This is the 3rd of three blogs that describe the fundamentals all businesses need to grow a profitable business. Having covered the Consumer and the Competitors we move on to understanding the ‘Commercials’.
This might seem obvious, and of course it is, but not in the way some people think. In a small business, especially in start-up phase, it is not as simple as generating an annual profit, especially in the first year. Your business plan (you have one, right?) will no doubt have a set of numbers that show what sales and costs you expect to generate over multiple years - the all-important cash flow, as well as sales and profits. These numbers are likely to be pretty accurate for the early months, but as longer-term projections, they become forecasts not budgets. As someone once said to me, a “forecast” is a posh way to describe a “guess” And it’s true!
Beware the Hockey Stick forecast. This is where an entrepreneur’s passion and optimism outweighs good business sense. The challenge is to have both. The history can’t be changed, but it should be used to help sense check your forecasts. Any potential investors will want to understand that thinking.
It is also wise to model some scenarios – what will happen if sales are half those that you’ve forecasted (or worse)? Do costs and sales move in line, or will you incur costs that the profit from lower sales won’t cover? The dreaded cash flow conundrum. Pesky thing, cash….
Don’t just do scenarios of lower sales. Small businesses go bust because they are too successful as well. What happens if your sales are x2 or x5 what you forecast? How would that affect your cash flow? One business I worked with had payment terms with its customer that were >3 months, but its terms with its own suppliers was rarely better than 14 days: cash flow alert again!
For a small business, it is possible that the first year, or maybe longer, will be run at an operating loss, but that’s ok provided it is part of a robust multi year plan that sees the early stages incurring business set-up costs, and sales unlikely to be optimised as customers are still finding out about your business proposition.
‘Where the Magic Happens’ is describing the point at which your forecast revenues take off, but you have to be certain that the actions that you are putting in place will generate the revenue growth, and contingency plans for if things don’t go according to plan, either in a good or a bad way.
The key point for me is this. A business plan is NOT just a spreadsheet. Fundamentally, it is the activities that your business will undertake and THEN the sales and costs these are expected to generate.
Your activities should focus on what might be called your Key Value Drivers KVDs). What are the aspects of your business that are key to driving sales growth, and which are those that incur costs to generate those sales? It would be simple to say that sales are good, and costs are bad, but it is not that simple. For example, one of the largest costs for an opticians is the cost of the team – but you can’t cut the cost of the Optometrist (unless they’ll work for free!) and still generate sales. Best to sort costs in to good and bad costs.
Similarly, sales: don’t feel you have to chase every sale. For example, if the buyer is going to be a poor or late payer. Prioritise your customers in to those that help grow your business, and those that you may have to provide less than a 100% service for if you are being stretched and or have capacity constraints.
Your selling price is likely to be the most obvious KVD, and where mistakes often happen. Beware finding out how much your product or service will cost and simply adding on a mark-up. The price must be set in the context of what customers expect, what the competitors are doing, and only then does the cost come in to it. Can you make a profit at the price you need to sell? Don’t think of it as ‘this is the price I need to sell to make a profit’. That’s the wrong way around.
Let’s think a little about the retailer and supplier relationship in a typical B2C context, which can help to explain the KVDs. It’s a similar model in the B2B world.
Let’s assume the retailer wants to sell your brand, and of course you would like to be listed in the retailer. Will it be profitable?
Know what the RETAILER wants
Cash is king (or queen) for all retailers and they wish to grow their business. They do this by:
Increasing volume sales of what they already sell that you supply them (e.g. by promotions)
Getting shoppers to trade up so volume is the same, but they spend more (e.g. you can sell them a larger pack size; or a version of the product with extra features and benefits – a ‘trade-up’ opportunity)
Getting customers to buy more of a regime (e.g. buying a conditioner as well as a shampoo)
Improving profit from driving down costs and optimising retail prices
And by introducing new products or brands that help them to expand the market, or steal share from their competitors
They will be keen to know what you plan to spend on marketing activity
Understand and speak the retailer language
What are the Key Performance Indicators (KPIs) that are important to them? How do they measure their performance and how are you going to help that?
How do they talk about sales – including or excluding VAT?
Are they more interested in volume of sales (i.e. selling more packs) or trading customers up (i.e. persuading customers to spend more per pack they buy)?
Are they interested in % gross margin or cash £ margin?
Is it profit on return or mark up?
What supplier funding is expected? E.g. an initial listing fee; retrospective discounts; site fees?
The key point is to understand what language they use and use it back to them – it may well be different with each retailer so be on your guard.
Understand your cash flow
Estimate the sales your brand might achieve. What distribution are you seeking? All stores and formats? National? Local? Can the retailer achieve what you want?
Factor in your costs: development costs, product costs, delivery, etc.
Factor in a marketing budget and what you want to achieve with that budget. Do a reality check.
Factor in retailer investment: listing fees, merchandising fees, promotional funding, retail marketing. Do another reality check.
Plot over 3 years; do you make any money at the bottom line?
How long can you afford to wait until you have enough profit to take an income out of the business?
Knowing all the above puts you in the right position for a negotiation with the buyer, so prepare your negotiation strategy and practice your negotiation skills.
It’s all about knowledge. Knowing your brand or your service. Whatever it is you’re selling, is more than just knowing how it works. It’s about understanding your costs and what drives your sales. The essential combination is to ‘Know your customer’, to ‘ Know your Competitors’, and then to know your business from a commercial perspective too.
Ross Crombie (@rosscrombie)is the Owner, Crombie Consulting Ltd and an Entrepreneur-In-Residence at Nottingham Business School