Back to: Business Planning 4 Financial Planning: Video Course
It’s usual to make assumptions when we progress through business planning exercises.
Sometimes it’s because we are missing pieces of information; the most up to date demographic breakdown of a target city for a potential customer count for example. Other times it is because we need to give our best educated guess on a cashflow forecast or how the industry might change in the future.
Although we make those assumptions all the way through the business planning process, more often than not, they will have the biggest impact on our cashflows. If we make an assumption that does not prove true, we could see an upturn or downturn in our expenses or sales.
Let’s talk about how we document those Assumptions:
- First we will identify our key assumptions.
- Then we’ll look at how to explain our justifications.
Let’s get started.
Key assumptions are those have been made during the planning process and have influenced in the way we have estimated our Cashflow forecasts.
Assumptions can be generated from any part of the plan ie assumptions you made when formulating your business idea, services/products, ideal clients, marketing approach, operations, but it is when those Assumptions have a direct effect on the numbers (either sales or expenses) that you are forecasting, that we need to ensure they are included in an Assumptions Statement.
A financial analyst looking at your cashflows will want to see how you came to the figures you did, and by looking at your assumptions they may see the answer they are looking for. They may even ask you to talk them through the assumptions you made as part of your Business Plan, and so it’s handy to have them documented in one place.
Most assumptions will be built around statistics or estimates such as the type and number of clients you will be attracting, or the number of sales you believe you will make in a given timeframe, but they could be about any decision you’ve made in connection to launching your business, and so the funds you need to do so, and the length of time it will take your to have a profitable business.
Let’s look at couple of example assumptions from the table on the slide.
Firstly: “My business will attract clients from all over northern Alberta – so I will extend my marketing to that area.”
As an analyst, I would be asking: Why do they think they will attract clients from such a large area? And, how much will it cost to extend marketing that far?
We’ll answer the assumptions in a moment, but let’s look at a second example: “My business assets are valued at $78,000.” This works a little differently. As an Analyst, I’m wondering why they haven’t done the work to value those assets up front. Can’t they be bothered?
Okay, let’s move on and look at why these are assumptions for the business owner, and why they felt they were important enough to add to Assumptions Statement.
It’s not enough just to identify the assumption you have made, there must be some justification for it otherwise you are basing it on a hunch only.
So let’s see what our business owners justifications were:
For the first assumption about their marketing strategy to extend to Northern Alberta, they say:
Based on previous experience working for others, we were regularly called by clients as far-a-field as High Level, Fort McMurray, and Peace River. I have checked online and in service directories and found that this region is underserved. While I will not build my sales expectations specifically around this customer group, I assume they will represent around 5% of my income if I extend my marketing to that area.
As an analyst, I’m now impressed after reading this. They are basing their assumption on real world experience, and it looks like they may even have some figures to back this assumption up, as well as making a determination that 5% of their income is worth an increase in a marketing budget. I may ask them to show me some figures around this, but after reading this Statement I feel that this assumption is based on reality.
For the second assumption regarding value of assets, they have this to say:
I have valued my trucks by comparing similar vehicles in Kijiji ads. I could not find an exact match. My vehicles appeared in better condition than those advertised so I added a further 10% on those prices. I will have them properly valued (by a dealer) at the end of my current season (September) and will then adjust the value as necessary.
For me, this is sufficient. There’s definitely a reason why the assumption is being made and the owners has obviously looked to try and find the resale value of his trucks. Often it is hard to find a vehicle that is in exactly the same condition as those advertised, so to at least give a guideline here is sensible. However, before I make a lending offer, I would be expecting a full evaluation of the vehicles if they are going to form some sort of security or collatoral to a loan. I would be following up on this one, but appreciate the explanation.
In terms of how many assumptions you document, I would suggest start with top 3 and only include more if you feel they have a real impact on your financial forecasts or the loan amount you may be considering. The second one here, is probably borderline for me, but it has demonstrated the business owners honesty in his evaluation, which is admirable.
So, what if you aren’t submitting your Business Plan for a loan or, not creating a Business Plan at all, but just going through a business planning exercise for your own purposes?
I would still suggest your write down any assumptions you make as you go through the business planning activities. It’s rare that new business owners will have the answer to every question at their finger tips as they go through all these exercises, so you may have to make assumptions just to move on to the next activity. However, will you remember them down the line? Maybe. But documenting the assumptions you make in a list, and then ticking them off as you do the research a learn more, will help you create an accurate business strategy and meaninful financial forecasts.
And remember, if you don’t have justification for your assumption – it’s not an assumption, it’s a hunch!
In the next video we’ll look at a final consideration to financial planning, managing Risk.