be met in order for the business to stay on track:

  • Your marketing strategy, which identifies your target audience and explains how you will position your product or service to reach that audience. Your specific advertising and promotional activities will be linked to sales targets.
  • Your operational plans, which deal with how your business will conduct its day-to-day activities. The timing of these activities is crucial, since there is little point in running ads for a product that isn't available for sale.

A good business plan also includes a substantial amount of detail regarding cash flow projections. These projections help establish if the business will meet its obligations to vendors and others who provide the business with goods or services. Most of these projections are tied directly to planned operational results. For example, the sales projected to occur in one month are supposed to generate the income necessary to pay expenses that are due the following month.

In a well-crafted plan, the overall rhythm of the business will be realistically reflected. If some portion of the business is cyclical, as is often the case, the cycle will be identified and accounted for. For example, many retail outlets rely on the period from Thanksgiving to Christmas for a substantial part of their annual sales volume. This cycle might be reflected in their plan by increasing inventory as November approaches, planning for the addition of temporary workers to handle the expanded sales volume, and planning expense payments for directly following the busy season when cash is most available.

Using your written business plan as a modeling tool

When you go into business for yourself, you have to strike a balance between the risks that you assume and the return you expect to receive if you succeed. Obviously, no one likes to take big risks to obtain a small return. A business plan can be used as a modeling tool to look at a variety of scenarios.

How do you make interrelated decisions, such as setting targets for price levels and sales volume? If increasing the price reduces sales volume, at what point do you achieve maximum profit? Is it better to make a lot of money on fewer units, or a little money on more units? The answer may surprise you.

Let's looks at an example. Assume that it cost $75 to produce and sell one unit of a product. Look at the following table. It projects how many units of a product can be sold at different price levels.

This type of projection would commonly be based on market research into price elasticity (the extent to which demand for your goods or services is affected by price).

Knowing that your cost to produce and sell each unit is $75, you can also project the overall profit you'll attain at various pricing levels. The profit is determined by subtracting the cost ($75) of each unit from the selling price and multiplying the result by the projected sales volume. Take a look:

As you can see, in this example, the profit remains relatively constant over a rather broad range of sales volume. A sales price of about $90 maximizes profit on sales of about 95 units. In this case, however, any sales price from $85 to $105 is projected to generate at least a $1,200 profit.

If a $1,200 profit is acceptable, the unit sales could be as high as 120 units and as low as 30 units. This means that other factors, primarily operational, will be important considerations in setting a price. Merely maximizing net profit won't necessarily yield the best long-term result. Consider how different your business's needs would be if you produced 30 units versus 120 to produce the same net profit.

This is the type of modeling that you can do if you have a written business plan to serve as an organized framework for considering all the interrelated issues. Suppose you decide to accept a somewhat lower overall profit in exchange for greater sales volume. Will you have enough production capacity? Will you need additional help? Have you got enough space to store that many units? Can your suppliers provide the raw materials you need? Answers to these and other questions are much more readily available if you have a written plan as a modeling tool.

Use your written business plan to track progress

When your written business plan is complete and you begin operating your business, your plan can help keep you on track. In addition to outlining the order of operations, your business plan identifies milestones that can be used to check your progress. Some of these milestones will be checklist items, such as acquiring a facility, obtaining insurance, getting needed equipment, and some will help you look at the operational results of the business.

Two questions at the top of almost every business owner's mind are

  • How do I know if my business is on track?
  • Is there a simple formula that lets me know if I'm doing okay?

It is probably no surprise that until recently, even some very large companies used a "cigar box approach" to tracking business results--every dollar that comes into the business goes into the cigar box; all the expenses are paid from the cigar box. As long as the box isn't empty and there's adequate money left over for the business owner, everything is fine. However, a better way to track your business is with a written business plan, which provides real-time feedback regarding operations. Deviations between actual and planned results provide clues that you can use to tweak or fine-tune certain elements of the plan.

Use your written business plan to adjust operations

It is important to know when and how operations should be adjusted. For example, if your plan projects that the business will be the successful bidder on five jobs in the first quarter of the year, and on April 1 you've only gotten two jobs, you can take steps to adjust. The key is knowing that there is a need to adjust. A good business plan has definitive targets associated with a timetable for achievement. It's a lot easier to know how you're doing if you start out with solid expectations about how your business will run.

Most business plans quantify, in one way or another, the sales levels that must be reached for the business to be profitable. Your plan might call for annual sales of $1,000,000, or quarterly sales of 1,200 units,or provide some other objective measure of success. If you wait until the end of the year to see if the target has been reached, you won't have any opportunity to react to anything that alters your plans. The only way to know for certain whether those goals are being met is to track actual performance against predicted performance throughout the year.

You might also choose to make some operational changes to take advantage of opportunities that may arise. Without meaningful data and milestones against which to measure and compare, such mid-course alterations are difficult to make. For example, if sales consistently outperform your projections, you might amend the plan to set more aggressive goals and adjust your projected inventory levels, if applicable. On the other hand, you might want to take advantage of the additional cash flow by retiring debt early, or investing in new business development, etc. Another option is to adopt a wait-and-see attitude if you believe that the total sales volume won't exceed the plan's estimates and that the higher level of sales you are experiencing merely reflects a seasonal timing differential.

Sometimes no matter how well you plan, things just don't work out as expected. In some cases, there was something wrong with the assumptions or projections that were made when the plan was created. In that case, the correct response is to revise the plan to better reflect your actual experience. When you correct your assumptions or projections, you can establish new, more realistic goals for your business.

Unfortunately, sometimes the plan is sound, and the failure to meet targets is a result of problems in your business operations for a variety of reasons. When creating your plan, try to consider all the factors that might help or hurt your business. By doing so, you'll already have a list of potential problem areas. Review the plan and try to identify exactly where your operations are deviating. Did you overestimate the demand for your product or service? Are sales people not performing the way you had hoped? Are there problems with back office functions, such as billing? In this capacity, a written business plan makes your troubleshooting efforts easier.

Using a written business plan to present credentials

A formal, written plan is the business equivalent of an individual's resume. It outlines the business owner's qualifications and experience, and provides a clear picture of what the business will do and how it will be operated. It addresses all of the issues that the business will have to face, from selecting a location, to realizing staffing needs, to finding vendors, to creating advertising, and a myriad of other things. To the extent that a plan reasonably reflects the structure of a carefully managed business, it gives its audience a positive image of what the business is and what it can be expected to do.

For vendors and suppliers. When you negotiate with a key vendor or supplier, you'll want to obtain the best prices possible and terms that permit you to defer payment for some period and/or obtain a discount for prompt payment. The terms you'll be able to negotiate will depend in large part on the vendor's practices and on the vendor's perceptions of your desirability as a customer. Your desirability is based on the vendor's perception of your ability to pay for what you buy and your staying power as a customer. A business plan that demonstrates that your business will have the cash flow to honor its obligations can do a lot for you. If a supplier forecasts getting a lot of business from you in the future, you are more likely to get a good price and more favorable terms.

For lenders. Starting a new business, or expanding an existing one, may require more money than you can get together on your own. This means turning to an outside source for financing. While you might consider taking on a partner or finding an investor, you'll most likely go to a bank for a loan. The very first thing that you'll be asked for is a copy of your business plan.

If you've been in business for awhile and you need financing to expand into a new market or introduce a new product or service, your business plan will illustrate the successful operations that got you where you are today. That track record provides strong support for the projections you provide regarding your business's new venture.

If you're just starting out, you won't have the benefit of a history of successful operations. In the past, this made banks very hesitant to lend money to unproven businesses. However, bankers are becoming more open to financing startup operations because many of their clients are coming from this business sector. As with an existing business, a business plan is essential to getting this type of financing. It is one of the first things that a potential lender will want to see (along with a list of your personal assets!). A good idea, presented in a carefully drafted business plan, can be a very persuasive tool.

Venture capitalists, prospective partners or shareholders, and even relatives who might loan money or invest in your business will likely want some assurances that they have used their money wisely. A business plan demonstrates how their money will be used, and what they, and the business, can expect in return. If you expect an ongoing need for funding, showing that the business is meeting or exceeding planned goals can help you build the proven track record that might let you borrow under more desirable rates and conditions.

For prospective employees. Portions of a business plan can also serve to introduce prospective employees to your business. If you intend to hire long-time or high-level employees, you'll want to present a fair picture of what your business is and what type of work needs to be performed. You can also establish expectations regarding income and growth opportunities based on the plan's projections.

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