One of my favourite quotes in business is by Emmanuel Faber, CEO at Danone he famously said “Finance without strategy is just numbers but strategy without finance is just dreaming”. In other words there’s an inextricable link between strategy and finance, if you can’t make the numbers work for your strategy then it’s not a business, it’s a hobby. A business has to make money! Why then do so many businesses and particularly start-ups develop strategy and product ideas but avoid financial planning like the plague? Well firstly strategy and product are infinitely more exciting than numbers and secondly they’re scared it will tell them something they don’t want to know; namely they don’t have a viable business. The simple truth though is that once you have produced a financial plan it’s liberating because you now know it’s viable and not just a dream. There are then some simple steps to follow when developing a financial plan.
Volume, Volume, Volume
First of all understand the volume of sales you plan to make, the actual units of sale for your product or service each month or year. Always how many, never the monetary value. Why is this important? Because it tells you the resources you need in place to deliver it. Only sales volume tells you that, monetary value does not and that leads to the next step; cost.
People, People, People
It’s a fact that in most businesses most of the cost is people so, knowing how many you need to deliver and support the volume of product or service you sell is key to understanding cost and why volume is so important. These are costs incurred regardless of how much or how little is sold and are called “Fixed” costs. If you manufacture a product then the other big costs are raw materials and production. These costs are incurred on a per unit basis and only if something is sold so are called “Variable” costs. Once the total cost is understood you’re in a position to look at the next step; what does the revenue need to be to cover these costs and generate some profit?
Money, Money, Money
Because everything so far was based on volume, getting to revenue is straightforward. It’s simply a case of setting a price that creates enough revenue to cover the costs plus the desired profit margin, as revenue is simply volume multiplied by price. But, the question is will the customer pay that price and that goes to the next step; viability.
Testing, Testing, Testing
If the customer will pay what you want the business is viable but how do you know the customer will pay what you want? You have to test the price in the market and against different parameters to see if it can be justified. If not, at least you now know what revenue is needed to execute the current plan and optimisation is the next step. There are two steps to take: increase revenue or decrease cost or both.
Taking revenue first, you either have to sell more or charge more. If you can’t justify charging more then you need sell more but, this may in turn impact the cost. This is something you have to test to see the impact of higher volume on cost. If it’s manageable you have a viable business if not you have to look at cost.
With cost you have more variables but they mostly relate to increasing efficiency, in other words can you do the same for less through automation, outsourcing and the like. If you can you have a viable business.
As a consequence of this the financial plan will likely need to iterate several times before you can make it work, first optimising revenue and then cost and so on. This comes as a surprise to many businesses. If after all optimisations the business is still not viable you have a problem so, whatever you do don’t continue and hope it will be ok, it won’t. In this situation you have to revisit the strategy, you have to change something to make the numbers work. Only when strategy and finance are in harmony do you have a viable business.
Following these simple steps will help you build a financial plan to assess whether your business or strategy is viable and ensure your business doesn’t become a hobby.