Q1: We're still in the research and development stage of our business concept and have just settled on a product. We don't have enough information to put together five-year projections. We're loaded with testing data we can include, but how do we get around a five-year projection?
Q2: I'm writing a business plan for a Web-based community aimed at the small-business segment of the construction industry. There's no way to benchmark our activities against customer needs and potential market share. What should we do?
A:Because I get so many questions about projections, I'm answering two letters that are typical of the ones I receive.
Creating good projections is conceptually easy but takes thought and legwork to get right. Sales projections are an act of faith. They're backed by your assumptions about sales, channels and markets, but in the end, it comes down to simple faith. Expenses are easier--you'll be able to get your numbers with a little research.
Base your sales numbers on how you'll acquire customers. Let's assume you plan to sell your product for $500 and spend $100,000 on advertising. You believe your ads will reach an audience of 130,000, of whom 50,000 will need your product. You believe 3 percent of those will respond. That translates into 3 percent X 50,000=1,500 customers and sales of $750,000.
Use numbers that reflect your business assumptions: you will sell your product through ads; customers will pay $500 for your product; and a 3 percent response rate is reasonable. Magazines can give you circulation and demographic figures. You can run your own minitest to get response rates or check out market research firms.
If your product requires direct sales, you might start with a budget for salespeople and make assumptions about how many sales per year each salesperson could bring in during a specific time frame.
But what about market size and share? By all means use market numbers to limit your projections. If you project capturing 5 percent of the market in the first quarter (a rare feat indeed), that could signal faulty assumptions. Base your numbers on understanding what drives purchases. Use market numbers to check reasonableness, but don't use them to generate the numbers directly.
And remember your timing! Sales happen weeks or months after your marketing expenditures. So if you project spending on ads in January, make sure the associated revenue numbers don't show up in your projections until February (or later).
Nothing brings you mentally to the brink of the abyss like sales projections. All your assumptions about sales, customer needs and how to reach customers come together to produce a glorious revenue figure that, at best, will be wildly inaccurate. And not only that, but building your projections means mentally committing to those assumptions. All the visionary inspiration suddenly becomes black and white assumptions for anyone to question. And that's scary. Really scary.
But it's worth it. After building your model, you'll have ready answers when investors ask probing questions. And you'll benefit as a manager--having laid bare your business model, you can track your progress. You projected a 3 percent response rate? When the actual rate comes, you have early warning if you need to tweak your plan.
After doing sales projections, expenses are almost easy. Sales made you estimate pretty much everything. With expenses, you choose the line items and quantities you think you'll need to make the business fly. If you imagine a 5,000 square foot store with six salespeople, you've found two big line items: rent and salaries. The trick is identifying the line items to make the business real. If no one on your team has the experience to identify relevant expenses, you can often find help from consultants who have built similar operations.
Once you know your line items, a few days on the Web and phone calls with vendors can give you amounts for each expense line. For salary data, use your projected headcount (you did remember to do a headcount projection, didn't you?) and head to Salary.com for actual salary figures. For equipment purchases, a Dell salesperson would be glad to help. Office supplies? Staples is there when you need them. Rent? Call Coldwell Banker. And if you're a high-tech company, remember to budget M&Ms and Coke for your programmers (they'll love you for it).
Just make sure your expenses link to each other and your revenue. If you're buying 10 servers, have your ISP fees reflect that, and make sure 10 servers is right for your projected customer base. The more your numbers support each other, the better your chances of presenting a rock-solid business case to prospective investors.
Creating your projections is often one of the hardest parts of writing your plan, but the discipline and understanding you'll develop will lay the foundation for a thriving, healthy business.
Stever Robbins is a consultant specializing in mastering overwhelm, power and influence. The author of It Takes a Lot More Than Attitude...to Lead a Stellar Organization, he has been a team member or co-founder of nine startups, an advisor and angel investor, and co-developer of Harvard's MBA program. You can find his other articles and information at SteverRobbins.com.
This article originally appeared on Entrepreneur.com in 2000.