Are you thinking of starting a business? Maybe you are thinking about leaving the comfort of permanent full time employment for the thrill of contracting / consulting or freelancing. Either way you need a business plan.
Everyone has heard the old axiom if you fail to plan then plan to fail. And you probably know that if you want to start a business you should start with a business plan. But what actually is it, how do you go about getting it, what does a good one look like and what good does it do anyway?
"...what actually is it, how do you go about getting it, what does a good one look like..."
The first, and potentially most important function of a business plan, is that it makes you really think about your new venture and how it will work. This could result in validation for your idea and a renewed sense of optimism and energy. Great! It could also result in the realization that actually your business idea won’t work. This will be disappointing, but it will be a lot better than spending large amounts of time and money on an idea that is doomed to fail.
There are too many tales of people who have launched a business full of optimism. They’ve worked really hard and the business has started to gain traction.
Clients love them and they start getting more and more work. Everything seems great, but then they realize that their bank balance is still going down. Why? Because they never invested in a proper business plan. So they set the price of their product or service at the level that they think the market will accept. But they don’t realize that they are not charging enough to cover all of their costs and make a profit. They never realized that although there was a market for their product, they were not able to profitably deliver that product at a price that the market would accept.
Ok, so you’ve had the lightbulb moment and you’ve got your shiny new business idea. How do you create a business plan and what should be in it?
There are a number of key elements that a business plan needs, and we will take a look at each of them. But the best place to start is with a budget. Other elements that come later will support the budget and may lead to you revising your budget assumptions. But if you can’t make the numbers work to begin with then everything else becomes academic.
If you’ve read our recent Budget Friendly
blog post you may think you already know how to prepare a budget. However that post was on personal budgeting, so it assumed that income was fixed. Budgeting for a business is very different. There are many different ways to build a budget, with different methods suiting different business models and industries. Given this, here is not the place for in depth analysis of every possible flavour of budget. That’s why God (and Larry and Sergey) gave us Google.
We will cover the basics of budgeting though, because this is fundamental to business planning. A business plan without a budget is like an unsharpened pencil – pointless.
"...A business plan without a budget is like an unsharpened pencil – pointless..."
The first thing you need to do is estimate your revenue. You’re revenue will be a function of how much you charge and the volume of your product or service that you deliver. At this point you can take a guess at both, but won’t really know either number for certain. That is ok, you’re going to build what is called a flex budget. That means you can play around with your assumptions and see what the impact is on revenue, and ultimately on your bottom line.
The simplest thing to do is start with a spreadsheet. There are apps out there to help you, but a spreadsheet provides infinite flexibility. You’ll only require very basic spreadsheeting skills, and if you don’t already have these my advice is to learn them. They are invaluable to any business owner.
Have a guess at what you think you’ll be selling your product for and how many you think you’ll sell and put them in your spreadsheet like this:
Don’t worry if you’re not sure of these numbers at this stage. You’ve got to start somewhere! And we’ll challenge the assumptions later to see if your plan is feasible.
In virtually every business you have costs that increase the more you sell, called variable costs, and costs that are fixed regardless of sales volumes. These are called fixed costs. This is most obvious in businesses that deal in physical goods, like manufacturing or retail. For example if you have a bike shop the more bikes you sell the more you need to buy, so bikes are a variable cost. While the rent of the shop doesn’t change if you sell one thousand bikes or two – so rent is a fixed cost.
Almost all businesses also have startup costs. If you are planning an online business this might be the cost of your website. If you are a manufacturer it might be the cost of the manufacturing equipment. Or if you are a bike shop it might be the cost of fitting out the shop. Either way it will probably be a relatively substantial sum of money that will not need to be repeated every year.
"...I’m sorry but if you want to be a business owner you will need to understand at least a little bit of accounting..."
In accounting (I’m sorry but if you want to be a business owner you will need to understand at least a little bit of accounting) where you have large payments that are unlikely to be repeated every year the cost of these payments is spread across the period of time until you think you’ll need to pay them again. This is called depreciation. If it cost you £10,000 to fit out your shop, and you think you won’t need to do it again for 5 years you would include in your income statement a depreciation charge of £2,000 per year. The reason this is done is it allows the income statement to better reflect the profitability of the business. Otherwise it may appear that the business dips in profitability every five years when the reality is that this is just the five yearly cost of refitting the shop. Depreciation is included as a fixed cost as it does not directly change depending on the activity of the business.
Under the Total Revenue line on your spreadsheet list all of your variable costs and what you expect to pay for one unit. Then multiply the single unit price by the sales volume in revenue to get your variable cost for your given revenue assumption.
So far so good. If we sell 400 bikes we think we’ll make a Gross Profit of £88k. But now we need to think about our fixed costs.
Oh no! Our fixed costs have pushed us into a loss. This is clearly not ideal, but this is why we do a budget in the first place. We now know that assuming our costing assumptions are right, if we sell 400 bikes for £500 each we’ll lose £24k. So what can we do?
Fortunately we have options. To keep it simple, the obvious choices are to cut costs, increase our sales price or sell more bikes. Now is the time to start doing a bit of research to see how realistic our assumptions are so we can decide what we should do.
We may find that we can get a cheaper premises, but will this affect sales? Also we could buy cheaper bike parts, but this would result in a lower quality bike and we’d need to lower the sales price and possibly sales volumes might suffer. Or we could keep the same components and raise the price, but again this may lead to lower sales volumes.
Maybe our best option is to increase our marketing budget, hire an extra sales person and try to sell more bikes. Then our new Budgeted Income Statement might look like this:
We’ve increased our marketing and sales staff and doubled our sales. Notice our variable costs have also doubled with the increased sales. But happy days, we’re now showing a £58k profit before tax. Don’t worry too much about tax at this stage. You only have to pay tax if you make a profit, so it’s a good problem to have.
Now that you have a budget demonstrating how your business could be profitable you need to start challenging the assumptions in the model and thinking about what kind of strategy you want to employ to maximize your business’s chances of success. Now is the time for some marked research.
"...Market research is an organized effort to gather information about target markets and customers" ... "It is a very important component of business strategy and a major factor in maintaining competitiveness..."
Traditionally market research was conducted by market research companies who would send out large numbers of surveys to get a broad but shallow view of people’s opinions, or they would hold focus groups to get a deeper understanding from a much smaller sample size.
The idea of market research is to find out if there is a market for your product. What do people like and not like about it? Would they buy it and how much would they be willing to pay? Products are often refined, or cancelled altogether based on market research. In the modern world a lot of market research can be done yourself using our old friend Google.
From the internet you’ll be able to learn a lot about the size of your market, you’re competitors product offerings and pricing and much more.
If you find that no one else is offering the product that you are looking to launch there could be two reasons for this. Maybe your product is truly innovative and no one else has thought of it. In this case you may be onto a winner. Or it may be than no one sells it because no one wants to buy it. If you are truly honest with yourself you will probably know which one it is. If you believe it is the first option it is a good idea to speak to some people who you trust to see what they think. This shouldn’t necessarily be your close friends and family, as they may want to be encouraging not realising that this is not necessarily in your best interests.
Now that you have done some market research and got a good idea of what products are currently on the market and how much people are paying for them go back and revise your budget. With this new data does your budget still seem realistic? Really challenge every number on your budget, gather as much information on it as you can. You can never be 100% certain at this stage but make sure you have a reasonable level of confidence in it. Update your budget where necessary and see if it is still showing a profit.
If you still think you are onto a winner it is time to start thinking about strategy.
It used to be that there were two basic strategies:
High volume low margin
is where you compete based on price. Using this strategy you work to find cheaper and more efficient means of delivering your product and maintain slim margins in order to undercut your rivals and generate high sales. This strategy works best where the products are homogenous, like petrol or electricity or milk. Where a product is differentiated but cheap people take the low price to mean poor quality, even if this is not the case.
Low volume high margin
is where you build a luxury, high end or exclusive brand and charge a premium for the privilege of being your customer. This strategy relies on marketing, PR and promotion to create the impression among your customers that your product is the exclusive, luxurious or desirable. This strategy works well for highly differentiated products such as cars. Based on marketing people are willing to pay huge premiums for cars viewed as superior when the reality is the service they provide – transporting people and goods – is identical to much cheaper alternatives.
With the advent of the internet, social media and the digital distribution of products such as software and content the range of strategies applicable to your business may be far greater than it once was. There is a lot of on-line information on the different strategies available so I encourage you to do some further research. Just make sure you chose one that is right for your business and how you want to run it.
Once you have chosen a strategy go back to your budget and see if anything needs to change. You may even want to play with your budget to see what strategy you think will work best for your business. Adjust your figures for a low volume high margin strategy versus low margin high volume and see which option works best for your business.
Now that you have your strategy you should think about your marketing plan. How do you plan to get word out about your products or services? Will you have an advertising and promotions budget, and if so how will you spend it?
Also how do you plan to distribute your product or service? Will you have a bricks and mortar shop or will you be purely on-line?
Who are your target customers? Will you target individuals or business to business? Is there a niche of specific individuals you want to target? If so how will you reach them and will there be enough of them to buy your product in sufficient volumes to meet your sales assumptions?
What about new product development? Will your business simply rely on one product or will it require a pipeline of new products being regularly released to market?
If you do rely on a steady stream of innovation do you have a plan for how this will be achieved? You may have developed your first product yourself before the business was launched, but if you are busy running the business will you have time for product development as well? And how will you finance your research and development? Will this come from cashflow, or will new money need to be found from somewhere?
All of these questions should be considered and written down in your business plan. This will give you a structure to follow once you come to actually launching your business. Also make sure you update your budget for any decisions made here. For example, if you plan to fund new product development out of cashflow you should include this as a fixed cost.
Will your new business be a partnership, a joint venture, a limited company, a sole trader or something else? Different corporate structures suit different business models and it is important to choose the right one for your business. This is a decision often driven by the regulatory environment the business will operate in and taxation considerations. Therefore it is a good idea to seek professional guidance on this point.
All businesses take time and money to achieve the scale necessary to be cashflow positive. And if it is to be your primary source of income it will also need to generate sufficient cash to meet your living costs. Growth and expansion can also require additional resources. How do you plan to fund the set up and growth of your business and also your life? It is vital that you think about this before chucking in your day job to go chase your dream.
"...How do you plan to fund the set up and growth of your business and also your life?..."
A good place to start in answering this question is an estimate of how much cash you will need to get the business to a point where it is generating enough cash to cover all of its expenses and your living costs. To do this we are going to need a cashflow statement. There is a common misconception among new business owners that their income statement, which we have been discussing above, will reflect how much cash they have in the bank at the end of the day. As we saw above with depreciation, this is not the case. Our cash outlay to fit out the shop was £10,000, but because we only need to pay this every five years our depreciation in the income statement was only £2,000.
There are other reasons why your income statement does not equal the movement in your bank account. These are mainly to do with movements in debtors and creditors, but this is too complicated and way too accountant-y for today so for now we will not worry too much about this right now.
Let’s return to your simple budgeted Income Statement and modify it slightly to be an even simpler cashflow forecast.
Below is a simplified version of a cashflow forecast. There are a lot of numbers! Don’t be overwhelmed, once you’ve had a look at it it’s really not to complicated. It is basically just the Income Statement from above expanded out to be monthly instead of covering a full year, and with a few small tweaks, which I will explain below.
The obvious first thing is that this forecast is now monthly. This is necessary as we are trying to determine how much cash you need to start with. It may be that your cash position dips in the middle of the year before recovering by the end. An annual statement would hide this and you may run out of cash mid-year.
To make this report monthly I started with the forecast sales. As this is a new business the assumption is a low sales to begin with and rapid growth. To model this I started with a conservative estimate of 47 bikes a month and increased it by 10% a month. Your market research will hopefully have given you an idea of how your growth curve will look. Because the variable costs are based on sales volume there was nothing else to do but drag the formulas across so that they reference the increasing sales volumes and increase in line with them.
For simplicities sake it is assumed here that fixed cost payments are spread evenly across the year, other than depreciation, which we know was the up-front cost of the shop fit out. You may find that your fixed costs are higher in month one. Also I’ve included revenue from month 1. You may find that due to the need for product development, website development or other start-up costs that it is not possible to generate revenue immediately. It is important to be aware of this as it will increase the pot of cash you need to have prior to launching.
Another thing you’ll notice is that I have added a tax payable line. This will take a little explanation as it may initially look a bit odd. The first thing to note is that I’ve included tax in the monthly cashflow statement when tax isn’t actually payable until after year end. The reason for this is that it’s a good idea to put aside some of your profits for tax as you go through the year, so that when the time comes the money is there and you don’t get into strife for not having the cash to pay the tax man.
"...this is the whole point of the exercise ... the Cash Position line at the very bottom..."
The eagle eyed among you will also have noticed that the tax payments don’t start until August. That is because you don’t pay tax on losses and the first few months are loss making. It is not until the early losses are covered and the year to date position becomes profitable that tax becomes payable.
The final thing you’ll note, and really this is the whole point of the exercise, is the Cash Position line at the very bottom. The opening cash balance is £16,000 and by March the early losses have brought this down to £320 before the business becomes profitable and the balance starts building up again. What this tells us is that if we want to launch this business, assuming our forecast is accurate, then £16,000 is the minimum we can do it with. Further to this, the business has not generated enough cash for us to start taking money out to fund our living costs until July, at which point we start drawing £5k per month. So in this example, not only do we need £16k to fund the business, we also need enough cash reserves to fund our lifestyle for six months. If you don’t know how much this will be read Budget Friendly
on preparing a personal budget.
Once you’ve got to this point it is a good idea to sense check and stress test your assumptions. What happens if revenue growth is slower than expected? What happens if you get some large unexpected bills? For how long will you be able to survive on your cash reserves without any revenue? Do you have a plan B? If things don’t go quite to plan is there anything you could do differently? Could you delay some planned expenditure or find an alternative revenue source? Using our bike shop example, maybe you could launch another line of bikes targeted at a different niche? Or maybe you need a big local promotion to kick start your sales?
"... What happens if revenue growth is slower than expected?..."
Obviously ours is a highly simplified example to illustrate a point. In your business there may be a lot more to think about. Like what if your customers delay paying you? If you are likely to have large unpaid balances from customers you might want to consider using a factoring company. This is where you sell your uncollected revenue to a collections company. You’ll receive slightly less cash but have the benefit of getting paid straight away and also save the hassle of chasing your customers for payment.
In our simple example we only needed £16k to launch the business. The reality for most businesses is that it will cost much more than that, especially if you are developing a new product from scratch. Also after launch many businesses require additional money to fund their growth plans. There are a number of different ways to raise the cash you need to launch a business and fund expansion. This is something you need to think about before you take the plunge.
Firstly you need to decide if you want the business to be funded by debt or equity. Both have their pros and cons. With equity you don’t have the pressure of interest payments to make and if things don’t work out and you lose everything you don’t necessarily have to pay it back. On the other hand if you work your socks off and things go well a portion of all of your gains will belong to someone else. And if you sell more than 50% of your equity you face the chance that someone else could take control of your company. You could find yourself kicked out of your own company (it happened to Steve Jobs!).
Debt can be structured in different ways. You could have an informal loan from friends and family. These tend to have the most favorable terms but it could be very awkward at Christmas if you lose all of their money.
The most obvious option is a business loan from a bank. If you shop around you should be able to find a loan with a structure that suits you. However it may not also have an interest rate you find agreeable. Business loans are most commonly interest only, with a seven year term. So you’ll need to pay interest throughout the term of the loan, then after seven years you’ll need to repay the principal. This puts a lot of pressure on the business to generate sufficient cash from the get go to cover the interest payments, and prove its self a success within seven years. The debt will not necessarily need to all be paid back at that time, but a track record of good financial performances will need to be shown in order to raise new debt to roll the loan over.
A popular source of cash for tech start-ups is venture capital funding. This is often a hybrid of debt and equity and sometimes which side of the fence it lands on can depend on the performance of the business. For example a VC might have convertible preference shares that pay a guaranteed coupon until the business clears certain hurdles, at which point they convert into standard equity. If you are looking to rapidly grow a high risk, high reward business with high up-front capital requirements then VC funding may be the answer.
A final financing option, which can be a good solution if you want to slowly grow a business, maybe initially as a side project, is bootstrapping. This is where you fund the business out of your own savings and keep costs as low as possible until the business begins to generate cash. This can be a good option if you are not yet ready to take the leap into the unknown by walking away from your current career. Read more about this option in Learning to Fly.
It doesn’t matter too much at what point in the process you do this, but you should definitely analyse the market you plan to operate in and your prospective competitors before you launch your business. If the market is saturated with incumbents who are big, strong, established, better and cheaper than you then you are going to have to be crafty and look for chinks in their armor. That means finding niches that they have neglected and finding better ways to service the needs of that niche to give yourself a competitive advantage.
You need to analyse your competitor’s products, prices and strategies to learn from what they do well, and to devise a strategy of your own to compete with them. You may find gaps in their product offering or there may be things they don’t do well that you can exploit. You should complete a SWOT analysis, which stands for Strengths, Weaknesses, Opportunities and Threats. There is an abundance of information online about how to do this, so I will let you return to your trusty friend Google for further guidance.
Having done your SWOT analysis you may conclude that there is simply no way to compete. Perhaps your target market is totally saturated and the barriers to entry are really quite high. Just when you thought you had it all planned you might realize that actually trying to bootstrap an aircraft manufacturer to compete with Boeing and Airbus might have been a bit too ambitious. This is exactly why this step is vital. It is much better to realize now - before you’ve wasted your savings and years of your life - that actually it was always an impossible dream. Or it might just give you some valuable insight into how best to launch your business in a competitive way.
Sometimes it can be the things you least expect that can derail a business. That is why it is important to think about your full business cycle before you commit resources to launching.
We’ve talked mostly about financials, but do you fully understand how your business will actually operate? There is no point having a good supply chain and eager customers if bottlenecks in your own process mean your throughput is too slow for you to be able to make a profit.
"... Sometimes it can be the things you least expect that can derail a business..."
If you’re in a service industry will you be able to get appropriately skilled staff at a supportable cost? If you are hiring out your own skills will there be enough hours in the day to rack up the billable hours and still do admin, marketing ect?
Will you be able to source everything you require, and at a cost that will allow you to sell at a price the market will accept, and still make profit after covering all of your overheads? Will your suppliers be reliable? Will you be overly reliant on one supplier, and what happens if that business ceases to trade?
If you have an amazing idea and it goes off with a bang will you be able to protect it? Do you have patents or copyrights or other mechanisms to ensure that your nascent revolution isn’t just crushed by someone with deeper pockets?
Are you fully aware of the regulatory environment you will be operating in? A gang busting start is no use if you end up in jail because you didn’t realize there were rules against selling heroin to school children.
"... it is important that you update and revise your plans, altering course where necessary to respond to whatever the business world throws at you..."
Have you thought about logistics? Can you get everything you need to where you need it to be? And then can you get it to where your customers want it? Will this add to your costs?
Have you thought about growth and succession planning or an exit strategy? Many good single person businesses find they can’t grow or be sold because in effect that single person is the business. It is the single person’s knowledge and expertise that customers are paying for so the business is limited by the number of hours that person is able to work. This is fine if that is all you want for your business. But if you wish to expand and ultimately sell the business you will need to find a way to replicate the outputs so that they are not reliant on the single key person.
If you are worried about your product or service being rendered obsolete by technological advancement, don’t sweat it. Probably now more than ever technology has the potential to impact every product and service in the world. However while there has no doubt been victims of technology, history has shown that well run and forward thinking businesses have been able to adapt and pivot when threatened by technology. In fact it is often the case that businesses threatened by new technology are able to actually embrace the new technology and rather than being wiped out they become stronger as a result. All that is required is a positive attitude to progress.
That’s it! You now know what you’re going to charge, how much you’re going to spend and what your profit margins will be. You know where you’ll get the money from and how long until it runs out. You understand your supply chain and how the business will operate and you know how you’ll tell people about your business and what rules and regulations you must follow. All that remains to be said is good luck, and let me know how you get on.
One final final thought. Once you’ve thought hard about all of the above, crafted a comprehensive business plan, stress tested it, decided you’re on to a winner and launched your business don’t then forget about your business plan. A good business plan should prevent you from launching a rubbish business. But that is not the end of it. It should guide you as you run your business. It should be a living working document that you update as circumstances change and the business grows. Most importantly you should compare your actual results against your budget to see if you are doing better or worse than expected. It is very unlikely that everything will go exactly as planned. So it is important that you update and revise your plans, altering course where necessary to respond to whatever the business world throws at you.