What about the money?
How do you decide which projects and programs get funded in you annual strategic planning?
It’s time to hear from Finance.
They’re a bit like a traffic cop in this process because this is where we make decisions about spending real money. And we can’t spend it all at one time or in one place.
How should Finance present their view of the business?
Funding Your Strategic Plan
First, we need to know how much money we have access to for the next year. Your bank will more than likely base their decision on the profits and cash flow from the last 12 months, your actual growth rate, and the value of your hard assets. They’ll use these along with your current debts and personal financial statements to calculate your debt ratios and decide how much they’ll increase your line of credit for the following year.
In order to get ready for the following year you should start this process as soon as your Q3 financials have been finalized. That way you have new money in place early in Q1.
The next thing we need to do is set aside the money that we need to maintain the machine running as it is today.
It’s likely that Operations presented some capital equipment expenditures (CapEx) that need to be made because some equipment is wearing out and needs to be replaced. Finance should build this into the budget first. You should also consider getting this equipment financed outside of any credit line increase that you may have already received.
Just because you may have already increased your credit line for next year is no reason not to try to get separate financing for a piece of equipment. However this isn’t financing at any cost – you don’t want to work with loan sharks.
If you find that you have a purchase large enough to justify a separate and additional loan, ask. It won’t hurt and the worst you’ll hear is “No.”
I’ve bought vehicles on my line of credit and then replaced the money by getting a loan on the vehicle the very next week. You want to call your bank first before you try something like that though. Don’t just assume they’ll play along.
Rank Your Growth Options
Both Sales and Operations presented ideas about how to grow the business. Operations was given the opportunity to test Sales’ assumptions. It’s time to prioritize those opportunities.
Rank your growth opportunities according to those that line up with the current business and strategic plan. The ideas that don’t line up with your strategic and business plans are lowest on the list.
The second factor that you use to rank the opportunities is the Return on Investment (ROI) or rate of return.
The Minimum ROI
Is there a minimum ROI requirement for a new opportunity?
Yes…
The common mistake most business owners make is that they think it should be at least equal to the interest rate they pay on their line of credit or business loans. That’s not high enough. At that point you would just be the middleman for money that moves from your client to your bank.
Compare your potential program to other opportunities you can invest the money in. The most commonly accepted standard is the S&P500. In recent years the S&P500 has returned 10% per year.
I suggest pushing your minimum required rate of return on a new program, product line, or location to 14% per year. The reason for this is that many business loans aren’t generally given for more than 7 years. To pay off the loan in time you’ll need the project to give you 14% per year rate of return.
No Investment Required?
It’s likely that there are growth opportunities that line up with your plans and they don’t need any CapEx investment. But there’s no such thing as a free lunch. There will be money required to cover labor, materials, and overhead. These items should be worked into the forecast.
As an example: Sales may have stated that by increasing the sales team by one person there are additional accounts that can be gained this year.
There’s no capital equipment investment needed other than maybe a new laptop for the sales rep, but that can be expensed.
Adding a new sales person creates a cash flow drain up front and then there’s the additional production work to be done which means additional employees. You may need to cover these costs for six months before you see the operating profits rolling through to the bottom line.
So while a growth opportunity may not require new equipment, it puts a drain on your credit line for a little while.
At this point Finance has a budget for next year that includes the money we need to spend to keep the machine running as is, as well as the money needed to finance good ROI and non-CapEx efforts. The leftover available money can be used to fund new programs, product lines, locations, or added efficiencies.
How to Rank Proposed New Investments
We’re almost ready to start picking new programs and CapEx investments. There’s one more easy weed-out step for Finance to take. Finance can easily calculate the ROI on each of the options.
First, for new programs, product lines, or business locations shelve anything that doesn’t have a 14% annual rate of return. If you can’t get your money back in 7 years then hold on to it and look for better ideas to launch. Don’t discuss it. There’s no need. You can keep the idea on a watch list but don’t spend money on it today.
Second, for CapEx ideas that are more focused on increasing speed or efficiency shelve any idea where the new equipment won’t pay for itself in 24 months or less. If you’ve read my other articles you’re aware of the Presidential Recession Cycle and the fact that we’ve had a recession every four years since WWII.
Cutting your window of time to 24 months insulates you a bit because your crystal ball isn’t perfect and recessions don’t start and stop like clockwork. I prefer to enter a recession holding cash and not debt.
After you’ve shelved the low ROI projects you’ll next shelve anything that has low client interest.
When you only have one or two clients who want something the work is equivalent to custom work and you’re at the mercy of one client. That’s not a good way to build a business. You’ll have no leverage with the client but you’ll own all of the financial risk.
At this point you’re left with growth ideas that fit into two categories:
- Those that line up with your strategy and business plans and have good rate of return or a good return on investment;
- Those that don’t fit your strategy or business plans however they have good client interest and a good return on investment.
Finance should now fully test the Sales and Operations assumptions on these ideas. They’ll create financial projections utilizing the assumptions along with the necessary adjustments that Sales and Operations may not have considered.
Finance should come to the meeting prepared to discuss all ideas.
Rules To Change Your Strategic Plan By
One of my favorite sayings is, “If you don’t have a plan, then you don’t have anything to deviate from.”
You must have a strategic plan, that’s what we’ve been talking about in this series, so that you know where you’re going. And you need a plan to keep you from getting distracted by shiny objects.
At the same time you have to be willing to be flexible and change course when it’s obvious that’s business conditions are changing.
Blockbuster failed because they failed to consider how the landscape was changing in front of their eyes. You need a system, a set of rules, that will help you identify when to adapt and adjust.
Each year you’ll have opportunities put in front of you that have a good ROI and high client interest but don’t exactly fit into your strategic plan, business plan, or vision. In an earlier post I talked how it was important to be able to consider these opportunities and make decisions quickly.
Some of those opportunities will continue to resurface and if you fail to adapt your business to client needs and competitive changes you will go out of business.
When faced with opportunities that aren’t part of you strategic plan yet have good business prospects here’s a framework to use to decide if you need to adjust – answer the following questions about the non-fitting opportunities:
- How strong would you rate client interest in the new opportunity?
- Have you noticed any competitors changing their approach or strategy?
What do they know that you don’t?
Are they ahead of you?
- Are there other new substitutes showing up in the market?
Substitutes can be a good indicator that the opportunity has room to run because others are trying to find a good solution too.
- Do you have product or service lines that are underperforming your projections?
Why? What’s going on?
- An underperforming offering combined with significant requests for something new is an indicator that there’s a shift happening in the market.
- Are the assumptions that you used to develop you original strategic plan still valid?
Remember that the first question in the Sales strategic planning session asked how are our clients’ needs changing? Your Sales team provided answers to question about new initiatives that your clients are focusing on.
This is where you come full circle in your planning and consider funding new programs or projects based on the answers to those questions.
If you’re not able to answer all of these questions during the December 1st meeting don’t take forever to get the answers. You and your team should be informed about the answers to these questions no later than January 2nd of the next year.
What if?
You may be considering funding an idea that doesn’t fit your plan but on the surface has a good ROI and interest from your clients. Here’s the question you need to answer about that opportunity: If the answers to question 1 thru 4 come back a “yes” and question 5 comes back a “no”, would I fund this idea instead of a program that fits my current strategic plan?”
If the answer is yes, then earmark that money for the next 30 days and don’t authorize it to be spent on anything else.
Finalizing Next Year’s Plan
First, fund the investments you need to make to keep things running smoothly. These generally mean replacing old equipment.
Second, fund the non-CapEx growth opportunities that have good ROI’s.
Third, set the dates for when you expect to start the projects in #1 and #2 above.
Fourth, what’s left is money that can be put to work on high ROI projects that fit your current plan. Unless you believe that the answers about your non-fitting project would invalidate the reason for pursuing these projects you should fund them and move forward.
Anything shelved because it didn’t meet the guidelines but was close is a challenge for Sales and Operations to double-check the idea to see if they can find the additional cost savings, new business, or refine the business case so the idea can become viable. Shelved does not mean “no” forever; it just means “no” for today.
Set the metrics for measuring the success of new programs and verifying the ROI is achieved on all of your new investments.
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