Your team has built a promising prototype and received its initial round of funding. The investors have now asked Management to produce an annual financial plan. They plan to review results against the plan at every board meeting.
You gulp down the cool-aid the founders are serving up at Unicorno and take that 10% chance to change the world. You are going to need a lot of aid. For one of your initial tasks at the Company is to create the financial forecast for the next year. How do you build an accurate financial plan this year if Unicornos’ success is predicated on creating disruption? Forecasting results with insight can barely be done in the least volatile markets. Not only do you need to overcome the normal limits to vision, flaws in judgement and unconscious biases that make your management team vulnerable to planning error, but you need to predict results in a rapidly changing market. Your risk of blowing the forecast at Unicorno is huge.
Could you have predicted that Donald Trump would be the President of the United States in the summer of 2015? Unicorno is much like the candidacies of Bernie Sanders and Donald Trump. You emerge out of nowhere to disrupt the status quo with what you believe is a better vision for the future. Included in Unicorno’s vision is a financial model of the future. You build this model by making reasonable assumptions with the data you have. You have two goals: prediction accuracy and to advance the interests of management. Facts are important but what also matters is the pursuit of funding. Like a conservative talk show opinionator in 2015 you want to present your facts as fair and balanced, but your founders want them to add up to victory for their candidate.
How do you build such a model? Start by building it yourself. You do not really understand something unless you can express it as a full set of linked financial statements that you have created. The model must include an analysis of cash flows, especially working capital. At first, your input will be derived from past models of how the world has worked. Every subsequent event is an opportunity to learn and improve. Systematically scour the data from your operations, analyze it, synthesize multiple perspectives on the results, and then update the model.
To forecast is to fail. You forecast, analyze, adjust, and try again: there is always more trying, more failing, more analyzing, more mental tinkering. Expect to stumble. Then get up and draw the right lessons. The key is to cycle through this feedback loop more quickly than your competitors. This is possible if the plan model is simple and all assumptions have been clearly defined, including your capacity levels, limits of funding, costing step changes, and project ranking criteria.
The right lessons come from performing self-critical postmortems each month. Acknowledge and review both successes and failures. Not all successes imply your reasoning was right. You may have lucked out by making offsetting errors. Or you may have missed small errors that continue to accumulate. Keep score against your plan. Update the plan into a rolling four quarter forecast that is updated each quarter. Break big problems, like your revenue forecast, into smaller sub-problems like revenue per customer, revenue per product or the costs to acquire a customer. And encourage open debates about plan assumptions that strike a balance between insiders and outsiders, especially for internal projects. Remember, after each political event in 2015 and 2016, forecasting a Trump victory became easier. Feedback from each debate and primary pointed out that voters responded to Trump’s message. Subsequently, each update to the forecast increased Trump’s probability of winning the election, even if they did not predict the final outcome.
Do not fall into the classic budgeting traps. Issue a planning timetable and input deliverables prior to each planning cycle. You do not want to be planning three months into the year. Develop contribution margin (amounts that are directly related to your revenue producing activities) budgets that are linked to purchase orders so that you will not be surprised by rouge spending by employees. Link the budget to performance measurements and rewards but beware moral hazard with variable compensation payments to employees that do not align with company success. Do not create a model so complex that your building’s lights dim when you open it up. Do not build a plan that accepts only optimistic outcomes. Build in adaptability and resilience to your overall assumptions. And reserve an ample amount of cash and resources as a margin of safety to be used when unanticipated events smack you across the face.
Nail what has happened in the past and what is happening now. Accurate and timely reporting can only happen if information is shared freely across the organization. If they are on different teams, make sure that accounting and planning personnel both attend a monthly close meeting with your key business teams. Keep in mind that good reporting is the cornerstone of an accurate plan.
Last of all, manage the trade-off between calibration and marketing. Tension or pressure to emphasize marketing may be your most difficult challenge. Founders have a bias to see what they want to see. At times, this translates into an alternate view of the world, complete with alternate facts and, if you work for a Napoleonic type, pressure to create an alternate forecast of the future. But remember, when and if reality diverges from the plan you will be held accountable by the Board of Directors. The Board has the right to see your cash accounts and cash is the light that exposes false narratives. So stick to a plan with reasonable assumptions. Alternate facts may work in politics but they will eventually be trumped when exposed to the reality of cash flows over an extended period of time.
- Does your planning team perform self-critical postmortems each month? Do they acknowledge and review both successes and failures?
- Does your model must include an analysis of working capital?
- Do accounting and planning personnel both attend monthly close meetings with your key business teams?
Share similar problems with us