“If you fail to plan, you are planning to fail” – Benjamin Franklin
Most small business owners know this quote (and the meaning behind it) all too well. But when it comes to business growth, you need to more than just plan what you want from your business. You need to know how to plan for it.
And that’s where a lot of small businesses get it wrong.
What do you base revenue and profit targets on? To achieve your lag indicators—such as revenue and profit—you work backwards to the lead indicators that will create these results. There’s no point setting a revenue goal of $x when you don’t know how to get to $x. The trick is to identify your lead indicators and then work out the numbers you need to achieve in these areas that will then automatically result in your target revenue and profit.
Setting Process Goals, not Product Goals
Product goals are where you set a target and work towards it without any real strategy behind it. You just keep working and hope you ‘get closer’ to it.
Process goals are where you work towards the inputs that create the goal. You break down the big goal into the processes needed to get to the product.
Revenue and profit are only the result of inputs or processes. For instance, your revenue consists of Average transaction value x Average number of transactions per client per year x Total number of clients.
You could go back even further and work out how to calculate total number of clients. Depending on the type of business, Total number of clients might result from (Existing clients x Retention rate) + (Sales meetings x Conversion rate). From there you can drill down further to determine the lead indicators that result in the number sales meetings, for example, Number of enquires x Conversion rate to sales meeting.
You can see that a focus on lead indicators like these allows you to focus your efforts and it makes it more achievable and predictable for you to hit your lag indicator results. You might, for example, identify that your marketing campaigns and systems are generating a sufficient number of enquiries, but that these enquires are not being converted into enough sales meetings. That allows you to then look at processes such as how the enquires are being handled and by whom, or perhaps looking at the quality of enquiries your style of marketing and promotion is generating.
We’ve seen cases where a business owner was unaware that a conversion rate in their business was low (for example, 20%) and that a focus on improving this then doubled the conversion rate, which doubled the number of sales meetings, which doubled the resulting revenue from new customers.
Nice. You don’t achieve improvements like this by focusing solely on lag indicators.
Drawing Your Profit Recipe
Just like a recipe, you need work out what makes up your revenue and profit. Take out a piece of paper or open up a new document on your computer, and map out the ingredients to your revenue and profit. (We gave some clues earlier as to what makes up revenue.)
Once you have that, it’s time to move onto your Profit and Loss Statement. Subtract from your revenue your Cost of Goods Sold (‘COGS’) and also your Overheads. The resulting figure is your profit.
What you need to do next is work out what your month-by-month revenue was across the last 12 months.
Setting Your Business’ KPIs
That’s looking to the past. The next step it to focus on the future: The next 12 months.
How many new clients will your marketing bring in each month? What will your average transaction value be? How many transactions on average will you provide to each client across 12 months? What will it cost to sell those services? What overheads will the business incur?
Write these numbers beside the correlating section on your recipe. You should be left with your profit, and a good idea of how to get there.
Yes, what you’re doing is ‘big picture’ stuff. But it’s important to realise your potential is usually higher than you think. You also have a documented process of how a certain revenue and profit figure is attainable. Now it’s time to drill down on these numbers.
Profit is Theory. Cash is Fact
This is a great start, and much more structured than what most business owners would have prepared. But remember: revenue and profit aren’t the be all and end all. What you need to be attentive to is cash. We’ll cover the difference between profit and cash when we talk about budgeting and cash flow forecasting in our next article.