In a previous article, I described the differences between short term and long term planning. A challenge to both types of planning is how much detail to go into.
I’ve seen accountants trying to create perfect 30 year financial models based on the level of detail they use for tracking the day to day running of the business.
Needless to say, they quickly find an already large job turning into a mountain of work. When the time comes to update the plan (1-12 times/year depending on the organisation) the battle to ensure accurate detail in the plan needs to be taken up again.
So how do you get the right level of planning for your business?
When it comes to business planning, the source of the toil is trying to marry up the financial reality of the business with the business’s financial projections. In the case above, the accountants were planning 30 (YES THIRTY!) years in advance.
Beyond a certain point, planning is just sticking your finger in the air and seeing which way the wind is blowing. So why go to the trouble of making the details match up so completely in the short term?
This is the question I address in this article, where I will also share some advice and a few suggestions on how to balance your accuracy and detail when planning.
Planning with a purpose
Depth and detail are important in financial planning – but only when those depths and details serve a purpose. Whether you are making a 30 year plan or a 3 year plan, generally you’ll be doing so with a purpose in mind.
It might be as specific as providing grounds for a loan or investment into the business, or as general as having a picture of the business’s financial prospects several years into the future. No matter the plan length case, there will be things you need the plan to tell you:
1. How will the business’s revenue and the business’s costs change over time?
2. What is the financial impact of new projects, products or investments, immediately and longer term?
3. How do challenges within the business (customer loss, staff leaving, slow sales, unexpected bills, technological challenges) impact on this plan?
4. How to circumstances outside of the business (inflation, interest rates, legal & tax alterations, competitor performance) impact on this plan?
The level of detail you need in order to answer these questions is something only you can decide. But be realistic.
If you sell 1,000 products you do not need to split each one into a separate line in your plan. If you pay 50 suppliers, and plan to continue paying them a similar amount, how much do you gain, in planning terms, by splitting out these 50 suppliers?
This all comes down to how you choose to deal with levels of detail.
Managing detail in the short term
Determining the level of detail for a short term plan can be a challenge. Short term plans tend to be grounded in much more ‘real’ figures than long term plans are, and the effects of recent financial obligations can be projected into the short term future with much more certainty than the long term. This makes it tempting to replicate as many details as possible in a short term plan to ensure it is as accurate as possible.
Accuracy is important – and for plans covering very short periods (under a year) there are considerable benefits to planning the details (but even then maybe not all of them, as we’ll see). But once short term plans stretch beyond a year (as most startup business plans should) they leave the realms of certainty.
Planning in details becomes less and less useful – but it still takes the same amount of time! What you always need to ask yourself is – is planning in this level of detail benefitting me? Does it help the plan to answer the questions I will need it to answer?
Starting the plan – opening position
A plan’s opening position lays out the state of the business’s finances at the end of the accounting period just before the start of the plan. You could think of it as a snapshot of the business’s balance sheet on ‘Day 0’ of the plan.
The opening position generally includes:
- Assets owned by the business (current value)
- Inventory held by the business (current value)
- Money the business is owed (accounts receivable)
- Surplus cash
- Outstanding loan balances
- Money the business owes (accounts payable)
- Shareholder capital invested in the business
- Retained earnings
Getting these initial figures as correct as possible will increase the accuracy of your future predictions.
Being as close to reality as possible is actually meaningful when looking at the business’s starting position because it can be directly compared against the real world. But this does not mean you need to go into the same amount of depth as detail as your balance sheet.
If you are planning in the short term, you may well be updating your plan as often as once a month. Keeping the information you enter limited to the headings above may be enough for some plans.
Whatever system you use, make sure that it’s easy for you to create an accurate opening position. Don’t add detail for the sake of detail.
Looking forward – forecasting
The big question of detail vs time comes when actually forecasting the future. How much detail can, and should you go into?
There’s one golden rule here: focus on what’s useful. If it’s useful for the plan to distinguish between the business’s gas and electricity payments, then do so. If not, then it’s an added complication.
In general a business’s operating costs increase gradually with inflation. Many of these could be grouped together if it makes it easier to plan. But direct costs related to the sale of products or services are subject to a lot more fluctuation, and should ideally be linked to the revenue the business is forecasting.
Depending on how many products or services you sell (including any discounted ones) you may wish to take the average value for a set of products or services and use this figure in your plan, in place of several different price points. The same is true of costs relating to these sales.
For example, based on past sales, I might decide that on average the business pays 50% of the revenue received as a direct cost of making the sale. For every £100 of revenue I forecast, I will also be adding a £50 direct cost to the forecast.
The difficult period for deciding on levels of detail is the near-future, in which you may have actual invoices waiting to be paid, or current projects which you expect to bear fruit (or expenses). While adding certainty to elements of your forecast by including these expected invoices can be good, always remember the purpose of your plan.
In a 6 month plan, including these details (and many more) are going to be essential. But for a more strategic 3 year plan it is only necessary to include expected financial transactions that have a significant effect on your plan.
Trying to include great depth of detail and simultaneously keep the plan focussed on your forecasting assumptions can make the plan hard to keep up to date, and depending on how you build it, hard to flex and test.
What to do when the bank says “NO”
Remember your goals
Remember that planning is different to accountancy. When planning, you determine the needs of the plan. It’s easy to get stuck into the trap of trying to recreate every particular of a business’s financial activities in a plan.
Such a plan would definitely be a great plan for the immediate future. But looking beyond the first 12 months of the plan different needs arise for planners. Flexibility, ease of testing and ease of updating quickly become more important than the granular detail of day-to-day business.
The assumptions about the growth of the business, and factors external to the business will have far more impact than you might think. Focus your time on making and testing good assumptions, rather than trying to achieve perfect accuracy.
About the author
This article has been written exclusively for ByteStart by Robin Booth of Brixx.com the financial forecasting app that turns your ideas into numbers. Robin is a regular ByteStart contributor.