The First Step in Business Planning - Where is the Business Now?

Where is the Business Now?

The starting point for meaningful strategic and business planning begins with an objective assessment of how the business is currently performing. An objective analysis requires you to review your financial statements with a critical eye. You do not need to have an accounting background to perform a reasonable analysis. Instead, you can work with your business advisor to perform a thorough and thoughtful analysis using the profit and loss data from your last three tax returns. The basic goal of this analysis is to highlight the positive or negative trends in your financial results so that you can determine the drivers and drains on your profitability. Once the preliminary analysis is complete, your business advisor should review the findings with you to drill down into the root causes of your successes and areas for improvement. This analysis will require your business advisor to analyze rather than crunch the numbers to achieve the desired effect. Here are some of the typical types of analysis that will need to occur.

1) Did gross sales rise, stay consistent with the prior year, or decline on a year over year basis? Rising sales are typically found in businesses that have the ability to generate new customers, retain current customers, or increase the price of their product due to rising demand for their differentiated goods or services. This is obviously the desired state for most business owners.
Stagnant or declining sales are typically seen in businesses that are not generating new customers, not retaining current customers, or not able to raise their prices due to lack of demand or perceived customer value. The preliminary analysis simply allows you to identify whether sales are rising, consistent, or declining over the term of the analysis. In essence, it helps to identify the symptoms that are showing in the financial statements. However, it does not explain the root cause underlying the applicable trends. This will require further questioning and analysis that is best performed by a competent business advisor with deep experience interpreting the meaning of financial statements.

2) Are the business expenses increasing, remaining consistent, or declining on a year over year basis using a percentage of sales measurement process? Generally, declining expenses on a year over year percentage of sales basis are a good sign that the business is controlling its expenses, operating in a more efficient manner, and becoming more profitable. This is particularly true for general and administrative expenses which should be growing at a slower pace than sales growth in a lean and efficient enterprise. Consistent or increasing expenses on a percentage of sales basis are generally a sign that the business is not operating in a more efficient manner or at optimal capacity. The preliminary analysis allows you to measure the percentage change for each category of expense items in your business. However, the more important analysis lies in why the percentage changes occurred on a year over year basis. For example, if a particular expense category is rising significantly on a year over year basis, you should analyze the particular expense category to determine why it is increasing on a percentage basis during the analytical period. The goal of this in depth analysis is to identity non-revenue driven expenses that can be cut slightly to achieve increased profitability.

I would like to talk briefly about expenses. During many of my conversations with networking partners, the networking partner will express concern that cost cutting alone will eventually lead to negative trends. Though I agree with the sentiment that across the board cuts will imperil a business, I would seldom advocate for such an approach. Expenses come in different shapes and sizes. Sales producing expenses such as commissions for sales people, marketing costs, and business development costs should probably not be cut if the goal is to increase sales. However, I often find that the expense mix in these categories may need to be tweaked to achieve the best possible sales results. For example, it is important to measure the impact of these expenses become some vehicles such as basic advertising are becoming less effective in modern times. General and administrative expenses often represent a potential means of capturing additional profits within a business entity if they are increasing as a percentage of sales. General and administrative costs represent a cost of doing business. However, they should not outpace or evenly track sales growth unless inefficiencies are present. 

I would strongly encourage all business owners to perform this analysis on an annual basis with their business advisors. A financial statement represents the report card for your business. But, it does not have to be a predictor of future results if the trends are identified and plans are put in place to emphasize the positive trends and minimize the negative trends.

Brian Kerrigan, JD