Madness in detail!

Having put together a range of business plans, both for myself and others, I am continually struck by the strangeness that is financial projections.

In every case, I have been explicitly asked to include detailed financial projections for the next X years, where X is a number from three to seven.

In every case, I wonder what skill or piece of knowledge I must be missing to be unable to confidently predict accurate revenues, costs and profits expected several years hence.

I still don’t have the answer, but I most certainly have an opinion.

I believe that detailed (that is, month-by-month) income and cashflow projections are reasonable requests for the first year of a business’ life. After that, the inescapable variability of the underlying research and assumptions means that the confidence level must unavoidably be lowered.

The more useful approach is to start projecting numbers on a quarter-by-quarter basis for years two and three. This allows small bumps in the road ahead to be absorbed and a reaction formulated and implemented without the significant added stress of worrying about the impact on monthly figures.

For the same reasons, for projections further out than year three, I would recommend going half-yearly. The sheer scope of the variance of just the things you know about today is enormous. The number of things that may happen in four years’ time, not to mention the degree to which they will impact your business, that you haven’t thought about is almost by definition inifinite. Trying to predict today your starting-cash in August 2012 is at best folly and at worst, madness!

Having said all of that, there are two caveats to this – one small and the other large. The small caveat is that you must be diligent and honest about documenting your assumptions and calculations. Where a number is a ‘finger in the air’ guess, you should make that clear.

The larger caveat is that you must be able to convince your reader (probably a potential investor) that you and your team have the capabilities to react appropriately to changes in the road ahead to make those numbers.

By removing the minutiae of the projections, you are effectively asking your reader to sacrifice control. In return, you need to provide them with enough solid reasons to trust you.

That, I think, is the hardest part of all in business planning.

I’ll return to that thought in another blog post, but in the meantime let me know what you think. Are detailed projections over several years useful and an efficient use of time for the startup founder?