The future is uncertain. As any one of hundreds or even thousands of variables change, there is a knock on effect on many aspects of your business, any one of which is potentially fatal. These consequences need to be understood and managed in advance of their negative effects if your business is to thrive.

Thus, changes to sales volumes, wages, product costs, competitors pricing strategies and any others of the components of your business have multiple effects. You need to know the effects of those changes, not only on profit (which is obvious) but also on your cash flow, balance sheet, breakevens, payback period of your investment, funding requirements and several others, including your budget.


All financial plans reflect hundreds of assumptions

Every item on your financial plan has at least some element of uncertainty associated with it. Each item therefore reflects one or more assumptions, implied or stated. The more you are explicit about your assumptions, the more control you will have over the fate of your business.

You also need to know the effects of your assumptions not materialising. In other words you need to create different sets of assumptions and gauge their effect. This "scenario planning" or "What if?" analysis should be ongoing. For it to be useful, you need to be able to see all of the implications. The only way to achieve this is through an integrated set of projection schedules.


What are Integrated projection schedules?

Integrated projection schedules reflect a situation where the impact of any change in one schedule is directly and automatically reflected in all other schedules. When a fixed cost, such as rent changes, the impact of the new rental amount must automatically reflect on the income statement, balance sheet, cash flow forecast, budget, and on most of the financial indicators such as payback period, breakevens and return on assets.

While many people have a good grasp of these concepts, attempting to create a complete, consistent picture becomes highly time consuming, error prone, complicated and "intensely muddy". It also gets exhausting as you need to produce literally thousands of numbers. Even with an electronic spreadsheet, it is an incredibly arduous job. Then, to add insult to injury, you should know that the key results of your efforts are wrong.


Why are most financial projections wrong?

Dr Robert Ronstadt, Professor of Entrepreneurship at Pepperdine University who obtained his doctorate in business administration from Harvard Business School, is outspoken about why financial projections are rarely constructed correctly.

In The Portable MBA in Entrepreneurship, 2nd Edition, John Wiley & Sons, 1997, Dr Ronstadt writes:

"There are two reasons, and they reside in two myths:
Myth 1: Most people, especially those schooled in business, believe that they can develop technically correct financial projections. The Reality: Most people, including most MBAs cannot develop anything more than crude, generally misleading, financial projections.
Myth 2: Spreadsheets … make it possible for most people to create technically correct financial projections....The Reality: Only a tiny percentage of spreadsheet users are capable of putting together integrated financial projections."

Dr Ronstadt continues: "Consequently, most people don't know the numbers; they only think they know them."


Who should draw up financial projections?

In proposing how to overcome these problems, Dr Ronstadt addresses the issue of who should produce your financial projections. He is adamant that, despite the realities of existing deficiencies in peoples awareness of and skills in developing integrated financial projections, the responsibility for them lies in one and only one place: the owner of the business.

He writes that the road to truth and knowledge begins by becoming aware of the things that you don't know. "So first, You need to recognise that significant obstacles exist when it comes to developing meaningful financial projections. …the reality is that most people can't put together a valid and useful set of financial projections in a reasonable period of time… Second, you need to understand the concept of integrated financials and recognise its importance for doing everyday financial decision-making. Fudging your financials, or putting together a set of stand-alone projections … simply won't do. A financial model that truly reflects your business is a tremendous decision-making asset. In fact I have found that it can be the difference between success and failure - not just for occasional planning and budgeting exercises, but for running your venture from day to day.

"Given the real difficulties involved, you will probably need to find someone who will help you to build these financial decision-making models."

[Dr Ronstadt's italics throughout].


Is it really that difficult?

So why are we quoting the good doctor at such length? Those of our readers who have worked with us will know that we try to keep things simple (albeit not simplistic).

We believe that most of what Dr Ronstadt writes is correct. It is vital that you that your projections are accurate and complete (in addition to being conservative!) and that you as the owner of your business have a deep understanding of them. That is the foundation of our approach: "with you, not for you". We do, however, endorse Dr Ronstadt's viewpoint with a proviso.

While it is important to have a good understanding of a complete, integrated set of financial projections, the real enablement to taking control of your business comes from a deep understanding of a few basic, yet powerful concepts on which the financial projections are based. If these are genuinely well understood, the impacts of changes throughout the financial projections are relatively easily mastered.

Andrew McGregor is a director of the business PLAN. He can be contacted at adml@tbp.co.za or (011) 782 6746.

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