Twelve Months on One Page

The second layer of the floor is the financial model, and the first thing to say about it is what it is not, because the word frightens people who have never built one. It is not a forecast of the kind a bank asks for, forty tabs deep, with assumptions nobody believes. It is not the management accounts, which look backwards. It is not a budget. A financial model, for an owner-led business, is twelve columns and perhaps thirty rows, and it answers one question: if the business model is right, what does next year look like, month by month, in money?

The rows are simple. Revenue, split by the two or three things that actually earn it, from the business model. Costs of delivering that revenue, from the margin sums. Fixed costs, the ones that arrive whether or not you sell anything: rent, software, salaries, your own pay. What is left after all of it, which is profit. And then the row most models forget, which is cash: when the money actually arrives and leaves, as opposed to when the invoice is raised, because a profitable month with every customer paying sixty days late is a month you cannot make payroll in.

The columns are the twelve months of next year. That is all. The first draft takes a weekend and it will be wrong, and that is fine, because the point of the first draft is not accuracy. It is to make the owner write down, for the first time, what she believes will happen, so that each month she can see where she was wrong and by how much. A model that is wrong by ten percent and gets looked at every month is worth more than a perfect one in a drawer.

I have built these for companies with turnover in the hundreds of millions and for companies with one employee, and the structure is the same. The large company has more rows. The question is identical: what happens to profit, cash and the owner's pay, month by month, if we do what we say we are going to do?

The response is to build the first draft this weekend, and to do it in the order that keeps it honest.

Start with the costs, not the revenue. Owners who start with revenue write down what they hope and then fit the costs underneath. Owners who start with costs write down what the business actually has to earn each month before anyone gets paid, and that number, the break-even, is the most sobering and useful figure in the whole model. Fixed costs first, including your own salary at a proper rate. Then the cost of delivering each pound of revenue, from the margins you worked out this week.

Then revenue, and here the discipline is to use last year's actuals as the base and change them only where you can name the reason. If you are putting in a price rise, name the month it takes effect and the customers it applies to. If you are putting in a new client, name where they come from. A revenue line that goes up every month for no stated reason is a wish, not a model, and the month it fails to arrive you will have no idea why.

Then the cash row, which is where most owners discover their real problem. Take each month's revenue and move it to when it actually gets paid. Take each cost and move it to when it actually leaves. The gaps that appear are the months the business will struggle, and knowing them in November is the difference between a planned conversation with the bank and a panicked one.

When the draft is done, look at three numbers: the month profit turns positive, the lowest point the cash reaches, and what the business can pay you across the year. Tomorrow is about those three, because they are the columns a bank balance can never show you.

Continue reading: Profit, Cash, and Your Own Pay →

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