The Indirect Cash Flow Method: How to Use It and Why It Matters

As with a lot of projections and financial analyses, there is more than one correct way to handle cash flow.

That’s true with financial statements, which offer financial history in well-defined terms, and it’s also true with projections, which go along with business planning.

This article looks at an alternative cash flow method, often called the indirect cash flow method, which projects cash flow by starting with net income and adding back depreciation and other noncash expenses, then accounting for the changes in assets and liabilities that aren’t recorded in the income statement.

This method is also called the sources and uses statement, or a sources and uses projection.

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How to use the indirect cash flow method

The indirect method starts with net income and then adjusts for all the sources and uses of cash that aren’t part of the income calculation. Results should be the same for either direct or indirect.

It’s important to be aware of both common methods because, unfortunately, some people who ought to know better don’t. People will look at one or the other and think that it’s wrong if it doesn’t match the method they know. It isn’t—at least not necessarily.

Notice also that the example here doesn’t match the standard one-column sources and uses statement you may have seen with accounting statements, because some concepts are sources in some months and uses in other months.

For example, in the row for inventory, the negative number shown in January is negative because buying inventory absorbed cash in that month. Then it’s positive from February through May, because in these months more inventory was sold, as cost of goods sold, than was purchased. It goes negative in June because in that month, again, more cash was used to buy inventory than the amount of inventory that was sold that month as cost of sales. In a lot of accounting sources and uses statements, laid out as single column, rows divide into either sources or uses, but not both.

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Why does this matter?

The most important takeaway from this article is that there is more than one valid way to calculate projected cash flow.

Unfortunately, some would-be experts don’t understand that and are too quick to say “you’ve done it wrong” when what they should be saying is “you’ve used that other method that isn’t my favorite.”

You, as a business owner, need to know that there are different ways to calculate cash flow—so you don’t get put off when somebody uses the other way.

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Dressing and Growing

As your company grows, your planning grows. As you grow, if you add people to your team, then you want to bring them into the process, and make sure you're on the same page. You bring in skills.

The business gets more complex as it grows. Cash flow gets more sophisticated. You start to manage the money and administration differently.

Or you have a business plan event. You want or need to present a complete formal business plan, or the elevator speech, or the pitch presentation, or summary memo.

That's what this section is about. Grow it and dress it as needed.



Financial Forecast By the time you have the basic numbers in your evolving plan, it's not too hard to fill in some blanks and follow some standards to create a complete financial forecast. That's the projected income (profit and loss), balance sheet, cash flow, business ratios, the whole thing. It will make you look good and feel good to have a complete financial forecast.
Supporting Information This is about the classic market analysis, industry analysis, and business descriptions: your management team, company history, and so on. Earlier I said this should be separate from your plan until you're going to use it. This is about how to do it when you need it.
Dress It As Needed This is about the output. Having a plan, how to create an elevator speech, a pitch presentation, a summary memo, and of course the full formal business plan document.

From Basic Numbers to Financial Projections

There are some good reasons that you might need formal financial projections. The best reason is planning cash flow better. I wrote about the cash flow traps in the previous chapter; being aware of them is better than not, but with standard financial projections, you can take your sales forecast, expense budgets, and starting position and with a few reasonable assumptions you can project your cash. That, however, takes standard financial projections. The cash flow is like the link between your income and your balances. See the illustration above.

You may run into the acronym GAAP, which stands for Generally Accepted Accounting Principles. Everything in this section is according to GAAP.

If you've done the basic numbers, you're already more than half the way there. You've already estimated your future sales, cost of sales, and operating expenses. You're very close to a standard pro forma income statement. Just add projections for interest and taxes, and you have that done.

From there you want to project your balances. What will happen with capital, assets, and liabilities? If you can set your starting balances to match your beginning-of-the-plan estimated guesses, then some rolling assumptions will take you right from there to cash.

In fact, my favorite way to make these estimates is to change and manage numbers in the cash flow and use those changes to automatically generate the balance sheet. I'll show you how to do that in detail in this section.

Income vs. Balance vs. Cash
An income statement (also called profit and loss) shows your business performance over a defined period of time (usually a month or a year). This is sales less costs less expenses, which equals profits. A balance sheet, on the other hand, shows your financial position at some moment (usually at the end of the month or the end of the year). This is assets, liabilities, and capital. Assets must always be equal to capital (also called equity) and liabilities.The cash flow reconciles the other two. Not all your money received nor all your spending show up in the Income Statement, and not all of it shows up in the Balance Sheet. The cash flow links the two. And, much more important, shows where the money comes from and where it goes.

In the meantime, though, there are some standard conventions for the way these various statements link together. This is true in GAAP, true in Excel, in Lotus 1-2-3 if you do it right, and automatically in Business Plan Pro.

  • Your sales forecast should show sales and cost of sales. The same numbers in the sales forecast are the ones you use in the profit and loss statement.
  • As with sales, you should normally have a separate personnel table, but the numbers showing in that table should be the same numbers that show up for personnel costs in your profit and loss table.
  • Your profit and loss table should show the same numbers as sales and personnel plan tables in the proper areas. It should also show interest expenses as a logical reflection of interest rates and balances of debt.
  • Your cash flow has to reflect your profit and loss, plus changes in balance sheet items and noncash expenses such as depreciation, which are on the profit and loss. The changes in the balance sheet are critical. For example, when you borrow money, it doesn't affect the profit or loss (except for interest expenses later on), but it makes a huge difference to your checking account balance.
  • The balance sheet has to reflect the profit and loss and the cash flow.
  • Your business ratios should calculate automatically, based on the numbers in sales, profit and loss, personnel, cash flow, and balance sheet.

Facts About Financial Projections

Normal people hate financial projections because of their off-putting formats and buzzwords. Really, it's just a matter of making good estimated guesses about what you're going to be selling, what it'll cost and what your expenses will be.

Let's go over a few simple points that generate a lot of unnecessary errors in business plans. These are simple facts -- accounting conventions, in some cases -- that answer a lot of entrepreneurs' frequently asked questions. Don't let your business plan look bad because of easy-to-fix errors.

Before I start, take a breath. Don't glaze over when you see financial terms. They aren't that hard, and they are that important. Stick with me.

1. Tax law allows businesses to establish so-called fiscal years instead of calendar years for tax purposes. For example, your fiscal year might go from February through January, or October through September. Use "FY" (as in "FY07") to specify the year in your plan. The year is always the calendar year in which a plan ends, not the year it starts.

2. Understand sales on credit and accounts receivable. When your business sells anything to another business, you usually have to deliver an invoice and wait to get paid. That's called sales on credit, which has nothing to do with credit cards, but plenty to do with B2B sales. When you make the sale and deliver the invoice, the invoice amount increases sales and accounts receivable. When that money gets paid, it decreases accounts receivable and increases cash.

3. Separate costs from expenses. Costs are normally the cost of sales, sometimes called cost of goods sold and direct costs. Costs are the money you spend on whatever you're selling, like what a bookstore pays to buy books. Expenses are regular running expenses like rent and payroll -- expenses you'd have whether or not you had any sales.

4. Don't call your investment venture capital unless it comes from one of the few hundred actual VC firms. If you're getting venture capital, you'll know it. If not, just call it investment.

5. Don't confuse assets with expenses. New entrepreneurs think their companies look better if they have a lot of assets. One common example is wanting to take money spent on programmers and pretend that paying a programmer is buying an asset. Take my word for it: You don't really want that. It's better to expense those development expenses. That lowers your tax bill and makes your balance sheet look better, because you don't have fake assets.

6. The two main accounting standards are either cash basis or accrual; accrual is better because it gives you more accurate cash projections. It seems counterintuitive, but cash basis isn't as good for predicting cash. The difference is timing. In accrual, the sale happens when you deliver the goods or perform the service. In cash basis, the sale happens when you get the money. In accrual, you owe the money when you receive the good or service, regardless of when you pay. In cash basis, you don't show what you owe until you pay it. I strongly recommend accrual because it's much more realistic. Real businesses don't pay upfront; they pay later.

7. Pro forma is just a dressed up way to say projected or forecast. It's one of those potentially daunting buzzwords that really isn't that complicated. The pro forma income statement, for example, is the same as the projected profit and loss or the profit and loss forecast.

Adapted from an column, May 2007.

Projections: How Many Months? How Many Years?

For any normal planning purposes, for any normal company, you should have at least 12 months detailed month by month for business plan forecasts. That would be for sales forecast, cost of sales, your burn rate, and eventually the complete financial forecast, if you're going to do it. Then have another two years beyond that, for three years total, as annual projections.

That doesn't mean you don't think in longer terms. Think about what you want for your business for 5, 10, 20 years. I'm all in favor of that. But I don't think you should plan in the detail of financial forecasts, for very long time periods. The larger numbers -- sales, for example, involve so much uncertainty that you don't get your time's worth back by trying to project more detail. At least not in normal cases. If you're farming lumber from tree farms, maybe.

Be forewarned. You'll run into experts who will say you need more than 24 months by month, or more than five years in detail. They will be very sure of themselves. Sometimes what they mean when they say that is that they know more than you do, so they want you to suffer more. Or they want you to pay them to do the financials instead. Or they don't like you or your business plan and they're embarrassed to tell you that. So instead, they say you need to forecast in more detail. If they are investors, what they mean is that they don't want to invest and they don't want to tell you why. If they are loan managers, they don't want to make the loan. And they don't want to tell you the real reason.

My advice to you, when that comes up, is that unless you are a special case (if you are, you know who you are), look for another expert.

The Three Main Statements

I've taken you this far with just the basic business numbers. To be fair, that's far enough. It certainly gives you some numbers to get a hold on and to manage, review, correct, and revise.

It's likely that at some point you'll want to go further, into the straight financial projections that are part of a complete formal business plan.

The good news is that with what we did with the basic numbers, you're already a long way there.

The bad news is that here again the details and specific meanings of financial terms matter. You can't just guess. So I warned you earlier about the importance of timing with sales, costs, and expenses. This is very true with standard financials. Also, it starts to matter what goes where. It can be confusing and annoying. For example, interest expense goes into the income statement but principal repayment goes into the cash flow, which then affects the balance, but never appears anywhere in income. That means a standard debt payment that includes both interest and principal repayment has to be divided up into both parts. Interest is an expense on the profit and loss. Debt payment reduces debt on the balance sheet.

Elsewhere in this book I discuss the huge difference between planning and accounting. With the three main financial statements, specifically, financial analysts use the term pro forma to describe projected statements and predictions. An income statement, for example, is about past results. A pro forma income statement is a projected income statement.

The Income Statement

The income statement is also called profit and loss. People often refer to the bottom line as profits, the bottom line of the income statement. It has a very standard form. It shows sales first, then cost of sales (or COGS, or cost of goods sold, or direct costs, which is essentially the same thing). Then it subtracts costs from sales to calculate gross margin (which is defined as sales less cost of sales). Then it shows operating expenses, usually (but not always) subtracting operating expenses from gross margin to show EBIT (earnings before interest and taxes). Then it subtracts interest and taxes to show profit.

Sales – Cost of Sales = Gross Margin

Gross margin – Expenses = Profits

Notice that the income statement involves only four of the seven fundamental financial terms. While an income statement will have some influence on assets, liabilities, and capital, it includes only sales, costs, expenses, and profit.

A Word about Words: Profit, Income, and so on
Some say income statement, some say profit & loss, or profit or loss. That's the same thing. Accountants and financial analysts use those titles interchangeably. I use income and income statement, but you can read profit & loss if you like.

The income statement is about the flow of transactions over some specified period of time, like a month, a quarter, a year, or several years.

If you've done the basic numbers I recommended in the previous chapter -- sales and cost of sales in the sales forecast, and expenses (including payroll) -- then you've got the bulk of the income statement done. Take the sales and cost of sales from that table, and the expenses from that table, and If you have interest expenses, and taxes, add them in. And that's about what it takes.

The Balance Sheet

The most important thing about a balance sheet is that it includes a lot of spending and money management that isn't included in the income statement. It's most of the reason that profits are not cash, and that cash flow isn't intuitive. It's all very much related to the cash traps.

The balance sheet shows a business's financial position, which includes assets, liabilities, and capital, on a specified date. It will always show assets on the left side or on the top, with liabilities and capital on the right side or the bottom.

Balance sheets must always obey the following formula:

Assets = Liabilities + Capital

Unless that simple equation is true, the balance sheet doesn't balance and the numbers are not right. You can use that to help make estimated guesses, and pull things together for projected cash flow.

The Cash Flow Statement

The cash flow statement is the most important and the least intuitive of the three. In mathematical and financial detail it reconciles the income statement with the balance sheet, but that detail is hard to see and follow. What is most important is tracking the money. By cash we mean liquidity, as in the balance in checking and related savings accounts, not strictly bills and coins. And tracking that cash is the most important thing a business plan does. The underlying truth is:

Ending Cash = Starting Cash + Money Received – Money Spent

What's particularly important in planning is that neither the income statement alone nor the balance sheet alone is sufficient to plan and manage cash. I discuss the cash flow in much greater detail in the section Planning the Cash Flow.

Standard Tables and Charts

So those three main tables are just about essential for a complete business plan: you have to project income, balance, and cash flow. Cash flow is the single most important numerical analysis in a plan, and should never be missing. Most plans will also have a sales forecast, and profit and loss statements. I believe they should also have separate personnel listings, a projected balance sheet, projected business ratios, and market analysis. There are others that are common, but not necessarily required (depending on the situation and exact context of the plan). Those might include the following:

  • Startup costs, and startup funding. We've already talked about startup costs, but most business plans for startups also need to show where the money to pay for startup costs is coming from. That's a combination of investment and borrowed money. Your balances have to balance, and they don't balance without startup funding. Sometimes the startup funding will produce a useful business chart, a bar chart showing investment vs. borrowed money.
  • Past Performance. When a plan is doing a complete financial forecast for an existing company, past performance is required to set the starting balances for the future. The last balance of the past is the first balance of the future. In practice, people often have to project a few months forward to estimate what the final balance will be on the day the new plan starts. For example, if you're doing a plan for next year starting in January, and it's only October, then you have to guess what happens to balances between October and December.
  • Break-even analysis. A break-even analysis is a standard routine that compares sales to fixed and variable costs to determine how much sales will it take to cover costs. It can be an annoying analysis sometimes, because it requires averaging variable costs and unit prices over an entire business, but it can still be useful as a first look at the risks related to fixed and variable costs.
  • Market analysis. The market analysis is usually an important core component of the market information, supporting information that is required when you're working on a plan for outsiders. Investors, bankers, professors of business, consultants, and others like to see proof of market. The market analysis table shows what data you have, usually a market growth projection, in general by segment. It's really a good idea to break the market into useful subsets, called segments. Market analysis can produce some good-looking charts too, like pie charts breaking the market into segments, and bar charts showing market growth as projected into the future.
  • Ratios analysis. When you're projecting your income and balances, you can then use math and formulas to project standard business ratios. There are a couple dozen standard ratios that accountants and analysts often like to see. These are things like return on investment, profits to sales, inventory turnover, collection days, and so on.
  • Use of funds. For plans intended to go to either investors or lenders, use of funds is a list showing how the money coming in will be spent. Use this to convince investors that you will put their money to good use.

You should also use business charts, like bar charts and pie charts, to illustrate your projected numbers as much as possible. Graphics illustrate numbers very well. They are easier than numbers alone to see and understand.

Fixed and Variable Costs and Burn Rate.

As you consider your projected income statement, I hope you see three of your spending budgets there -- the cost of sales, the payroll, and the expenses. These also contain your fixed vs. variable costs, and your burn rate, which we went over in the Chapter 4. Those are good numbers to keep in mind.

Why do fixed costs matter? They add to the risk. You have to pay them, whether you're making money or not. Some companies reduce risk by trying to make as much as possible into variable costs, depending on sales, instead of fixed costs. For example, to make programming expenses variable instead of fixed costs, contract the work by milestone, or pay less fixed compensation and more royalty on sales.

The burn rate is the same thing. It's a sense of risk. If you know you need $10,000 every month to cover your burn rate, then when you watch your sales you have an instant sense of where they have to get.

Seven Simple Words You Should Know

You don't have to be an accountant or an MBA to do a business plan, but you will be better off with a basic understanding of some essential financial terms. Otherwise, you're doomed to either having somebody else develop and explain your numbers, or having your numbers be incorrect. This is a good point to note the advantage of teams in business: if you have somebody on your team who knows fundamental financial estimating, then you don't have to do it yourself.

It isn't that hard, and it's worth knowing. If you are going to plan your business, you will want to plan your numbers. So there are some terms to learn. I'm not going to get into formal business or legal definitions, and I will use examples.

  1. Assets. Cash, accounts receivable, inventory, land, buildings, vehicles, furniture, and other things the company owns are assets. Assets can usually be sold to somebody else. One definition is "anything with monetary value that a business owns."
  2. Liabilities. Debts, notes payable, accounts payable, amounts of money owed to be paid back.
  3. Capital (also called equity). Ownership, stock, investment, retained earnings. Actually there's an iron-clad and never-broken rule of accounting: Assets = Liabilities + Capital. That means you can subtract liabilities from assets to calculate capital.
  4. Sales. Exchanging goods or services for money. Most people understand sales already. Technically, the sale happens when the goods or services are delivered, whether or not there is immediate payment.
  5. Cost of sales (also called cost of goods sold, direct costs, and unit costs). The raw materials and assembly costs, the cost of finished goods that are then resold, the direct cost of delivering the service. This is what the bookstore paid for the book you buy, it's the gasoline and maintenance costs of a taxi ride, it's the cost of printing and binding and royalties when a publisher sells a book to a store for resale.
  6. Expenses (usually called operating expenses). Office rent, administrative and marketing and development payroll, telephone bills, Internet access, all those things a business pays for but doesn't resell. Taxes and interest are also expenses.
  7. Profits (also called Income). Sales minus cost of sales minus expenses.

Focusing on the Income Statement

The Income Statement is probably the most standard of all financial statements. It comes with standard math too.

Sales - Cost of Sales = Gross Margin.

Gross Margin
I didn't talk much about gross margins when we discussed the sales forecast and the cost of sales, but the gross margin is a useful basis for comparison. Generally, industries have some kind of standard gross margin. Retail sporting goods do about 34 percent on average, and grocery stores about 20 percent. You own results will always be different from the standard, so just understand why you're different, and don't worry about it too much.

Gross Margin - Operating Expenses = EBIT

EBIT is also called gross profit in some circles, but that same term is sometimes applied to the gross margin, so I like EBIT better.

EBIT - Interest - Taxes = Net Profit.

The numbers are usually presented in that order. For financial statements the presentation can become very complex, as various items get broken down into rows and rows of detail, but for planning purposes, you want to keep it simple if you can.

The following illustration shows a simple income statement. This example doesn't divide operating expenses into categories. The format and math starts with sales at the top.

Standard Income Statement
This is a partial graphic, showing only three months of a 12-month table.

I hope you notice that you've already gathered most of this data as part of your flesh and bones of the plan. You've already done the sales forecast, cost of sales, payroll, and expenses. If you've followed the standard financial definitions, as I hope you did (otherwise I'll have to say I told you so), then creating the income statement is a matter of pulling the information together into a single table. Then add estimates of interest expense, and taxes.

Keep you assumptions simple. Remember our principle about planning and accounting. Don't try to calculate interest based on a complex series of debt instruments, just average your interest over the projected debt. Don't try to do graduated tax rates; just use an average tax percentage for a profitable company.

Keep Your Balance Sheet Simple

A business's balance sheet shows the financial picture at some specific time, like at the end of the last day of the month or the end of the last day of the year. The financial picture is a matter of assets, liabilities, and capital. Through the magic of double-entry bookkeeping, your financial transactions are recorded in a way that ensures the balance sheet will indeed balance if the entries are correct.

The Law of Balance
Assets are always equal to the sum of capital and liabilities. Your books have to show that.

So let's make sure first that you know what's what. Some definitions are in order. These are three terms you should know in order to create a blanace sheet:

  • Assets. Cash, accounts receivable, inventory, land, buildings, vehicles, furniture, and other things the company owns are assets. Assets can usually be sold to somebody else. One definition is "anything with monetary value that a business owns."
  • Liabilities. Debts, notes payable, accounts payable, amounts of money owed to be paid back.
  • Capital (also called equity). Ownership, stock, investment, retained earnings. Actually there's an iron-clad and never-broken rule of accounting: Assets = Liabilities + Capital. That means you can subtract liabilities from assets to calculate capital.
Estimating the Balance
If you do it right, once you set your starting balances, you can use your cash flow assumptions to calculate the rest of the balance sheet.The idea is that you have educated guesses already for sales, costs, and expenses. You can use assumptions for sales on credit and payment days and collection days and inventory management to calculate these balances. Then use assumptions for debt and new investment to keep the cash flow accurate. The balance comes automatically.Read on, I'll show you that in the rest of this section.

This is planning, not accounting. That's one of the primary principles of the plan-as-you-go business plan. To make a powerful and useful cash flow projection you need to summarize and aggregate the rows of the balance sheet. Resist the temptation to break it down into detail the way you would with a tax report after the fact. This is a tool to help you forecast your cash.

Sample Balance Sheet
Keep your balance sheet simple because you need to link it to your cash flow assumptions.

Starting Your Balances

To do your financial projections well, you need to start the balance sheet and then adjust it according to assumptions in the cash flow. How you start your balance sheet depends on what numbers you have.

If you're an existing or ongoing company, startup costs and startup funding are irrelevant. Use an estimated ending balance to set up the beginning balance of the planning period. I say estimated, in this case, because usually you're doing your business plan to start a new period in a few months, such as working in October for a plan starting the following January. So you don't actually have the ending balance for the year that's going to end in December; but you do have pretty good numbers to estimate.

I usually recommend a past performance table showing three years of data, even though you actually use just that last year, which normally includes some estimates of ending balances and full-year data. Here's an example.

If you're planning a new company, just starting, then you set your starting balances using the estimated starting costs you did for basic business numbers. Your startup costs include assets and expenses. The expenses affect your capital, because they add up to a loss at startup (don't be disappointed, that's the way almost all startups begin. That loss means you're keeping track of expenses so you can deduct them from taxable income later, when you make a profit).

You know that assets have to equal capital and liabilities. You've got assets defined in the startup table, so what's left is to show where the capital and liabilities are. These are, between them, what you've used to pay for those expenses and assets. Here's an example:

Planning the Cash Flow

I worry most about cash flow because it's so insidious. Like the old saying about rivers, still waters run deep. Cash is frequently hardest to manage when businesses are growing. It is the least intuitive of the financial projections, but the most important. I hope you've read through the cash flow traps portion of Chapter 4. I was trying to scare you. It's good for you.

We got through the basic business numbers with that discussion of cash traps instead of the full detail of the cash flow. That might be enough for the early plan, but eventually you're going to want to build a real cash plan, using real numbers, and real financial math.

Experts can be annoying. There are several ways to do a cash flow plan. Sometimes it seems like as soon as you use one method, somebody who is supposed to know tells you you've done it wrong. Often that means she doesn't know enough to realize that there is more than one way to do it.

Let's start simple here, with a basic direct cash flow plan.

A Simple Basic Cash Flow Plan
There's nothing particularly fancy about this plan, or the table, or the math. You just need to keep track of money coming in, and money going out. This means paying bills as they come due (i.e., paying accounts payable), and paying off loans.

Even at this basic level, you can see the potential complications and the need for linking up the numbers using a computer. Your estimated receipts from accounts receivable must have a logical relationship to sales and the balance of accounts receivable. Likewise, your payments of accounts payable have to relate to the balances of payables and the costs and expenses that created the payables. Vital as this is to business survival, it is not nearly as intuitive as the sales forecast, personnel plan, or income statement. The mathematics and the financial projections are more complex.

A More Realistic Example

So that last one was a simple case, but let's take a more common case. It doesn't have to get that complicated -- remember this is planning, not accounting -- but I do want to deal with some of the more important issues. So let's create another case.

I can't explain cash flow without income and balance. Remember, I did say that the cash flow was what brings the two together. So let me show you some samples. Here's the hypothetical income statement:


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Notice that in this case you can see how we've divided sales into cash sales, in the top row, and sales on credit, in the second row, and that those two rows sum to total sales. Normally we wouldn't show that division in an income statement. I do it like this for this example, because it helps me show you what's going on.

Now let's look at the balance sheet. This is the starting balance for the sample case. In your own plan, you set up starting balances as part of your startup funding, or as the ending balance of your last plan. For now, here's the example.


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I'm going to use these two samples to show you how cash flow brings them together.

Breaking Down the Detail Cash Flow

So let's look then at a cash flow projection that unites these two other statements. In this case we're going to do a direct cash flow, but remember there's also an indirect cash flow method, and there are experts who insist on one or the other, even though you can really do it either way.

So please follow along with me as I go through the cash flow by sections. We start at the top with things that bring in money, meaning cash received. That includes both cash from sales, and cash from other things like borrowing and new investment. You see the example here:


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Cash sales is pretty obvious. It's the same number that was on the income statement. Remember, that's not really just coins and bills, that's also payments by check, and by credit card. In business planning, cash means money in the bank.

Cash from receivables can be confusing at first, but what we see is the way receivables hit your cash flow. When you compare this table with that income statement we just looked at, notice what happens to cash from receivables. The $230 we get as cash from receivables in March is just about the same $228 you made in sales on credit in January. I hope you're guessing that this is because we're estimating 60 days on average waiting for our money. Difference between $228 and $230 is the difference between 60 days and two months. That's a very slight difference.

Cash From Receivables

So let's look more closely at that second row, and how it's calculated. The numbers here are in the background. They don't show up on a standard cash flow statement, but they are critical calculations.

Remember: if you get paid immediately by your customers, by cash or credit card, you don't have to worry as much about this. If, however, you're selling to businesses, then this is really important. Unless you're really unusual, with business-to-business sales, you deliver invoices to your business customers and you then have to wait for them to pay you. You get into a balance situation, in which they don't want to tip the balance by waiting too long, and you don't want to tip the balance by insisting too hard. It's quite common.

Those Critical Assumptions
  1. Accountants normally figure collection days after the fact, using your sales on credit and average balances. With algebra, you can calculate in reverse. For example, if I know I'm selling $35,000 per month on credit, and I have 60 days of collection days, then my balance should be about $70,000.
  2. Not all of your sales are on credit. Some customers, even business customers, will pay cash. You might have a mix of consumers who pay cash and businesses that wait to pay. So you have an assumption of percent of sales on credit.

You deal with this with assumptions. In the illustration here you'll see an assumption for estimated collection period in days, meaning how many days, on average, you wait to get paid. You also have assumptions for sales on credit as a percent of total sales.

So that all boils down to a row in the illustration here, cash from receivables. That's the amount that gets into your cash. You can see how this is different from sales. You can also see the flow between last month's ending balance, this month's sales on credit, and this month's ending balance.


The collection days estimator sets the amounts received. (Amounts shown in thousands. Numbers may be affected by rounding.)

Just in case you have any doubt about how that works, take a look at the following illustration with the same numbers except for the change in your estimated collection days. What happens is that the more the estimated collection days, the more of your assets are in receivables, which means, ultimately, less cash. We stated that in cash flow traps: every additional dollar in receivables is a dollar less in cash.

This simple change turns acceptable cash flow into cash problems.

Additional Cash Received

All those other rows on the money coming in are about other ways that you might get money into your company from something other than sales. The illustration shows these category rows and you can see that new borrowing, new investment, and even sales taxes collected are other ways you get money.

Money off the income statement

What all these other elements have in common is that they are ways your company gets money that doesn't show up in the income statement.

I don't want to get into accounting jargon. The rest of these rows will look fairly simple to you if you've dealt with accounting and financial statements at all, and could be daunting if you haven't.

Tip: Calculating balances

Please notice that this table links to your balance sheet. In this example we're adding $100 to new long-term liabilities, which goes to the balance sheet. We're also adding $25 to the investment, which goes to the balance sheet in additional paid-in capital.

Other income is there because some companies have income from special operations, like interest income, that they don't put on their income statement. That's very rare.

Sales tax is there because you collect tax for the government, and you have to pay it, but it isn't really sales or income. You're a tax collector. So you need to keep track of what you collect.

The rest is new debt, money from sale of assets, or new investment. I should add that I use new other liabilities to keep track of debt that doesn't have an interest rate, such as loans from founders or from your rich relatives.

The total gives you all the money coming into the company. That's the happy first half of the cash flow. Now we need to look at what we're spending.

Estimating Expenditures

What I'm showing here in the illustration might look like it's a self-contained table, but it's really just the bottom half. This is where the money goes (or technically, where you plan to send it). The top half, on the previous pages, was where the money was coming from.

It starts with money you spend on operations. That's what you spend in cash, and what you spend to pay bills. These, between them, are the universe of things that happened on the income statement. The split between cash and payment of bills can be confusing, but we have to keep track of that to do a real cash flow.


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The Other Side of Sales on Credit
This paying the bills portion of the cash flow is where you get the other side, the good side, of sales on credit. This is where you are a business, so you get to wait a while before you pay the bills. The calculations are a lot like the ones for accounts receivable, based on the days of waiting, and the bills coming in. By the way, between what you pay in cash and what you pay as paying bills, you have to include all the payments on the income statement. That means all the costs, all the expenses, plus interest, and taxes, all go through the filter of either cash spending or bill payment. That includes inventory too.We'll look in detail at calculating these payments shortly.

And, just to make that even more fun, bill payment has to include payment for inventory, which is particularly tricky because inventory isn't directly on the cash flow. As we discussed in cash traps, inventory is money spent on assets first, and those assets become cost of goods sold when they are in fact sold. We'll look at that in a few pages, so bear with me.

Much like with the money received and accounts receivable, the first two rows of this table show money spent in cash and bill payments. Money spent in cash is frequently payroll, for example, for which you pay people directly, not after a few weeks. Sometimes there are other cash payments, such as petty cash.

The second obvious use of cash is bill payment. This accounts payable balance is money you owe. Every month, you pay off most of this, depending on how quickly you pay. As with receivables, there are some calculations in the background, like those shown in the illustration below:

In the example here, the calculations start with the ending balance of accounts payable from the previous month, then add new obligations, then subtract obligations paid directly in cash, as well as this month's bill payments, to calculate this month's ending balance. This month's bill payments depend on the assumption of waiting 30 days, on average, before paying bills.

Additional Expenditures

So aside from the cash payments and bill payments, the spending section of the cash flow table has a list of some other ways that companies spend their money -- ways that aren't on the income statement, which is why they have to get into the cash flow and affect the balance sheet.

The list is similar to the list we have of non-income-statement money received. Just as you can receive money from other income like interest or such, you can also pay money that way. Then there are taxes, like sales taxes, which have to be paid to the government. You collected them from customers, but you have to pay them as well.

Debt repayment can be important because it's easy to forget. The interest portion of your payments belongs in the income statement because interest reduces taxable income. It's deductible. Principal repayment, however, doesn't show up on the income statement and isn't deductible. But it does reduce your cash, so you have to plan for it. Also, it reduces the debt balance, so this calculation affects your balance sheet.

In the third row from the bottom, you record the purchase of new other current assets. You'll have to know how much you purchase in new assets in order to estimate your balance sheet. While in real life these might also be recorded as accounts payable and paid a few weeks later, we make them explicit here as if they were paid immediately in cash. That makes for better cash planning.

Logically, this next row is one for purchases of new long-term assets. These also reduce cash.

The last row in spending tracks dividends. Dividends are the distribution of profits to owners and investors. They reduce cash but don't appear anywhere else.

Planning Cash for Inventory

As we saw in the graphics in the cash flow traps, inventory (sometimes called stock) can have a major impact on cash flow. So we have to plan for it.

And If You Don't Manage Inventory?
Then you don't have to worry. Go on. This is one cash trap that won't catch you.

The illustration here shows one way -- and there are others -- to plan for inventory. You have an idea how much inventory (by value, dollar amount) you would use to match your sales forecast. Then you assume how much inventory (in months) you need to keep on hand, and what the minimum purchase is. You can then calculate the details, as shown.

Inventory goes into the books as an asset when it's purchased. It leaves the company as cost of goods sold when it's sold. The cost of inventory shows up in the cash flow when it's paid for, regardless of when it's sold, usually as cash spending or bill payments.

Inventory gets into your cash flow when you pay for it. In the example here, the beginning inventory balance supplies the amounts required until the third month, when additional inventory is purchased. That purchase goes into accounts payable, and is paid as part of the normal flow of bill payments. Inventory purchase is the bulk of the $346,000 new obligations in March shown in the spending details sample on the previous page.

Calculating the Cash Balance

So now you've done both halves of the equation, money coming in and money going back out, so you can put those two halves together to calculate the cash flow, and the cash balance.

Cash flow is the change in the cash balance from month to month. You get that by adding money received and subtracting money spent.

Cash balance is the amount of money on hand. You get that by taking the previous month's cash balance and adding this month's cash flow to it -- which means subtracting if the cash flow is negative.

Having a negative cash flow every so often, for a month, isn't a big problem. You should never have a negative cash balance. That's the same as bouncing checks.

Business Ratios

By the time you have your financial forecast complete, you have numbers available to do some standard business ratios. I can't say that I'm a big fan of ratios, but they can look good in a full and formal business plan, even though they are projected ratios. Here's an example.

The real use of ratios, in my opinion, is watching them as they change over time. In the best of the plan-as-you-go business planning idea, you have some key ratios that are important to you. They are in your objectives and you review them in meetings.

Notice in this case that I've also added a reference to standard business ratios. This is a good touch in a business plan. They come from available industry data, which I discuss in the next section. Don't expect your company projections to ever be an exact match. Be prepared to explain why they are different. And they are always different.

Break-Even Analysis

The break-even analysis is not my favorite analysis for a business plan. It has lots of problems. First, people often confuse it with payback period, meaning when do you break even on the money spent with money returned to you from a business, as it grows. That's not break-even. Second, it depends on being able to deal with estimated average numbers that are hard to do. Businesses rarely produce an average revenue per unit, or an average variable cost per revenue unit, or average fixed costs.

Still, it is useful if you take it with a grain of salt. It can help you see the implications of fixed vs. variable costs, and it can give you a basic idea of how much you need to sell to cover costs. If you don't expect it to be too exact and you don't put too much stock in it, then it can make sense and be useful.

I have an example here. The standard break-even financial formulas are:

The units break-even point is:

Fixed Cost ÷ Unit Price - Unit Variable Costs

The sales break-even point is: The sales break-even point is:

Fixed Cost ÷ (1-(Unit variable Costs/Unit Price))

This section of the model calculates technical break-even points, based on the assumptions for unit prices, variable costs, and fixed costs.

The break-even analysis depends on assumptions for fixed costs, unit price, and unit variable costs. These are rarely exact assumptions. This is not a true picture of fixed costs by any means, but is quite useful for determining a break-even point.

People often represent break-even a line chart, showing the break-even point as the point at which the line crosses zero as sales increase. The example here shows a break-even analysis that compares unit sales to profits, and assumes:

Fixed costs of $94,035

Average per-unit revenue of $325

Average per-unit variable cost of $248

Supporting Information

In Attitude Adjustment, looking at the principles of the plan-as-you-go business plan, I suggested separating the supporting information from the plan. The plan doesn't necessarily include the supporting information that everybody assumes is part of the traditional formal business plan.

And now we're looking at that supporting information, including market analysis, industry analysis, and descriptions and explanations that you make and include for outsiders, but not for a plan you're going to implement by yourself.

Market Research on the Web

For market research, as with business industry research, you go very quickly back to the Web. Here are some starting points: -- is a commercial site aggregating published market research. -- Hill Research Library, an excellent nonprofit library resource, offers market research at accessible rates. -- This is the U.S. government hub site for market research. -- ClickZ Network offers up-to-date statistics on Web usage. -- The U.S. government statistical site. -- is a marketing information site. -- American Marketing Association (AMA) main market information site. -- Hoovers is a database of American companies. -- Offers a wealth of links for additional information sites. -- The Bureau of Economic Analysis is part of the U.S. Department of Commerce, offering business statistics.

Simple and Practical Market Research

Market research doesn't have to be expensive to be credible. True, there are research companies out there that do custom research for larger companies for thousands of dollars. You can buy expensive research reports for some markets, generally high-growth markets of special interest to companies that can afford to buy expensive research reports. You may have budget for that, but you don't have to spend that much money. Most of the best research is research you do yourself.

Do Your Homework

Search for quotes. Magazines, blogs, books, and market research companies publish highlights and snippets with some key numbers from research reports. They really have to, it's part of their normal business. Gartner Group or IDC or NPD Intelect publish market reports that are expensive, but to develop leads they have to give highlights away in press releases. The key here is the search terms you use. Do the Web search first. If you have access to one or more of the powerful literature and published works search engines, like or, or competitors, use them. Check the blog for updates on this topic, these search facilities change often. And don't forget that the key is searching the major search engines, such as Google and Yahoo!, directly.

Look at existing, similar businesses. This is a very good first step. If you are planning a retail shoe store, for example, spend some time looking at existing retail shoe stores. Park across the street and count the customers that go into the store. Note how long they stay inside, and how many come out with boxes that look like purchased shoes. You can probably even count how many pairs of shoes each customer buys. Browse the store and look at prices. Look at several stores, including the discount shoe stores and department store shoe departments.

Find a similar business in another place. If you are planning a local business, find a similar business far enough away that you won't compete. For the shoe store example, you would identify shoe stores in similar towns in other states. Call the owner, explain your purpose truthfully, and ask about the business.

Scan local newspapers for people selling a similar business.Contact the broker and ask for as much information as possible. If you are thinking of creating a shoe store and you find one for sale, you should consider yourself a prospective buyer. Maybe buying the existing store is the best thing. Even if you don't buy, the information you gain will be very valuable. Why is the owner selling? Is there something wrong with the business? You can probably get detailed financial information.

Always shop the competition. If you're in the restaurant business, patronize your competition once a month, rotating through different restaurants. If you own a shoe store, shop your competition once a month, and visit different stores.

Talk to Customers

If you're considering starting a new business, talk to potential customers. In the shoe store example, talk to people coming out of the stores. Talk to your neighbors, talk to your friends, talk to your relatives. Ask them how often they buy shoes, what sizes, where, at what price, and whatever else you can think of. If you're starting a restaurant, landscape architecture business, butcher shop, bakery, or whatever, talk to customers.

At most business schools, when they teach business planning, students have to do a market survey as part of the plan. The plan isn't complete unless they go out and ask a credible number of people what they want, why, where they get it, how much they pay, and so forth. Although you may not go through the formality of a customer survey for your business, this information is vital. At Palo Alto Software, we frequently put a customer survey on two of our websites. People who are browsing the Internet looking for materials and information on business plans can visit us at or

One of those sites does no selling. Instead, it provides free information, including free downloadable sample plans, outlines, and discussions, including answers to several hundred specific questions about details of developing a business plan. We sometimes ask people stopping by our websites to answer a few quick questions that concern us. The invitation promises just a few questions, and promises also that we won't ask for names or e-mail addresses, and we won't follow up with sales information. When we run one of these surveys we get about 300 responses a month, which provides us with valuable information about the concerns people have as they consider writing a business plan.

If you have an ongoing business, the process of developing a plan should include talking to customers. Take a step away from the routine, dial up some of your customers, and ask them about your business. How are you doing? Why do they buy? How do they feel about your competitors? It is a good idea to take a customer to lunch once a month, just to keep yourself in touch.

Count Potential Customers

Most business plans contain an analysis of potential customers. As an essential first step, you should have a good idea of how many potential customers there are. The way you find that out depends on your type of business. For example, a retail shoe store needs to know about individuals living in a local area, a graphic design firm needs to know about local businesses, and a national catalog needs to know about households and companies in an entire nation.

What constitutes good sources depends on what you need. Government and commercial statistics are usually more than enough, but for some plans you may end up purchasing information from professional publishers or contract researchers.

For general demographic data about a local area, if you have no easier source, ask the reference desk at a local library. A local university library is even better, particularly a business library. Chambers of Commerce usually have general information about a local market. In the United States, there is the federal government's U.S. Census Bureau. Nowadays the quickest route to the census bureau is its website at

Before the Internet became so ubiquitous, I frequently turned to vendors of mailing lists for general information about people and types of business. The mailing list vendors often have catalogs listing total numbers of types of people and types of business. For example, to find out how many attorneys or CPA offices there are in the United States, I might look at the lists for sale at a list broker.

Magazines provide another good source of demographics. If you're selling to computer stores, for example, call Computer Retail Week and Computer Reseller News and ask both publications for a media kit. The media kit is intended to sell pages of advertising to potential advertisers. They are frequently full of demographics on the readers. For information on any specific type of business, get the media kits for the magazines that cater to those types of businesses as readers.

Just browsing the Census Bureau website while preparing this draft, it took me about 10 minutes to discover that my home county has 378 general contractors, of which 360 have fewer than 20 employees and the remaining 18 have between 20 and 100. There are 238 legal businesses in my county, of which only 12 have more than 20 employees. Also, following the shoe store example, there are 32 shoe stores in the county, none of them having more than 20 employees. There are 111,000 households in the county, 61 percent of them owner occupied, and an average of 2.49 people per household. Some 22 percent of adults in the county are college graduates, and the median household income is $26,000. All of this information was available for free at the census website.

Know Your Customers

Aside from just counting the customers, you also want to know what they need, what they want, and what makes them buy. The more you know about them, the better. For individuals as customers, you probably want to know their average age, income levels, family size, media preferences, buying patterns, and as much else as you can find out that relates to your business. If you can, you want to divide them into groups according to useful classifications, such as income, age, buying habits, social behavior, values, or whatever other factors are important. For the shoe store example, shoe size is good, but you might also want activity preferences and even — if you can find it — psychographics.

Psychographics divides customers into cultural groups, value groups, social sets, motivator sets, or other interesting categories that might be useful for classifying customers. For example, in literature intended for potential retailers, First Colony Mall of Sugarland, Texas, describes its local area psychographics as including:

  • 25 percent kids and cul-de-sacs (upscale suburban families, affluent)
  • 5.4 percent winner's circle (suburban executives, wealthy)
  • 19.2 percent boomers and babies (young white-collar suburban, upper middle income)
  • 7 percent country squires (elite ex-urban, wealthy).

Going into more detail, it calls the kids and cul-de-sacs group "a noisy medley of bikes, dogs, carpools, rock music and sports." The winner's circle customers are "well-educated, mobile, executives and professionals with teen-aged families. Big producers, prolific spenders, and global travelers." The country squires are "where the wealthy have escaped urban stress to live in rustic luxury. Number four in affluence, big bucks in the boondocks."

Know Your Industry

A standard business plan should explain the general state of the industry and the nature of the business. You might be able to skip this for an internal plan because most of the target readers already know the industry, but even in this case, taking a step away and taking a fresh look can be valuable.

Whether you're a service business, manufacturer, retailer, or some other type of business, you should do an industry analysis, describing

  • industry participants.
  • distribution patterns.
  • competition.

There is plenty of information available -- too much, in fact; your hardest task is sifting through it all. There are websites for business analysis, financial statistics, demographics, trade associations, and just about everything you'll need for a complete business plan.

Industry Participants

You can't easily describe a type of business without describing the nature of the participants. There is a huge difference, for example, between an industry like long-distance telephone services, in which there are only a few huge companies in any one country, and one like dry cleaning, in which there are tens of thousands of smaller participants.

This can make a big difference to a business and a business plan. The restaurant industry, for example, is what we call pulverized, which, like the dry cleaning industry, is made up of many small participants. The fast-food business, on the other hand, is composed of a few national brands participating in thousands of branded outlets, many of them franchised.

Economists talk of consolidation in an industry as a time when many small participants tend to disappear and a few large players emerge. In accounting, for example, there are a few large international firms whose names are well known and tens of thousands of smaller firms. The automobile business is composed of a few national brands participating in thousands of branded dealerships. In computer manufacturing, for example, there are a few large international firms whose names are well known, and thousands of smaller firms.

Prove Your Market

In the Heart of the Plan section we discussed knowing your market. Proving your market goes beyond knowing it. This is for when you need to show your business to outsiders, whether that's for investors, a business plan contest, a bank, partners, potential partners. Sometimes you need to talk about your market to close friends, team members. Sometimes it's a matter of really taking that fresh look we discussed in the Heart of the Plan.

There are no simple rules for what factors actually work to prove a market. Like so many things with business planning, it's going to be different for every different business.

What I can tell you though, is things I've seen in business plans that worked.

  1. Get some credible numbers. How many buyers are out there like your ideal target customer? A lot of times you do this with census numbers, or trade data. Given the state of the web these days, it's not too hard to find general census data (at on people in the U.S. by county, age, gender, economic status, employment, and so on. It's also not hard to find the numbers of types of businesses in your county. The blog addition to this book has a generally up to date listing of good market research links to get you started. We have more on getting market numbers in the following pages.
  2. Develop a credible segmentation scheme. We have more on that in a few pages.
  3. Cut and create. Innovate with segmentation, with market needs and wants. Come up with a new view of the market, or an interesting and creative view of a new market. What does that mean? It's hard to lay down definitions of creativity, but sometimes people discover new markets. A few years ago, for example, people concerned with fair trade in coffee were a new market that somebody discovered. that was a matter of segmenting. Once the definitions were laid down, the market was convincing. That can be a new spin on the product, the pricing, the delivery method, or whatever. It's up to you.
  4. Show how distribution will work. These days the most common and obvious distribution is based on the web. You're going to take orders, and deliver information on line, or products via physical shipping, or some other variation on direct. But that's to ignore business that runs through channels of distribution. That's a huge portion of commerce. Channels are full of gatekeepers and standard margins and commissions and percentages. Your market isn't proven if it doesn't include distribution.
  5. Demonstrate sales. The key question here is whether or not people will buy what you're selling. There's nothing better than actual sales. No market research is more credible. Here are our initial sales. We were able to sell this many units in this much time to that many buyers.

Think about sources. Brand names are credible. Third-party buyers, channel gatekeepers, and well-known experts are credible. Your brother in law, or partner, or next-door neighbor or advisor isn't as credible. Quotes are great. When you can find an expert, a known market research brand, or a magazine going on record about growth in your market, or the need for what you're selling, use that. Highlight it in summaries and presentations.

Explanations and Descriptions

As the following table shows, there are lots of sections in the formal plan document that are basically describing and explaining your business to outsiders. I'd like to go back to the general plan outline from the first section, and look this time at the kind of descriptions and explanations you'll need to add as supporting information for a formal business plan document.

Section Notes and comments
1.0 Executive Summary1.1 Objectives1.2 Mission1.3 Keys to Success These are pretty much in the Heart of the Plan. Jump ahead to the next Section, Dress it As Needed, to look at the Executive Summary. talked about objectives and mission and keys to success in the Heart of the plan.
2.0 Company Summary
2.1 Company Ownership
2.2 Start-up Plan (for new companies) or Company History (for ongoing companies)
2.3 Company Locations and Facilities
The formal plan should include basic summaries to get people up to speed with your company formation, history (if it has history), locations, facilities, intellectual property, and so on.This is where you put your startup costs if you're a startup, or the past performance information if you're an existing and ongoing company.
3.0 Products and Services
3.1 Product and Service Description
3.2 Competitive Comparison
3.3 Sales Literature
3.4 Sourcing
3.5 Technology
3.6 Future Products and Services
You've gone through this in the Heart of the Plan, but now we're talking about descriptions and explanations. Keep it simple. Remember, though, that this is a lot about credibility. You're proving that you have an interesting business offering, usually to outsiders. Proof -- designs, patents, quotes, and illustrations -- is very important.One of the mistakes a lot of people make in a formal business plan document is explaining too much about the technology. A business plan is about the business. Leave the technical explanations for the appendices. Use the team backgrounds and patent information (if you have it) to make the technology credible.
4.0 Market Analysis Summary
4.1 Market Segmentation
4.2 Target Market Segment Strategy

4.2.1 Market Needs
4.2.2 Market Trends
4.2.3 Market Growth
4.3 Industry Analysis

4.3.1 Industry Participants
4.3.2 Distribution Patterns
4.3.3 Competition and Buying Patterns
4.3.4 Main Competitors
This is mainly the market proof you've been doing in this section. Write it out, explain it, make it credible, and give it numbers.
5.0 Strategy and Implementation Summary
5.1 Strategy Pyramids
5.2 Value Proposition
5.3 Competitive Edge
5.4 Marketing Strategy

5.4.1 Positioning Statements
5.4.2 Pricing Strategy
5.4.3 Promotion Strategy
5.4.4 Distribution Patterns
5.4.5 Marketing Programs
5.5 Sales Strategy

5.5.1 Sales Forecast
5.5.2 Sales Programs
5.6 Strategic Alliances
5.7 Milestones
You've thought it through. You have the heart of your plan. This is where you explain it in text, preferably simple easy to read text, full of bullet points.The good news is that you do know your marketing strategy, sales strategy, and the rest of it. The bad news is that as we get into this as supporting information, you have to take the time to explain and describe it.

The complete plan requires textual explanation of the key numbers and tables you had in your organic plan-as-you-go plan. That includes explaining the assumptions behind the sales forecast, and the business activities in the milestones table. Add simple text, with lots of bullets instead of long paragraphs.

6.0 Management Summary
6.1 Organizational Structure
6.2 Management Team
6.3 Management Team Gaps
6.4 Personnel Plan
For a plan for investment, the description of the management team is often the single most important section. Professional investors usually look to the management team as the best way to reduce risk. They want to see backgrounds, track records, and successes. Angel investors follow the same pattern, and that's also true with business plans for business venture contests.You did a personnel plan in numbers in the expense budgets, and you linked that into the full financial forecast profit and loss. This is where to put that table into the plan.The organizational structure is the underlying logic of the who does what part of your plan in flesh and bones. Most standard plans include an organization chart at this point.

The section on management team gaps builds credibility for high-profile plans. If you're taking a plan to investors or to a business plan contest, your readers will probably see those gaps. Don't ignore them. Acknowledge the gaps and show that you're intending to fill them.

7.0 Financial Plan
7.1 Important Assumptions
7.2 Key Financial Indicators
7.3 Break-even Analysis
7.4 Projected Profit and Loss
7.5 Projected Cash Flow
7.6 Projected Balance Sheet
7.7 Business Ratios
7.8 Long-term Plan
Usually the formal complete plan starts this chapter with a simple summary explanation of the underlying financial strategy. That would be a reference to growing through investment, planning for multiple rounds of investment, for example. Or it could be financing growth with loans, whether SBA guaranteed or not. Or it might be simple bootstrapping (although those businesses aren't as likely to need the formal business plan document).Then most of the rest of this chapter is a matter of showing the financial projections we've discussed in this book. One very important addition, skipped in too many plans, is to offer basic explanations in text. Highlight the growth rates, and key points, in the tables.

As a general rule, I recommend including just annual projections in the tables embedded in the text of a plan, along with a heavy dose of business charts. Leave the monthly tables for the appendices.


If your new business is going to distribute products in the U.S. retail market, that means what people call "the channel." Also known as channels of distribution, or retail channels. As in stores. Big stores or little stores. Macy's, Office Depot, Staples, Safeway, whatever. I see too many business plans that underestimate the effort, resources, and problems involved in selling things through channels.

So you know, my experience with channels started in 1993 and has been almost entirely in stores and chains selling packaged computer software. I've talked to a lot of people dealing in other kinds of channels, and it seems to be quite the same. So that's a disclaimer.

  1. Understand tiers. Most of the major retail channels in the U.S. involve two-tiered distribution.
  2. The big retailers, who tend to be chains with hundreds of stores, want to buy from distributors, not from you. No offense intended. It's just that buying from distributors makes their life simple. One bill, one payment, easier administration.
  3. Distributors are tough gatekeepers to get through. They aren't looking for new vendors. New vendors mean more work. And more risk. So they aren't anxious to change the status quo. Of course there are exceptions, but that's the rule.
  4. Retailers are also tough gatekeepers, for the same reason. There too, there are exceptions, but it's hard to be one.
  5. Both tiers are much happier about new products when they come from existing vendors. Those major companies that are already selling into the channel have it easier.
  6. Packaging is really important for everybody in the channel, and more so for new companies. Obviously this is a matter of different products and different industries, but through retail, buyers make choices based on what they see. We vendors would like them to read reviews and make more informed decisions, but most of the time they decide based on what they see.
  7. Channels take a big cut of your money. How much varies by industry, but if you are planning a new business and you don't know, find out. The distributors take a smaller cut but they take forever to pay you. The retailers take a larger cut, and they don't have to pay you, because they bought from the distributors. Both tiers take cuts of the money for co-marketing and things like that. You get a much smaller revenue per unit, and it comes several months after you make the sale.
  8. Most channels will insist on being able to send unsold goods back to you the vendor, and have you purchase them back from them at the same price they paid you, without any allowance for all the co-marketing commissions. This makes financial analysis hard.

One of the things I learned early and hard about channels. They don't care about your problems. If you're hard to deal with, they'll find somebody else to sell into the same segment.

So if you can sell direct, count your blessings. Channels offer volume, and branding, and that's attractive. But direct sales have some very attractive advantages too.

And in the context of developing the formal business plan, for outsiders to read, unless distribution is completely direct and painfully obvious you should include a discussion of distribution in the marketing section of your plan.

Explain how distribution works in your industry. Is this an industry in which retailers are supported by regional distributors, as is the case for computer products, magazines, or auto parts? Does this industry depend on direct sales to large company customers? Do manufacturers generally support their own direct sales forces, or do they work with product representatives?

Then explain how your specific distribution strategy works. There are almost always variations on the industry norm. In many product categories there are several alternatives, and distribution choices are strategic. Encyclopedias and vacuum cleaners were traditionally sold door-to-door but are now also sold in stores and direct from manufacturer to consumer through radio, television, newspaper, and of course Web ads.

Technology can change the patterns of distribution in an industry or product category. The Internet, for example, changed the options for software distribution, books, music, and other products. Look what it's done to video and video rental. Look what cable distribution is doing to video and video rental as well.

This topic may not apply to most service companies, because distribution is normally about physical distribution of specific physical products. If you are a restaurant owner, graphic artist, architect, or some other service that doesn't involve distribution, just leave this topic out of your plan.

For a few services, distribution may still be relevant. A phone service, cable provider, or Internet provider might describe distribution related to physical infrastructure. Some publishers may prefer to treat their business as a service rather than a manufacturing company, and in that case distribution may also be relevant.

Heath Brothers on Business Language

"This is where so much business communication goes awry. Mission statements, synergies, strategies, visions -- they are often ambiguous to the point of being meaningless. Naturally sticky ideas are full of concrete images ... because our brains are trained to remember concrete data. In proverbs, abstract truths are often encoded in concrete language. "A bird in the hand is worth two in the bush." Speaking concretely is the only way to ensure that our idea will mean the same thing to everyone in our audience."

Adapted from Made to Stick, by Chip and Dan Heath

Crossword Puzzle Information Gathering

I was in Mexico City in the 1970s, working for Business International mostly and also for Business Week, Financial Times, and other business publications.

I usually couldn't get the information I wanted. Or needed. There was no Internet back then, or at least not anything available to anybody normal. And we were in a developing country, with scarce resources, much more worried about having enough jobs and schools than about providing information for business writers.

So I built conceptual crossword puzzles. Connected dots. I'd have one source of government information give me an overall growth rate for a related industry, then find a large company whose annual report gave me information on their particular segment, then an analysis somewhere telling me that the industry leader had 60% of the market, and I'd be able, sometimes, to generate an estimate of something I needed to know.

You can do that today. Find available statistics here and there, look for snippets quoting experts in published materials, find the annual report of a publicly traded company, and look for data to mine.

What can your new coffee house sell? You can use the reverse telephone tree technique to ask people, get an educated guess. Shouldn't you also be able to find out how much an average Starbucks location sells. How is yours going to be different from Starbucks? Estimate from what you know, and jump from there to what you don't know.

That's what I call crossword puzzle information gathering.

Financial Profiles and Industry Data

Look on the blog for the latest. These sources change fast. Do a web search for "industry profiles." As I write this now, some of the leading sites offering standard industry data include,, and Banks still look for standard industry ratios from Risk Management Association, at

What you're looking for is one or more of the compilations of standard financial information for different industries. The data providers compile reports breaking companies into their SIC or NAICS (these are standard business classification systems) categories, and report on the average financial statements and financial ratios.

Reports in Business Plan Pro
I haven't talked much about Business Plan Pro in this book, because it's about the plan-as-you-go approach, not about specific software. However, Business Plan Pro does include standard industry reports like the ones suggested here.

For example, you can fairly easily find out the average gross margin for restaurants, or sporting goods retail stores, and other retail stores. Find out some standard financial ratios, such as return on sales or debt to assets, by type of industry.

Your company will almost never match the standard. But in this section we're talking about supporting information for outsiders, so you have to assume that outsiders will have access to the standard reports and will expect you to explain the difference between your company and the standard. Usually you can, because there is almost always a difference between any company and the standard composite for any industry.

Cutting the Pie: Segmentation, Setting Targets.

The market segmentation concept is crucial to market assessment and market strategy. Divide the market into workable market segments — age, income, product type, geography, buying patterns, customer needs, or other classifications. Define your terms, and define your market. And of course, markets change. Don't assume you know your market because you've been in business a few years. Take a step back for a fresh look.

Segmentation can make a huge difference in understanding your market. For example, when a local computer store defines its customer segments as "high-end home office" and "high-technology small business," its segmentation says a lot about its customers. The segmentation helps the company plan its focus on the different types of potential customers.

When I was consulting for Apple Computer in the middle 1980s, we divided the markets into workable categories, including home, education, small business, large business, and all others. Some other groups in Apple also focused on government as a specific market segment. As you define the segment you point toward an understanding of the market.

In the 1970s, I knew a company that was selling candy bars through retail channels. They segmented the market in a way that defined a range of products as "oral satisfacters" (their term, not mine) that included candy, cookies, soft drinks, and bagged chips. The segmentation helped the marketers understand their real competition, which wasn't just other candy bars, but also other products targeting the same customer money. That understanding improved the marketing and sales programs.

In today's business it's easy to see segmentation in action. Consider the different tone, content, and media for ads that sell products to kids, compared to those that sell the same product to parents. Car companies change their advertising substantially from one type of program to another. Stand-up comedian Robert Klein used to joke about the beer company ads that changed the style of the music to match the audience. He complained that he kept getting the country music version, but he liked the blues version better. The company that did those ads used the styles of music to address different target customer groups.

In developing segmentation, consider what factors make a difference in the purchasing, media, and value patterns of your target groups. Does age matter in choice of restaurants, or is style and food preference more important? Is income level a key factor? Education? I suspect some restaurants will sell more meals to college graduates than others. Is this because of education, age, or income levels? That depends on your business.

Presumably you've already done the thinking about segmentation. It was part of your core market thinking for the heart of the plan. At this point, as you look for more and better and proof, put some numbers and credible sources and creativity into your segmentation. Put it squarely into your strategy. Look at your segmentation critically and strategically. Is this the best segmentation? Be sure to revise and polish your numbers.

Competition and Buying Patterns

Explain the nature of competition in this market. This topic is still in the general area of describing the industry, or type of business. Explain the general nature of competition in this business, and how the customers seem to choose one provider over another.

What are the keys to success? What buying factors make the most difference? Price? Product features? Service? Support? Training? Software? Delivery dates? Are brand names important?

In the computer business, for example, competition might depend on reputation and trends in one part of the market, and on channels of distribution and advertising in another. In many business-to-business industries, the nature of competition depends on direct selling, because channels are impractical. Price is vital in products competing with each other on retail shelves, but delivery and reliability might be more important for materials used by manufacturers in volume, where a shortage can affect an entire production line.

In the restaurant business, competition might depend on reputation and trends in one part of the market, and on location and parking in another.

In many professional service practices, the nature of competition depends on word of mouth, because advertising is not completely accepted. Is there price competition between accountants, doctors, and lawyers? How do people choose travel agencies or florists for weddings? Why does someone hire one landscape architect over another? Why choose Starbucks, a national brand, over the local coffee house? All of this is the nature of competition.

List the main competitors. What are the strengths and weaknesses of each? Consider their products, pricing, reputation, management, financial position, channels of distribution, brand awareness, business development, technology, or other factors that you feel are important. In what segments of the market do they operate? What seems to be their strategy? How much do they impact your products, and what threats and opportunities do they represent?

Develop A Market Forecast

To prove a market, you build a forecast on credible numbers. Nobody expects you to be correct or right about the future, but you do have to be reasonable, logical, and credible. You should cite sources, such as the U.S. census or trade group statistics, or published articles, or known experts, as much as you can.

Potential Market, Not Served Market
Usually in a business plan, particularly when proving a market, you focus on potential market, not served market.That means your forecast is about the whole wide larger market (cut into segments of course) not just the people or companies you already sell to. Market potential is growth. It makes the forecast interesting.

For example, the market for a move theater, restaurant, or bicycle rental is the local population plus tourists or visitors. The market for downloadable software is the world of users of that operating system, who have the target problem.

Growth Rates (CAGR)
To calculate compound average growth rate (CAGR), the standard formula is:(last number/first number)^(1/periods)-1

You can see that formula at work in the illustration, in the formula shown in the edit bar of the spreadsheet, calculating the CAGR from the two numbers. Average growth in the Consumer segment during that period was 2%.

While it's not strictly necessary, a market forecast is generally a good addition. That means numbers, like shown here, estimating potential market at present and market growth over five years. This illustrates your segmentation as well, and works as support for your segmentation strategy and choice of targets. You can see how segments are handled in this sample.

In the illustration you can see how the spreadsheet works. It is pointing to cell H5, and the formula in the edit bar is the formula in that cell. It identifies the last year in row-column notation as G5, and the first year as C5. The growth rate calculation produces the number showing in H5, 2%.

As you can probably guess, the formulas in the rest of this row take the growth rate assumption in column B and apply it to the other cells, after the initial value in column C. You add 1 to the growth rate and multiply it by the previous year to get the next year's calculated amount.

You can create a simple market analysis by estimating the number of potential customers for each segment and the growth rate, as shown in this example. Once you have those numbers, it should be a simple step to develop a corresponding chart, such as the classic market pie chart on the previous page, or a bar chart showing growth by segment.

Documents, Presentations, Live

One of the principles of the plan-as-you-go business plan is that form follows function. Your plan isn't your plan document. It isn't your elevator speech, or your summary memo. Those are outputs. Your plan is what you're going to do with your business. It's what's going to happen, set out concretely so you can track what actually happens and compare it to what you thought would happen.

Think about how the plot of a well-known story generates different versions -- the novel, the movie, the television mini-series, the comic book version, the performance by the high school drama department. All of them have the same story at their core.

Your business plan is like that too. What people traditionally think of as the plan, the document, is just an output. Other common outputs include the pitch and the summary.

This matters because people get very confused. "Don't do a business plan," some experts say. "Just do a presentation." They justify that with the idea that few investors read business plans. But wait, the presentation has to describe what you're going to do, so you'd better have a plan. And maybe, just maybe, you don't create the plan document, just the presentation ... but if so, you better know what the plan is.

In this section I'd like to look at some of the standard outputs: the business plan document, the summary (or summary memo), the elevator speech, and the pitch presentation. For all of these, you start with a plan and then create the output as needed.

And these are hardly the only business plan outputs these days. Others include websites, blogs, and more recently Twitter had a business plan contest limited to 140 characters. The plan is whatever works for you, but only as long as it works for you.

The Standard Traditional Business Plan

I hope at this point I've made it clear that you don't necessarily need to have a standard, traditional, formal business plan. Until you really need to show a plan to some outsider who needs, wants, or expects the full formal plan, you can just use your plan-as-you-go plan to reap the benefits and avoid the hassle of the document.

However, there are business reasons that force you to produce the traditional plan document. We call these business plan events. The more common business plan events are related to seeking loans or investments. Ironically, the bank loan manager,  angel investor, or venture capitalist may not read your plan, but most of them want to know you have one, which means they want it to appear in their inbox or on their desk.

Approaching a business plan event without being ready to produce a traditional business plan is something like approaching a publisher without having an outline and sample chapter. You'll look dumb if you don't have it. So have it.

The good news is that you already have the core of your plan ready, so you're a long way down the path from start to done. You have only to dress it up to make it a formal business plan. You know what you want to do, and why, so from here you spin it out from your core into the proper words. You already have the numbers, right? And you know your strategy, too, as well as your dates, and deadlines, responsibility assignments, and metrics.

So the bad news is that depending on how much you have, and why you need to show that plan, you may of course have to go through the exercise of supporting market information with something beyond just hunches and experience. I've said earlier that your plan doesn't necessarily include supporting information like market research and industry analysis, but when you're going to dress it up formally and send it out to represent you, it probably does need to include more background information.

At this point we've done a standard outline twice already, once in About This Book with explanations of where to look for what part, and again in Supporting Information, with notes about the explanations and descriptions involved. I'd like to do it here for a third time, this time with notes about the tables and charts to include as well. Some of this might be redundant, but, oh well, I hope it's convenient.

Section Tables and Charts
1.0 Executive Summary1.1 Objectives1.2 Mission1.3 Keys to Success I like a highlights chart here, a bar chart showing sales, gross margin, and net profit, by year, for the next three years. No tables.
2.0 Company Summary
2.1 Company Ownership
2.2 Start-up Plan (for new companies) or Company History (for ongoing companies)
2.3 Company Locations and Facilities
Include either the startup costs or past performance data as a table (not both, just one of those two). You know which you need.A chart showing highlights of either one, as a bar chart, is a good idea.Particularly for retail, photos of locations might also be good.
3.0 Products and Services
3.1 Product and Service Description
3.2 Competitive Comparison
3.3 Sales Literature
3.4 Sourcing
3.5 Technology
3.6 Future Products and Services
No standard tables or charts here. Use illustrations or product drawings to show products. Menus are nice for restaurants. Product lists or catalogs or website illustrations could help.
4.0 Market Analysis Summary
4.1 Market Segmentation
4.2 Target Market Segment Strategy

4.2.1 Market Needs
4.2.2 Market Trends
4.2.3 Market Growth
4.3 Industry Analysis

4.3.1 Industry Participants
4.3.2 Distribution Patterns
4.3.3 Competition and Buying Patterns
4.3.4 Main Competitors
Ideally you include a market forecast table, along with a pie chart showing the market segments by size as they are today, and a bar chart showing projected growth of the segments over five years.
5.0 Strategy and Implementation Summary
5.1 Strategy Pyramids
5.2 Value Proposition
5.3 Competitive Edge
5.4 Marketing Strategy

5.4.1 Positioning Statements
5.4.2 Pricing Strategy
5.4.3 Promotion Strategy
5.4.4 Distribution Patterns
5.4.5 Marketing Programs
5.5 Sales Strategy

5.5.1 Sales Forecast
5.5.2 Sales Programs
5.6 Strategic Alliances
5.7 Milestones
Include your sales forecast, and bar charts illustrating the next year's sales, by row, by months; and another illustrating projected sales for the length of the plan, also by row, and by year.Your rows are your sales items, from your sales forecast. Depending on your business, that might be actual items sold, or types of items, or types of services. The details have to fit your business.Also include the milestones table, with a Gantt chart if possible, illustrating the milestones flow for the next year.
6.0 Management Summary
6.1 Organizational Structure
6.2 Management Team
6.3 Management Team Gaps
6.4 Personnel Plan
Include the personnel table, with projected compensation.
7.0 Financial Plan
7.1 Important Assumptions
7.2 Key Financial Indicators
7.3 Break-even Analysis
7.4 Projected Profit and Loss
7.5 Projected Cash Flow
7.6 Projected Balance Sheet
7.7 Business Ratios
7.8 Long-term Plan
This section is full of tables and charts. The assumptions are a table, and so are the Profit and Loss, Cash Flow, Balance Sheet, and Ratios. Some plans will include a table of projected five- or ten-year plans in summarized fashion (sales, gross margin, net profit, assets, liabilities, and capital).Illustrate these tables as much as possible with business charts: Bar charts showing gross margin and profit by month and year, and bar charts showing cash flow by month for the next year.

As a general rule, I recommend including just annual projections in the tables embedded in the text of a plan, along with a heavy dose of business charts. Leave the monthly tables for the appendices.

Always Lead With Your Story

Start with stories. In your business plan, your presentation, and even your elevator pitch, always start with a story about who needs what you're selling. Needs and wants are the biggest thing in business, so make that come alive.

Ralph promised his wife Mabel that he'd get new suits before his London trip, but Mabel normally goes with him to the stores and she's been busy with their daughter and new grandson, and Ralph hates shopping. His solution, for this and his long-term need for a steady supply of good-looking clothes befitting his position as president and founder, is The Trunk Club. He doesn't have to shop, his clothes will fit, he'll be able to just call the club and ask for what he needs, whether it's business casual, office suits, or formal, or even golf and hiking. He'll be in style and matched and he won't have to worry about it. And he won't have to go into a store either.

I just made that story up to illustrate a point. That one paragraph does a decent job, in my opinion, at setting up the market need, the target market, and the business offering. This is one of the more interesting new businesses I've seen lately. The plan, the presentation and the elevator pitch could begin with this story.

Linda's been dreaming about and thinking about the business she wants to start. Sometimes she can't sleep at night for thinking about it. Will people want what I'm selling, she asks herself? How many? How much will they pay? What's the right equipment to start? Can I afford it? What will I need to spend to get going, and what will I need to spend on people, rent, and so on as I start? How much will it cost me to build what I'm delivering? Can I make an offering that will be attractive to outside investors? Finally Linda gets Business Plan Pro and starts working, building the plan. She takes it a topic at a time, a step at a time; she jumps around the different projections and concepts. Now when she wakes up in the middle of the night thinking about it, she has a plan underway, somewhere to put those thoughts down. Now she has a much better idea of what she needs, how long it might take, what the key points are.

Leslie and Terry both work, and they also both care very much about creating the right home life for their two children, three and one years old. When they shop for groceries they always go to the more health-oriented grocery store. They buy organic, they cook organic, but they don't always have the time to cook. They hate giving their kids the foods they can get delivered, and they hate giving their kids the meals they can pick up. Then they discover a new business that prepares healthy family meals and sells a subscription plan. Terry stops by several days a week to pick up the family dinner on the way home from work. What business is this story for? You tell me; I'm just thinking here about a problem that needs solving. It's about telling the story. That makes a business plan come alive.

One final example, this one a true story: Recently, I spent most of Thursday and Friday one week at the University of Notre Dame with seven other people reviewing more than 60 executive summaries submitted to the two Notre Dame venture competitions – the McCloskey Business Plan Competition. As part of this we reviewed two otherwise equal executive summaries. One starts with the founder's story of how he had this problem nobody could solve. That one scored significantly higher than the other one, which was relatively similar on all other noticeable points but was missing a story.

This story idea isn't new. For more on how to do it, try reading Made to Stick by Chip and Dan Heath or All Marketers are Liars by Seth Godin. What's new here is that I've experienced another example of how much difference this tactic can make. Turn your core marketing strategy into a story, and then tell that story first.

Adapted with permission from Planning Startups Stories blog

The Executive Summary: Write It for Whomever Will Read it.

Let's take a couple of real-world cases. First, the executive summary for a formal business plan, which will be used in a venture competition or as a tool for seeking outside investment. Second, the executive summary for a bank, as part of a loan document. Third, the executive summary for internal use, for employees, or managing a plan. Each of these is a different animal.

The Classic: Seeking Investment

This summary, whether you like it or not, performs a sales function. You are selling your concept, your startup, or your growing company to an outsider who is interested in becoming an investor. So put yourself in the investor's place and emphasize the elements that will make her money.

What's strongest about your plan, compared to others? Make that a highlight. You might even lead with it. For example, if you've got a venture already backed by major brand-name backers, say so early in the summary. If you've got a founders team that includes several known entrepreneurs with good track records, then get that up front. If you have a good business track record, like impressive early sales or landmark deals with major channels or corporations or governments, put that first. If you have an amazing new invention or break-through technology, lead with that. Use good judgement. You're an editor, at this point, looking at things through the audience's eyes.

So the order depends on the specifics of your company, but, regardless of order, here are some elements you should definitely include:

  • The heart of the plan. That includes the essential reason for buying, the target market, and key elements that match identifiable core competencies and market opportunities.
  • If you have a new product or new technology, sell it to the investors. Sell it by showing there are already customers and commitments, if you can. If you don't have that, and you have a patent, then say so, but don't think you don't have to defend the patent. Be prepared for objections and don't make the summary imply that a patent alone is enough. If you have working prototypes, say so.
  • Description of the management team. You can't get away with saying nothing about this. If you have to depend on board members or advisors, so be it; investors are always looking for the team. The better the track record, the lower the risk. If your team has no experience, say very little.
  • Some key numbers. Usually this includes a sales forecast. In some rare cases, some Web companies can get away with forecasting traffic; in those cases, however, they'd better explain a business model. Sales are almost always essential, and profits are good too, if you have a realistic projection. Include just a few numbers as bait in the summary, don't go too deep.
  • The offering to investors. What do you want from investors, and what are you prepared to give in return. You have to see the deal from the investors' point of view. Don't tell them just how great your company will be, tell them how they make money. They want to know how much money you need now and how much equity you are prepared to give.
  • About the business model: if you have a traditional business, the business model is obvious. You have to explain it only if it's not obvious. Channels of distribution can make a big difference too; if your business depends on physical distribution, you should show that you know the channel and that your projections are realistic. Your sales should assume channel margins too.

The Summary for Lenders

Read through my recommended points for the investment or venture competition-oriented summary, and think about the revisions you'll want for a summary for a bank. Here are some highlights you want to hit:

  • The heart of the plan. Just about the same as for investors. People want to know what you're doing.
  • Financial history. How long have you been in business? What legal formation or legal entity is involved? Who owns this company, and what kind of financial history do they have?
  • A balance sheet. Banks can't lend you money for ideas; they need to secure the money with assets. You have to have more assets than liabilities.
  • Payment history. Your company has to live with the debt and payment record it has, and the bank has to check that. Give a head start.
  • Description of the management team. You can't get away with saying nothing about this. If you have to depend on board members or advisors, so be it; investors are always looking for the team. The better the track record, the lower the risk. If your team has no experience, say very little.
  • Some key numbers. Usually this includes a sales forecast. In some rare cases, some Web companies can get away with forecasting traffic; in those cases, however, they'd better explain a business model. Sales are almost always essential, and profits are good too, if you have a realistic projection. Include just a few numbers to make your reader interested in the summary; don't go too deep.
  • For bank purposes, expect to submit a complete financial projection including profit and loss, balance sheet, and cash flow, both for recent past and projected into the future.

What Else Should an Executive Summary Include?

For a standard summary you should generally include:

  • business name
  • business location
  • what product or service you sell
  • purpose of the plan

Another paragraph should highlight important points, such as projected sales and profits, unit sales, profitability and keys to success. Include the news you don’t want anyone to miss. This is a good place to put a highlights chart, a bar chart that shows sales, gross margin, and profits before interest and taxes for the next three years. You should also cite and explain those numbers in the text.

How long should an executive summary be?

The shorter the better. If you can say it in a single page, then wow, that's really impressive. Generally two pages is better than five, and five is better than 10, but ten pages is probably too much.

Stay sensitive to the exact purpose and audience. These days you run into situations in which people use the phrase "executive summary" to mean "business plan, but keep it short." Always ask if you can.

Particularly in venture competitions, find out what the general standard is and how the summary will be used. I've seen competitions (and been among the judges as well) in which the best summaries were penalized for being short. Longer summaries seemed to do better because they included more information and the judges were impressed. The short ones didn't get a chance to make all the points they wanted.

Realize that some people say summary or summary memo when what they want is a one-page letter or email. As I said above, always ask if you can.

If you check around, you'll see that experts differ on how long an executive summary or summary memo should be. Some insist that it takes just a page or two, others recommend a more detailed summary, taking as much as ten pages, covering enough information to substitute for the plan itself. Although business plans of 50 pages used to be common, investors and lenders these days expect a concise, focused plan.

The Pitch Presentation

For a bit of venture capital history, the pitch presentation became fashionable in the late 1990s during the dotcom boom, when investors were frequently buying into businesses that had website traffic and no money, and no business model they could use to get money.

The pitch presentation is a 20-minute (or so) slide presentation, usually done live but with either PowerPoint or Keynote slides in the background, that tells investors about a new business.

The best writing anywhere on this is in Guy Kawasaki's "Art of the Pitch" chapter in his book The Art of the Start.

The Art of the Start by Guy Kawasaki Read more about this book...

And I'm happy to say that Kawasaki has posted much of the same material on his blog, in the post named The 10/20/30 rule for PowerPoint presentations. He says on that post:

It’s quite simple: a PowerPoint presentation should have ten slides, last no more than twenty minutes, and contain no font smaller than thirty points. While I’m in the venture capital business, this rule is applicable for any presentation to reach agreement: for example, raising capital, making a sale, forming a partnership, etc.

Ten is the optimal number of slides in a PowerPoint presentation because a normal human being cannot comprehend more than ten concepts in a meeting -- and venture capitalists are very normal. (The only difference between you and a venture capitalist is that he is getting paid to gamble with someone else’s money.) If you must use more than ten slides to explain your business, you probably don’t have a business. The ten topics that a venture capitalist cares about are:

  1. Problem
  2. Your solution
  3. Business model
  4. Underlying magic/technology
  5. Marketing and sales
  6. Competition
  7. Team
  8. Projections and milestones
  9. Status and timeline
  10. Summary and call to action

Of course that's an excellent general guideline, but you'll customize and tailor it to fit your exact needs.

For example, you don't need a slide on the business model unless your model is unusual. If you're buying things and reselling them with a profit margin, or you're providing a service and making a profit, or manufacturing something that you can sell for a profit, then ignore the business model. If it isn't obvious, then you have to explain it. That comes up most often with website businesses.

Or, if you're doing a presentation for your own team, summarizing the key points in your business plan, you don't necessarily include slides showing the team, or the business model, or the underlying magic. Those descriptions are for outsiders, not for internal use.

Always be flexible. Don't change the truth for a presentation, but do present first that part of the truth that answers the audiences' more important questions. Make the presentation easy for people to follow, and highlight the most important things, not all the details.

Please use good presentation technique. Give people pictures to look at that are related to your topic, but not lots of bullet points to read while you talk.

Presentation Zen by Garr Reynolds Read more about this book...
Beyond Bullet Pointsby Cliff Atkinson Read more about this book...

PowerPoint slide presentations can be terribly boring. Read Garr Reynolds' book Presentation Zen if you can, or Cliff Atkinson's book Beyond Bullet Points, or Seth Godin's excellent post Really Bad PowerPoint, or, at the very least, Guy Kawasaki's chapter on presentations in The Art of the Start.

Don't forget that you might be using a slide presentation as the only output of your core business plan. That would be unusual, but it could work very well. Instead of bullet points or an elevator speech, wrap it up in a slide presentation. Then you'll be ready when the pitch moment comes.

The Elevator Speech

If you can't give your elevator speech in 60 seconds, you have a problem. Your strategy isn't clear enough. It should be a quick description of the business that you could give in the time you share with a stranger in an elevator. The term is becoming popular in the everyday language of the entrepreneur, the venture capitalist, and the teaching of entrepreneurship. There are even elevator speech contests at business schools.

I don't think its academic, though. I think it's important. I think it's a great exercise that everybody in business should be able to do. Let's get simple, let's get focused, let's get powerful. So we're talking about the heart of the plan strategy. What better way to condense it than in a quick elevator speech. If you can't do it, worry.

Start with a Story

Start your speech with a person (or business or organization) in a situation. Personalize. Identify clearly. For example:

John Jones doesn't particularly care about clothes but he knows he has to look good. He sees clients every day in the office, and he lives in a ritzy suburb, where he often sees clients by accident on weekends. But he hates to shop for clothes. (The Trunk Club)

Jane Smith wants to do her own business plan. She knows her business and what she wants to do, but wants help organizing the plan and getting the right pieces together. The plan needs to look professional because she's promised to show it to her bank as part of the merchant account process. (Business Plan Pro)

Paul and Milena live in a beautiful apartment in Manhattan, with their two kids. Paul has a great job in Soho, Milena works from home, and neither has time for food shopping (Just Fresh).

Acme Consulting has five people managing several shared email addresses:,, and The five of them have trouble not stepping on each other. Sometimes a single email gets answered three or four times, with different answers. Sometimes an email goes unanswered for days, because everybody thinks somebody else answered it. (EmailCenter Pro)

Notice that in each of these examples I could be much more general. The Trunk Club targets mainly men who don't like to shop but need to dress well and have enough money to pay for a shopping service. Business Plan Pro is for the do-it-yourselfer who wants good business planning software. Email Center Pro is for companies managing shared email addresses like sales@ or info@. But instead of generally describing a market, I've made it personal.

Sometimes you can get away with generalizing. "Farmers in the Willamette Valley," for example, or "parents of gifted children." It's an easy way to slide into describing a market. However, I suspect that you're almost always better off starting with a more readily imaginable single person, and let that person stand for your target market.

Follow With What's Special About You

In the next part of your elevator speech address "Why you"? Why your business? What's special about you that makes your offering or solution interesting to the target person or organization you just identified.

This is where you bring in your background, your core competence, your track record, your management team, or whatever. For example:

The Trunk Club invented the best-possible solution to this problem. Founder Joanna Van Vleck first succeeded in sales at Nordstrom's and then took her personalized shopping-for-others style into a hugely successful first market in Bend, Oregon. Now, having proven the idea on the front lines ...

Palo Alto Software has dedicated itself to business planning for more than 20 years. Its founder is one of the best-known experts in the field. Its current management team grew up with business planning, in the trenches. The 8-person development team has more than 50 person years in the same focused area.

Palo Alto Software has been managing this e-mail problem internally for more than ten years now, and has been working with its own in-house solution for nine years. It has a very strong relationship with hundreds of thousands of small but growing businesses.

What we focus on here is core competence and differentiation. And, in the classic elevator speech, you have to say it fast. You make your point quickly and go on.

Make sure your point is the right point: benefits to the target customer. It's not what's great about you, but rather, what about you lends credibility to your ability to meet the need and solve the problem.

I included two different paragraphs for the same company on purpose. See how the unique qualifications differ for different contexts. It's the same company, but in the first example it's relating its speech to Business Plan Pro, the flagship product. In the second example it's building up Email Center Pro, the new product. The descriptions have to change for each.

You might also think of this as the classic "What do you bring to the party?" question. It's not just your brilliance or good looks or great track record, it's fostering credibility for solving the problem.

Then Explain Your Offering

Now explain what that person you're selling to gets. You've personalized the need or want, identified your unique qualities to solve the problem, and now you have to put the need or want in concrete terms that anybody can see. For example:

For a Trunk Club member, when his wife says it's time for a new trip or a new activity is coming up, or the mood strikes him, he just grabs the phone and calls his Trunk Club counselor. "I need more casual stuff for the golf course, or cargo pants for hiking, or two more slacks-and-sports-coat combinations." She knows his size, knows what he likes, what his wife likes, and what he needs. The new clothes come three days later, with a complete money-back guarantee if he or his wife doesn't like them.

Business Plan Pro lets Jane jump into and out of her business plan at a moment's notice whenever she wants. She can start with the core strategy and build it in blocks, planning while she goes, refining projections as needed. It's built around a solid error-checked, financially and mathematically correct financial model, and a generalized set of suggestions for outlines, but is also completely flexible for adding and deleting topics and creating a unique business plan. Each task, whether topic or table, comes with easy-to-understand instructions and useful examples.

Email Center Pro lets a team share an email address like sales@ or info@ efficiently. E-mails can be assigned to team members or not, and answered e-mails are processed and visible, and unanswered e-mails remain at the top until answered. Furthermore, it manages collections of snippets or text templates to build on standard but flexibly customizable answers to frequently asked questions.

In each example here, we can see clearly how this product or service meets the need or solves the problem. Forget features as much as possible, and illustrate benefits. You've already described the person with the situation, and built up your ability to solve it, so now it's just about the solution. Stay focused and concentrated. People will get one or at the most two unique attributes of your business offering. Don't confuse them with more.

A Note About Context

For the purposes of planning as you go, that's it, you've done your elevator speech. However, since we're right here together on this page at the end of this discussion, let me suggest what you might do

in a real elevator speech situation: finish strong. The finish depends on who you are, where you are, and what you want. If you've personalized in the first part, sold yourself and/or your organization in the second, and established the attractiveness or suitability of the business offering in the third, it's time to finish strong with a closing.

Your closing depends completely on context. What do you want from the person or people you're talking to? The classic elevator speech context is a venture competition when looking for investors. But there's also the true elevator speech for the established company, simply describing your company to somebody who asked, with no real close. Be honest, you're not always asking for an order, even when you're just chatting with the person in the next seat on the plane. If you are trying to sell, then do ask for the order. Seriously: "If you give me a card, I'll send you a copy with an invoice. If you don't like it, send it back. Here's my card."

For the venture competition or investment-variety elevator speech, don't try to convey too much information. Do establish in general terms where you are or what you want. "We're looking for seed money of half a million dollars." Or "We're now raising round two financing of three million dollars to be used for the mainstream marketing launch." Or "We're looking for serious marketing partners able to put money up front in return for privileged first-year pricing." Or "We're trying to establish a royalty relationship with an appropriate manufacturer." And then, ask for a business card, and give one. "If you know anybody who might fit that bill, feel free to recommend us." Or "Please give me a call." Don't offer to send a business plan, and don't ask a person directly to invest when it's about investment; reduce the awkwardness by suggesting that your audience might know somebody, not that your audience might invest.

Don't talk terms in the elevator speech. Just establish what you want or need.

If you're in a real elevator with a real potential investor, soft pedal: "If you know anybody who might be interested, please pass this along. Or maybe you want a business card and permission to send a follow-up e-mail."

And if you're doing an elevator speech in a business venture competition, close with an appropriate call for investment. Venture competitions always hinge on the would-be or hypothetical pitch to the investor, so make it clear. The better ones end up with something like an intriguing reference to seed capital or first-round equity investment. Stay general. Make them want more.