Business Planning: January 2006 Archives

Accurate revenue forecasting is one of the single most important steps an entrepreneur takes in planning for a new venture. And yet, we find that most entrepreneurs do not spend enough time determining how much revenue will come in their front doors. Although underestimating expenses is a common mistake in business planning, missing the mark on revenues can be catastrophic.

If sales fall way short of expectations, the business can fail due to lack of adequate cash flow. And if sales wildly exceed expectations, the business is not prepared for demand and customers will abandon the new start-up due to inability to meet their needs with products or services in a timely manner.

Some estimates indicate that entrepreneurs spend only about 20% of their time forecasting on revenues and 80% of their time on expenses, when they should spend most of their time trying to gain an accurate forecast of revenues.

Specifically accurate revenue forecasting is important for a number of critical reasons:

- Bank financing and equity investment are based in part of these forecasts. If the entrepreneurs misses the mark and as a result needs more cash than they first thought, this will cause a significant loss of confidence on the part of the banker or investor.

- Inventory assumptions are based on this forecast. Inaccurate revenue assumptions can lead to either too much or too little inventory. Both are potentially fatal errors for a start-up.

- Staffing decisions are also made in anticipation of future sales. If the forecasts are wrong, the business is either over or under staffed.

- Revenue forecasts will determine how much space is needed for the business. Again, too much or too little space are both detrimental to the new venture.

Revenue forecasting can be overwhelming for the entrepreneur. Some say they feel like they are looking into a crystal ball, and it is too cloudy to see the future. So rather than do the work to improve these forecasts, entrepreneurs take short-cuts. They simply plug in numbers into revenues that have no real basis in fact. Often they put in numbers that seem to give them the profits they hope to achieve. Expenses are easier to estimate as we can do fairly simple research to get these numbers. So we spend time getting good expense forecasts and then plug in revenues that make things look right.

There is a time tested approach to revenue forecasting that can significantly improve the odds that they will be more accurate. Revenues are a simply formula:

Revenues = Price X Number of Units Sold

A well developed marketing plan should be able to give you these numbers. Pricing is one of the questions that are answered in the marketing plan, so that will give you half the equation. Knowing what our customers want, how many customers we can likely expect, and how much of what we have to sell they will want will tell us the rest. That is why a good plan helps us to "Think Like the Customer." If we know how the customer thinks, that helps us determine how to position our product.

Knowing more about the overall market, including size and competition, can help us to begin to estimate demand. The promotion plan will tell us how we will reach these customers to tell them about our new business.

Experts on reading business plans, such as investors and bankers, usually do not read a business plan in the order it is written. They will often read the marketing plan and then go back to the revenue forecast to see if it numerically represents what is said in words in the marketing plan. That is the backbone of any good business plan. If the revenue forecast does not make sense based on the marketing plan, the investor or banker will usually read no further.

There are many really good business opportunities that never make it past paper. Would-be entrepreneurs agonize over every detail of their plan to the point that it never gets off the ground, or they miss their window of opportunity.

One of the virtues that Mike Naughton and I are writing about in our new book The Good Entrepreneur is prudence, which entails being good stewards of the resources we have at our disposal. Entrepreneurs who agonize over getting started are often concerned with being good stewards of their own resources they plan to put into their business and of the resources they will get from friends, family, other investors, and creditors.

But there are two critical errors that one can make when looking at how the entrepreneur manages their resources. One error is being careless, reckless and wasteful with resources. In this case the entrepreneur spends money without thought often on things that will do little to create sales and grow the business. For example, they lease expensive space or build huge and opulent buildings, they pay themselves huge salaries, or they hire more staff all that the business cannot support. They burn the investment on things that will not create a sustainable business within the time that their seed resources will carry them.

However, another error is to not ever put those resources to use. It is like the parable in the Bible of the man who buried the money that was entrusted to him, never putting it to use.

StartupJournal has a case study of Gary Doan and his innovative design for a network router that illustrates this error.

He proudly showed it off at trade shows and to industry reps. Amid the late 1990s tech craze, he raised some $19 million from investors over a couple of years. "We got feedback from all sorts of places, what it should look like and how it should be different," he recalls. His 70 engineers on staff continued to refine it with every new review. "It most definitely took too long to get out the door."

I tell entrepreneurs that they often have to be comfortable with a plan that is 80-90% ready. The time it takes to perfect the plan is often time that will keep them from ever getting their business started. Here are some things to keep in mind if you are having trouble "pulling the trigger" to launch your business:

- Your business will most likely not look anything like your plan within six to twelve months. Your plan is a living document, not a blueprint that prescribes every step in detail for the entire life of your new venture. You will learn with each step along the way and that learning should inform and shape your planning as you go.

- You are most likely entering a dynamic market. That is usually what creates the opportunity you are pursuing in the first place. Be ready for what Peter Vaill call the permanent whitewater that you are about to enter. The assumptions you make today in your plan will likely look very different in a few months as your market evolves.

- You can never eliminate all risk and uncertainty, no matter how long you plan. That is part of the game. There will be surprises around every turn. Your success will be determined in how flexible and nimble you are in adjusting to all of these surprises. You cannot plan it all away no matter how hard you try. Entrepreneurship will always have some risk. Plan for as much as you can, and then forge ahead.