The Floor Has Three Layers

Last week was about the house built from the roof down. This week is about the floor, and I want to begin by saying exactly what it is made of, because the word gets used loosely and when it is loose it gets skipped.

The floor has three layers, and they go in a fixed order. The first is the business model, which is the plain-language account of what you sell, to whom, at what price and margin, and why they buy it more than once. The second is the financial model, which takes the business model and turns it into twelve months of arithmetic: revenue by month, costs by month, what is left, and when the cash actually arrives and leaves. The third is the operating plan, which says what gets measured, by whom, and how often, so the model is held against reality rather than admired and forgotten.

Each layer depends on the one before it. You cannot build a financial model without a business model, because you would have nothing to put numbers to. You cannot build an operating plan without a financial model, because you would have nothing to measure against. This is why the owner who skips straight to a spreadsheet usually abandons it: the spreadsheet has no model underneath it, so the numbers are guesses, so nobody trusts them, so nobody looks. The order is not a nicety. It is what makes the whole thing hold.

I should say what the floor is not, because the confusion costs people months. It is not a business plan of the kind written for a bank, forty pages that nobody reads. It is not the management accounts your accountant sends a month in arrears, which look backwards. It is not a budget, which is a list of what you are allowed to spend. The floor is forward-looking, short, and owned by the person running the business rather than by the person who files the returns. The whole of it fits on a few pages, and the first draft can be done in a weekend.

The response, this week, is to build each layer in turn, and I am going to spend the next eight essays doing that with you. Three on the business model, three on the financial model, two on the operating plan. Today is for getting ready.

Getting ready means collecting three things. First, your last twelve months of actual numbers: revenue by month, costs by month, and the bank balance at each month end. Your accountant or your bookkeeping software has these, and if neither does, the bank statements will do. Second, a list of your customers from the last year with what each paid you. Third, a list of what you sell, with the price of each and your best guess of what it costs you to deliver, including your own time.

None of this requires skill. It requires about two hours and a willingness to see the numbers as they are. Most owners who do this discover at least one thing they did not know, and it is nearly always about where the money went rather than where it came from. That discovery is the floor beginning to form, because a business you can see is a business you can plan.

One warning before you start. The temptation, once the numbers are in front of you, is to start fixing things immediately: cancel the subscription, chase the invoice, raise the price. Resist it for a week. The point of this stage is to see the business whole, not to react to the first thing that looks wrong, and the fixes will be better once the model tells you which of them matters.

If you want to know why I am so insistent on the order, it is because I have watched what happens when it is ignored. A business model without numbers is a story. A financial model without a business model is a fiction. An operating plan without either is a list of meetings. Together, in order, they are the thing that lets an owner stop running the business on feel and start running it on what it actually does. Tomorrow, the first layer: what you sell, and why it repeats.

Continue reading: What You Sell, and Why It Repeats →

The session: The Nine Fears, and the floor underneath your business. Wednesday 2 December, 5pm UK, free →

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The book: The Science of Getting Rich and How to Apply It →