(Author’s note: This is a special labor-of-love article for me. As I write this additional note, months after this article was first published, I have become steadily more concerned about the negative impact of that myth of the start-up business plan in the second paragraph here. There’s a huge loss, because of that myth, for all those existing companies who fail to plan. Everybody running a company should have the benefit of planning. And, please note, it’s planning that matters, not the plan. Military genius and ex president Dwight Eisenhower once said: “the plan is useless, but planning is essential.” So what do you miss if you don’t have a working planning process in an existing company? You miss the opportunity to use that planning process to steer and manage your company, managing change, correcting the course, keeping the long-term objectives in mind.

– Tim Berry.)

Does your company have an annual strategic plan? Does your company develop an annual plan to polish its strategy, focus on main priorities, and manage its cash?

Every business needs to plan
Unfortunately, there is a myth that associates planning with start-ups. That’s particularly common in the United States. Because of that myth, inertia, putting out fires, and related reasons, a lot of businesses miss out on the opportunity to manage themselves a bit better.

As an owner or manager of a small or medium business, can you afford not to plan? Do you leave the annual plan for the large businesses, and let your business depend on reacting to events? Or do you want to plan for priorities, and manage your growth proactively. That’s a leading question, of course, the answer is obvious.

You could call it strategic plan, annual plan, operational plan; the name doesn’t matter as much as the management of it. While these kinds of plans are common in larger enterprises, they are surprisingly rare in small and medium business.

Benefits

1. Guide your growth: Your business will grow or not depending on a lot of different factors, including overall economic trends, location, specific market needs, hard work, and other elements. Businesses that plan do it to guide and influence their growth, so that they move proactively towards defined objectives rather than just reacting to business events.
2. Manage priorities: Strategy is focus. Allocate resources where they will do the most good. Work towards your strengths and away from your weaknesses. Develop the company by doing the most important things, according to your long-term objectives.
3. Assign responsibilities: A plan gives you a place to develop organizational responsibilities.
4. Track progress: Think of a plan as a business positioning device. With a plan, you can track your progress towards goals, measure results, and manage the business. Without a plan, how do you tell whether or not you are moving in the right direction. What do you measure against?
5. Plan for cash: Profits are not cash, and cash is not intuitive. You spend cash, you don’t spend profits. However, businesses don’t plan well for cash, and they need to. That may not sound strategic, but it is. It is also the core of an operations plan, and an annual plan. Whatever else, you have to plan for cash.

Main elements
Regardless of the name you use, strategic plan or annual plan or operational plan, the vast majority of these plans include some or all of the following main points:

1. High-level strategy: Strategy is focus. It guides your growth. Strategy assigns priorities. Of the whole range of possible market segments, and the whole range of services and possible sales and marketing activities, which are your main priorities? Strategy is often a matter of understanding when and how to say no, selecting opportunities.
2. Specific responsibilities, activities, deadlines, and budgets: We call these milestones. They are the bricks and mortar of business planning, critical to business success.
3. Financial plan: One of the most important gains from an annual plan is the financial plan, which of course hinges on cash flow. A business needs to stress its priorities by making sure they get the right amount of money. Growth costs cash.

The illustration below shows a Business Ratios table. It includes dozens of standard business ratios calculated from business plan financials, and used and expected by bankers, financial analysts, and investors. It also includes a column of statistical indicators for the specific type of business. This industry information is classified and categorized by Standard Industrial Classification (SIC) codes. The data involved comes from the database of Integra Information System, a leading provider of industry-specific economic information.

Business ratios table

Main ratios

• Current. Measures company’s ability to meet financial obligations. Expressed as the number of times current assets exceed current liabilities. A high ratio indicates that a company can pay its creditors. A number less than one indicates potential cash flow problems.
• Quick. This ratio is very similar to the Acid Test (see below), and measures a company’s ability to meet its current obligations using its most liquid assets. It shows Total Current Assets excluding Inventory divided by Total Current Liabilities.
• Total Debt to Total Assets. Percentage of Total Assets financed with debt.
• Pre-Tax Return on Net Worth. Indicates shareholders’ earnings before taxes for each dollar invested. This ratio is not applicable if the subject company’s net worth for the period being analyzed has a negative value.
• Pre-Tax Return on Assets. Indicates profit as a percentage of Total Assets before taxes. Measures a company’s ability to manage and allocate resources.

Additional ratios

• Net Profit Margin. This ratio is calculated by dividing Sales into the Net Profit, expressed as a percentage.
• Return on Equity. This ratio is calculated by dividing Net Profit by Net Worth, expressed as a percentage.

Activity ratios

• Accounts Receivable Turnover. This ratio is calculated by dividing Sales on Credit by Accounts Receivable. This is a measure of how well your business collects its debts.
• Collection Days. This ratio is calculated by multiplying Accounts Receivable by 360, which is then divided by annual Sales on Credit. Generally, 30 days is exceptionally good, 60 days is bothersome, and 90 days or more is a real problem.
• Inventory Turnover. This ratio is calculated by dividing the Cost of Sales by the average Inventory balance.
• Accounts Payable Turnover. This ratio is a measure of how quickly the business pays its bills. It divides the total new Accounts Payable for the year by the average Accounts Payable balance.
• Payment Days. This ratio is calculated by multiplying average Accounts Payable by 360, which is then divided by new Accounts Payable.
• Total Asset Turnover. This ratio is calculated by dividing Sales by Total Assets.

Debt ratios

• Debt to Net Worth. This ratio is calculated by dividing Total Liabilities by total Net Worth.
• Current Liab. to Liab. This ratio is calculated by dividing Current Liabilities by Total Liabilities.

Liquidity ratios

• Net Working Capital. This ratio is calculated by subtracting Current Liabilities from Current Assets. This is another measure of cash position.
• Interest Coverage. This ratio is calculated by dividing Profits Before Interest and Taxes by total Interest Expense.

Additional ratios

• Assets to Sales. This ratio is calculated by dividing Assets by Sales.
• Current Debt/Total Assets. This ratio is calculated by dividing Current Liabilities by Total Assets.
• Acid Test. This ratio is calculated by dividing Current Assets (excluding Inventory and Accounts Receivable) by Current Liabilities.
• Sales/Net Worth. This ratio is calculated by dividing Total Sales by Net Worth.
• Dividend Payout. This ratio is calculated by dividing Dividends by Net Profit.

In the real world, financial profile information involves some compromise. Very few organizations fit any one profile exactly. Variations, such as doing several types of business under one roof, are quite common. If you cannot find a classification that fits your business exactly, use the closest one and explain in your text how and why your business is different from the standard.

Understanding variance analysis
Many businesses, especially the small, entrepreneurial kind, ignore or forget the other half of the budgeting. Budgets are too often proposed, discussed, accepted, and forgotten. Variance analysis looks after-the-fact at what caused a difference between plan vs. actual. Good management looks at what that difference means to the business. Business Plan Pro Premier Edition provides the plan vs. actual data that owners and managers need to do that critical variance analysis.

Variance analysis ranges from simple and straightforward to sophisticated and complex. Some cost-accounting systems separate variances into many types and categories. Sometimes a single result can be broken down into many different variances, both positive and negative.

The most sophisticated systems separate unit and price factors on materials, hours worked, cost-per-hour on direct labor, and fixed and variable overhead variances. Though difficult, this kind of analysis can be invaluable in a complex business.

Look for specifics
This presentation of variances shows how important good analysis is. In theory, the positive variances are good news because they mean spending less than budgeted. The negative variance means spending more than the budget.

Variance analysis for sample company
Illustration 1, below, shows the Profit and Loss Variance table for the hypothetical company used as an example in Part 1 and Part 2 of this series.

In this example, the $5,000 positive variance in advertising in January means $5,000 less than planned was spent, and the $7,000 positive variance for literature in February means $7,000 less than planned was spent. The negative variance for advertising in February and March, and the negative variance for literature in March, show that more was spent than was planned for those items.

Illustration 1: Profit and Loss Variance

Evaluating these variances takes thought. Positive variances aren’t always good news. For example, the positive variance of $5,000 in advertising means that money wasn’t spent, but it also means that advertising wasn’t placed. Systems sales are way below expectations for this same period–could the advertising missed in January be a possible cause?

Among the larger single variances for an expense item in a month shown on the illustration was the positive $7,000 variance for the new literature expenses in February. Is this good news or bad news? It may be evidence of a missed deadline for literature that wasn’t actually completed until March. If so, at least it appears that the costs on completion were $6,401, a bit less than the $7,000 planned.

Every variance should stimulate questions. Why did one project cost more or less? Were objectives met? Is a positive variance a cost saving or a failure to implement? Is a negative variance a change in plans, a management failure, or an unrealistic budget?

A variance table can provide management with significant information. Without this data, some of these important questions might go unasked.

More on variance
Variance analysis on sales can be very complex. There can be very significant differences between higher or lower sales because of different unit volumes, or because of different average prices. Illustration 2 shows the Sales Forecast table (including costs) in variance mode, for the example company.

Illustration 2: Sales Forecast Variance

The units variance shows that the sales of systems were disappointing. In the expenses outlined in Illustration 1, we see that advertising and mailing costs were below plan. Could there be a correlation between the saved expenses in mailing, and the lower-than-planned sales? Yes, of course there could.

The mailing cost was much less than planned, but as a result the planned sales never came. The positive expense variance is not good for the company.

In systems, the comparison between units variance and sales variance yields no surprises. The lower-than-expected unit sales also had lower-than-expected sales values. Compare that to service, in which lower units yielded higher sales (indicating much higher prices than planned). Is this an indication of a new profit opportunity, or a new trend? This clearly depends on the specifics of your business.

It is often hard to tell what caused differences in costs. If spending schedules aren’t met, variance might be caused simply by lower unit volume. Management probably wants to know the results per unit, and the actual price, and the detailed feedback on the marketing programs.

Variance analysis is vital to good management. You have to track follow up on budgets, mainly through variance analysis, or the budgets are useless.

Although variance analysis can be very complex, the main guide is common sense. In general, going under budget is a positive variance, and over budget is a negative variance. But the real test of management should be whether or not the result was good for business.

Read Part 1 of this series.

Read Part 2 of this series.

Catching trends as they develop
A Plan vs. Actual Cash Flow table for the same sample plan shown in Part 1 of this series would show the variance in cash flow and cash balance and how much can change, in the real world, despite good planning. A company needs to adjust to change by keeping its plan live.

Illustration 1: Plan vs. Actual Cash Flow

You can see in this illustration how much the cash flow changed as the actual sales differed from plan. The company had to make significant adjustments to its short-term credit management in order to compensate for changed plans. It postponed payments of short-term debt on its credit line and planned on additional adjustments with the short-term credit line. This points out the importance of keeping a live plan and making adjustments. The projected cash flow in the revised scenario is acceptable to the bank, if planned in advance.

Tracking variances is the best way of following through to assure implementation and the success of the business plan.

A simple profit and loss example

The starting plan for profit and loss
Following the example in this series of articles, the Planned Profit and Loss illustration shows the gross margin, and sales and marketing expense area of the Profit and Loss table for the sample company, as it stood in the business plan developed in Business Plan Pro.

Illustration 2: Planned Profit and Loss

Actual results for profit and loss
The next illustration shows the actual results recorded in that portion of Profit and Loss table, after the end of March. Looking at Actual Profit and Loss Results, the actual results illustration means little without comparison to the original budget in Illustration 2 above. Note how actual sales, costs, and expenses are different from planned results.

Illustration 3: Actual Profit and Loss Results

Plan vs. actual profit and loss
The following illustration, Planned vs. Actual Profit and Loss, shows the variance in expenses. The actual results are subtracted from the budget numbers, leaving negative numbers when the actual spending was more than budget or when the sales or profits were less than budget.

Illustration 4: Planned vs. Actual Profit and Loss

The illustration shows a portion of the Profit and Loss Variance table. March results showed sales below plan and costs above plan, for a large negative variance. Sales and Marketing expenses were also above plan in March, causing another negative variance. This is a portion of the table.

Variances are calculated differently in different portions of the plan.

• In expense rows, variance becomes the planned amount minus the actual amount. Lower expenses are a positive variance.
• In the profits and sales areas, variance becomes actual amount minus planned amount. In these cases, higher sales are a positive variance.

Unfortunately, many businesses also forget to compare the original to the actual. Especially if business is going well–the operation shows a profit, and cash flow is satisfactory–comparisons with the original budget are made poorly or not at all.

Continue reading about Growing your Businesses and Plan vs. Actual in Part 3 of this series.

Read Part 1 of this series.

As you review implementation results with the people responsible, you will often find the need to set new goals and make course corrections. Keep track of the original plan and manage changes carefully. Although changes should be made only with good reason, don’t be afraid to update your plan and keep it alive. Business Plan Pro Premier Edition has Planned, Actual and Variance tables, complete with linked formulas, to facilitate active cash flow analysis.

Prescription for live planning

1. After your plan starts, save a copy of your plan in Business Plan Pro and then type actual results into the sales forecast, profit and loss, and milestones Actual tables. Then watch what the variance views tell you.
2. Note when actual results indicate you need to make changes.
3. Stay in the Business Plan Pro Actual mode and make adjustments to future months of your Actual cash plan. After all, it is already more accurate than the original plan, because it has actual results for the months already completed.
4. As each month closes, type actual results over your revised plan numbers into the Actual area.

The starting sales plan
The example begins in this first illustration with the sales forecast imported from a finished business plan, developed in Business Plan Pro.

Illustration 1: Beginning Sales Plan

Actual results for sales
In the next illustration, you see the actual results for the same company for the first three months of the plan, at the end of March, showing actual sales numbers.

Illustration 2: Actual Sales Results

Plan vs. actual sales
The third illustration below shows you the plan vs. actual results (or variance) for this hypothetical company. The Management Dashboard in Business Plan Pro 11.0 automatically shows plan vs. actual results for the different tables.

Illustration 3: Sales Variance

As you look at the variance for the sales forecast for the first three months, you should see several important trends:

1. Unit sales of systems are disappointing, well below expectations.
2. The average revenue for systems sales is also disappointing.
3. Unit sales for service are disappointing, but dollar sales are way up.
4. Sales are well above expectations for software and training.

Adjusting the sales plan
One of the main advantages of creating a plan on a computer is how easily you can change it. Month by month, as you record your actual results, you can make changes to your plan in the future months of the actual tables, preserve the plan tables, and be able to see the plan vs. actual variance.

In this example, if the company knows by March that sales will be different than planned in April, they should estimate the revised forecast, as a correction to future results. When the actual results are available, they can then replace the revised plan numbers with actual results. The actual results area can then become a plan area for course corrections.

Compare the difference in the February and March columns in Illustration 1: Beginning Sales Plan (the original plan) above, and Illustration 4: Adjusted Sales Plan in Actual Table, (the actual results area).

Illustration 4: Adjusted Sales Plan in Actual Table

Illustration 4 shows how this company makes its course corrections with revisions in the April and May columns of the Sales Forecast Actual table, even before they happen, to reflect the changes shown in the January-March period. Since the company knew systems sales would be down, they planned on it and made a revised forecast in the actuals area. The same revision affects projected profits, balance sheet, and–most importantly–cash.

Continue reading about Growing your Businesses and Plan vs. Actual in Part 2 of this series.