Business plan models deal with relationships in time. Many entrepreneurs and independent business owner/operators understand their operations in terms of units – so many sheets of plywood, so many tons of steel, so many pounds of flour, so much work in hours, this many machines, that much floor space, this customer, and that customer, the other chain store, and that foreign distributor. The problem arise for many when they try to equate all those real life units into their proxies – dollars, and then analyse the dollars.
For this reason, it is often best (and most accurate) to model the business plan on the basis of units, and then assign costs and prices to those units. This results in dollars, but also provides the units for a sanity cross-check .
A second problem is that owner/operators do not work in fiscal years, or in quarters. Many work in months, and some work in weeks. The financial statements that they receive tend to be annuals. Frankly, by the time many small businesses get their annual financials back from the accountant, they are ancient history. Even if they use a monthly financial reporting cycle, the information is already stale dated, or is so contaminated by the accounting convention that it is of little practical application.
Information and Decision Making Cycle
Most small business people manage their businesses with the cash position – is there money in the bank today. This results in management on the shortest possible time horizon, and is almost as big a problem as no information at all. For example, suppose an operation takes 10 days to order and receive material, 15 days to process it into goods ready for sale, 10 days to sell the goods, and 30 days to collect the money. The overall operating cycle is 65 days. The minimum decision window is ten days. For information to be of value to the operator by supporting the decision making process, the information needs to be a continuous stream that covers the operating cycle, and is available within 10 days.
The planning model has to reflect the same constraints. It too must grind information small enough to reflect operating cycle issues, and also permit the modelling of minimum window decisions. The tradeoff in terms of complexity and effectiveness appears to break at a one month model – meaning that the time frame of the model must be in months. It is worth noting that for decent feedback, the accounting and other information systems should match the planning horizon. There are businesses that need tighter time frames – notably beverage operations, and custom manufacturing shops that have very short production cycles. Some distribution businesses are also tight on time horizons.
Relationships in Time, Sequence and Process
This brings us to relationships modelling. In the real world of operations, the law of conservation of energy applies (well in a way). The law is that materials, labour, physical infrastructure and money are all conserved in a properly built model. You cannot wave a magic wand and make the materials appear, unless you know where the cash is coming from. The materials cannot simply disappear – they have to be either consumed into saleable product and sold, or written off as waste. The model needs to detail relationships moving input resources through the “production” processes, into the selling processes, and back again as collected sales. And the model has to be closed, in the sense that stuff does not just disappear. You do that “closing” by modelling both the operations side (loosely, the income statement), and the resources side (loosely the balance sheet). The closing of the model is accomplished by tying both into the cash flow statement and the bank balance. Only then are you certain that the model is closed.
Elements of a Business Model
So what do we have. An effective business plan model for an operator is a series of relationships built in time describing processes, based on real-life units converted into money equivalents, ground into months, and fully closed. The model incorporates assumptions and projections that have been researched to match an understanding of reality. The most frequently used tool is a spreadsheet because it lets you simulate relationships over time between numbers. We have used more powerful simulation tools for more complex business problems, but the spreadsheet is the standard tool. It is also easy to learn, and fairly powerful.
What It Used to Take
Time consuming? Technically difficult? Here is what we used to go through.
In a typical small business of say 30 employees, with sales revenue on the order of 2 million per year, 3 identifiable product lines selling through 2 channels, operating a production plant of 20,000 square feet, assets of $400,000, and a capital budget of some $200,000 building the model from scratch could take about 2 weeks of a modeller’s time, plus at least a week of the operator’s time, plus the research and accounting inputs. The cost for the modeller alone is usually about $4,000.
Typically, the process takes about a month in duration, and no one is ever happy with it. Generally, by the time the effort is complete no one ever wants to look at it again. It does not have to be that way. We have prepared about 200 or so of these for clients. We got tired of reinventing the wheel every time, so we built a standard model for a typical small to medium sized operation.
A Business Model, Free
Now the process can take as little as 3 hours for the first pass, plus another ten hours of refinement and improvement. What emerges is a plan and model that assists operators in generating business improvements that create more profit, and help manage the future.
That model is free, and you can get it, and the users’ guide here. Navigate under Free, and the link is there. There are versions for Excel and for Calc.
So what is all of that elegant prose and those pretty pictures – most people believe that they are the business plan. Well, they aren’t. At the very best they are descriptions of what is already in the business plan model for those who don’t like looking at the real guts of a business – people like your banker, your father-in-law, and others you are hoping to impress.
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