Business Planning

What Your Business Plan May Be Missing

I recently came across a good article in Entrepreneur by Jayson Demers titled 7 Flaws in Your Business Plan You Need to Fix.  I agree with most of them because I see them in my clients’ financial projections.  The first one pertains to cash flow.  Demers states:

Technically, a business can be “profitable” on paper, but still have cash flow issues; imagine, for example, a scenario in which the bills are piling up and your customers aren’t paying their invoices on time.

This is the reality, customers always pay slower than you anticipate while you have very little flexibility in how you pay your vendors and employees.  I have my clients focus on the total cash cycle (accounts receivable days, plus inventory days minus days of payables outstanding) with the emphasis on conservatism.  With that information in hand, you get a much better handle on debt needs.

Demers then points out that business plans are not specific enough:

When setting goals, describing scenarios, or making long-term models, you need to get specific. Most new business owners skip the details in favor of vague descriptors, like “significant growth over the first few years,” instead of “40 percent increase in sales during year one, and 30 percent in year two.”

Again, we try to get our clients to focus on their market and determine how to segment their market into manageable components.  Then they can make assumptions about how they would reach those segments and determine how potential customers might convert to actual customers.  That provides the assumptions around volume which in import and leads the most important assumptions–price and cost.  With that information, we can generate solid forecasts for gross profit.

The final flaw is a disorganized plan: 

Remember, you aren’t the only one who’s going to read your business plan. Investors, partners, and  even new team members  will be reviewing this before they come to their final decisions. If your work is sloppily written or your sections are improperly organized, readers will be left with a bad impression (even if your idea, in theory, is sound).

This is simple to remedy given all the tools that are available online.  SCORE is a good resource for business planning templates at this link.  If more complex Excel models are needed for revenue planning ,cash flow projections and the like, contact Profitwyse.  We have models for many different industries.  

Great article by Demers on some of the pitfalls of business plans.  If you’d like to avoid many of them, contact Profitwyse today.

About the Author
About the Author
Chase Morrison provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy.  Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.

How to value a business is a complicated questions, but it is not a game of chance.

What is my Business WORTH?

How to Value a Business is a Complicated Question

This is a common question asked by our clients and prospects.  Now that so many Baby Boomer business owners are more seriously contemplating their succession plan options, how to value a business is coming more to the fore.  The first thing to understand is that a business can have a wide range of values depending upon the how a business owner decides to exit their business.  Though there are many options, for now we are going to focus on valuing businesses from the perspective of a buyer.

What is EBITDA?

Even though we are going to approach business valuation assuming that you want to sell your business, only a professional valuation expert can give you a truly accurate valuation on your business.  But for simplicity we have narrowed the range of exit options to a sale.  So what do potential acquirers care about?  At the most fundamental, potential buyers care about–current and future cash flows. 

To get a handle on cash flow, a potential buyer will try to estimate free cash flow using a metric called Earnings Before Interest, Taxes, Depreciation, and Amortization, which is also known as EBITDA (commonly pronounced “ee-bit-dah”).  This is a straightforward computation that adds back Interest Expense (and subtracts Interest Income), Tax Expense, Depreciation and Amortization to your net income.  Why adjust for these items you may wonder.  Depreciation and Amortization are non-cash expenses and are always added back to cash flow.  Interest and Taxes can be rather variable depending on the current business use of debt, and other tax-related factors and are eliminated from net income to produce a “normalized” free cash flow. 

How are Multiples of EBITDA Used?

With an estimated EBITDA in hand, a potential acquire can compare the cash flow potential of different businesses to identify acquisition targets.  Generally, businesses are valued in multiples of EBITDA that are adjusted for a number of factors.  As a multiple increases, so does business value.  So a business with $1M of EBITDA and a multiple of 4x, could be valued at $4M.  Multiples represent the potential return an acquirer needs to move forward with an acquisition.  You can compute the acquirer’s return by taking the reciprocal of the multiple.  In our example above, a multiple of 4x equates to a 25% return (1/4x = 25%).  A multiple of 3x equates to a 33% return, and so on and so forth.  Multiples for privately held businesses typically range from 2x to 11x.

What Kind of Multiple to Expect

You are probably wondering what factors control the multiple for privately businesses given that the expected return ranges from 50% (2x) to 9% (11x).  The first and foremost is the lack of an open market to buy and sell privately held businesses.  If there was a liquid market for privately held businesses, then multiples would be higher.  The relative illiquidity of the market for privately held business increases return levels just like coupon rates increase and decrease based on the quality of different bonds.  The next level of factors pertain to business size and industry.  The greater the business size, the greater the multiple.  And as you can imagine, businesses in certain industries are in greater demand than others.

How to Influence Your EBITDA

The next set of factors are the ones that a business owner, can influence.  Though they require varying amounts of time, there are many items a business owner can affect to increase their business multiple.  The first and foremost is revenue growth.  Are you able to grow revenue?  A decreasing revenue trend will be a significant red flag for potential acquirers.  Next, have you established protection around your intellectual property?  Do you have trademarks?  Are they registered?  How about your logo, is it registered?  Have you had your CPA firm review your financial statements recently?  Do you have reviewed financial statements?  How do your financial metrics for profitability and working capital use compare to your industry cohort?  Are your IT systems current with the latest technology for security and speed?  Does your company have outstanding litigation with other companies and/or employees that needs to be resolved? 

Think about the types of things that a prudent acquirer would try to uncover during due diligence and work to resolve any obvious or latent risk items that can impact price well ahead of time.  Frequently business owners spend little time getting into these details only to have the acquirer demand price concessions at close, for items that surfaced during due diligence. 

Lastly, the most important way you can influence your multiple is to build a team to help you with the process.  Many business owners become distracted from their typical day-to-day sales and marketing activities need to maintain/grow the top line, which can have disastrous effects the value of a company.  As a CFO services firm, we help business owners build a team, address how to value business and much more.

About the Author
About the Author
Chase Morrison provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy.  Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.

The Value of KPIs

The Value of KPIs — 4 Lessons From the Trenches

From the book Peak: Secrets from the Science of Expertise, 4 Lessons on the Importance of KPIs With Application to Your Business

I recently finished reading an excellent book titled Peak: Secrets from the Science of Expertise, written by Anders Ericsson and Robert Pool.  The book is filled with inspiring examples of the power of diligent practice.  I can’t recommend the book enough, especially to organizational leaders that are striving to achieve more with their troops’, as well as their own, capabilities.

There was one specific example in the book that I thought really brought together a number of important insights that combined how the value of KPIs (Key Performance Indicators) can be used to identify issues needing to be addressed with the application of Ericsson’s and Pool’s concepts on deliberate practice to produce an extraordinary result.  There a many facets to deliberate practice, but it is a fundamentally different way of acquiring a skill beyond dedicating 10,000 hours, as is described in Malcom Gladwell’s Outliers.  But first the story…

The situation, as described in Peak:

It was 1968 and the Vietnam war was in full swing with Navy and Air Force pilots regularly engaging Soviet-trained North Vietnamese pilots flying Soviet-made MIG fighter planes in dog fights and the Americans weren’t doing so well.

In the previous three years, pilots of both the Navy and Air Force had been wining about two thirds of their dog fights.  They downed roughly 2 North Vietnamese jets for every one jet they lost.  But in the first 5 months of 1968, the ratio had dropped to about 1 to 1.  The Navy had shot down 9 enemy jets and lost 10 of their own jets.  Furthermore, over the summer of 1968, Navy pilots had fired more than 50 air-to-air missiles without shooting down a single MIG.

The Value of KPIs — Lesson #1

The Navy was using a descriptive analytic or KPI to measure their effectiveness.  The Navy knew they had a problem and went about developing a strategy to deal with their declining metrics.  Does your business have a set of KPIs to monitor business performance?  Examples of similar descriptive analytics include: 1) # unique products sold; 2) share of new products sold; 3) win rate; 4) # accounts per sales rep; and 5) # of bundled deals.  Important lesson number one is that your business needs a set of KPIs so that key management personnel can closely monitor business performance and take corrective action.  The Navy had KPIs to monitor their effectiveness in the skies over North and South Vietnam, which were painfully obvious because it resulted in crews not returning to base.  Continuing with the story…

The Navy’s brass decided something had to be done.  That something turned out to be the establishment of the Top Gun School.  The purpose of the school was to teach Navy pilots to fight more effectively and improve their performance in dog fights…

The Navy picked its best pilots to be the trainers.  These men would play the role of enemy North Vietnamese pilots and engage the students in air-to-air combat.  The trainers known collectively as the Red Force flew fighter planes that were similar to the MIGs and used similar tactics to those the North Vietnamese pilots had learned.  Their aircraft were fitted with cameras rather than bullets and missiles, to record each encounter.

The Value of KPIs — Lesson #2

Important lesson number two is selecting the right trainers or coaches.  How do you find the best coaches?  If your business uses KPIs or some other tool to collect assess employee efficiency, either of those would be a good place to identify potential coaches.  Finding coaches that can “walk the talk” is critically important to your training program.  With the coaches in place, the trainees show up for class…

The students who attended the Top Gun Academy were the next best fighter pilots in the Navy after the trainers.  Collectively they were known as the Blue Force.  They flew U.S. made fighter jets, again without any bullets or missiles.  Each day they would climb aboard their fighter jets to engage the Red Force.  It was expected that they would push their jets and themselves right up to the edge of failure in order to learn what the planes were capable of and what was required to get that performance out of them.

The pilots of the Red Force, being the best pilots the Navy had, generally won the dog fights.  And the trainers’ superiority only increased over time.  Because every few weeks a whole new class of students would enter the Top Gun Academy while the trainers stayed there month after month accumulating more and more dog fighting experience as time went on, getting to the point where they had seen everything a student might throw at them. 

For a new class, the first few days of dog fights were usually brutal defeats for the Blue Force.  That was okay however, because once the pilots landed, in what the Navy called after action reports, the two sides would meet.  During these sessions the trainers grilled the students relentlessly, “what did you notice when you were up there,” “what actions did you take,” “why did you do that,” “what could you have done differently.”

The Value of KPIs — Lesson #3

Lesson number three is the application of extensive focused practice that is measured, combined with feedback.  Both are invaluable parts of the process.  A good analogy is assuming you want to become a professional golfer.  Going out and pounding golf balls for 10,000 hours without a professional teacher is more than likely not going to get you to the professional level. 

When it was all over the Blue Force pilots would return to their units, now much more experienced with dog fighting than anyone else in their units, where they would become the squadron training officers and pass on what they had learned to the other pilots in their squadrons. 

The Value of KPIs — Lesson #4

Lesson number four, be smart about the “train the trainer” aspect of your employee development programs.  The next level of trainers need to be as effective as the pilots on the Red Force, as a goal. 

So here’s what happened next…

U.S. forces had stopped their bombing through all of 1969.  So there were no dog fights that year.  But the air war resumed in 1970, including air-to-air combat between fighters.  Over the next three years from 1970 to 1973, the U.S. Navy pilots shot down 12.5 North Vietnamese fighter planes for every one Navy plane lost. 

Perhaps the best way to view the improvement is through the Kills per engagement statistics.  Throughout the entire war, U.S. fighter jets downed an enemy fighter jet once every five encounters.  However in 1972, which was the last full year of air combat, Navy fighter pilots shot down an average of 1.04 jets per encounter.  In other words, on average every time Navy pilots engaged an enemy jet fighter, they would down an enemy plane. 

Final Takeaway on The Value of KPIs

There are a number of valuable lessons for business owners and executives in this great story.  The effectiveness of the Top Gun Schools results with Navy pilot was so dramatic that the Air Force started their own program and experienced similar results.  In fact during the first seven months of the Gulf War, pilots shot down 33 enemy planes while losing only one aircraft.  This kind of improvement starts with determining your KPIs, measuring them, and developing strategies for continuously improving them through Anders Ericsson’s and Robert Pool’s techniques for deliberate practice as described in Peak: Secrets from the Science of Expertise.  I highly recommend this book.

About the Author
About the Author
Chase Morrison provides CFO services, utilizing Profitwyse’s 3D Growth Platform™, enabling his business owner clients to more readily achieve their goals for wealth creation and family legacy.  Contact him today to learn how your business can hit the accelerator using Profitwyse’s proven platform.