Make sure your customers aren’t driving with blinders

n many ways, operating a business is like venturing off on a road trip. But it’s surprising how many small and midsize companies have no road map to guide them. Detailed business plans can improve the odds that a borrower will arrive at its destination on time and on budget.

Essential components of a business plan

Business plans provide investors and lenders with an assessment of current operations, as well as a game plan for the future. They traditionally include these components:

  • Executive summary,
  • Business description,
  • Industry and marketing analysis,
  • Management team description,
  • Implementation plan, and
  • Financials.

Small and midsize businesses might balk at compiling a comprehensive business plan, but they’re imperative when a company is teetering on the edge of bankruptcy or needs financing for a major capital expenditure. The best plans are quite simple, however. Executive summaries can be as short as a paragraph. Long-winded plans tend to bury management’s message. For small businesses, executive summaries shouldn’t exceed one page, and the maximum overall length should be less than 40 pages.

A logical starting point

Executive summaries are often the first place lenders look, but they are the last page management should write. For a road trip, most people think of a destination first (say, the Grand Canyon or Disney World) and then map out the optimal route. Similarly, business planning starts with a long-term vision: Where is the company now and where does it want to be in three, five or 10 years? In other words, start with historic financial results and then identify key benchmarks that management wants to achieve. These assumptions drive the financials.

Budgets as a driving force

The second place lenders look when reviewing a business plan is the financials section. Management’s goals are fleshed out in its budgets and financial projections.

For example, suppose a company with $10 million in sales last year expects that figure to double over a three-year period. How will the borrower get from Point A ($10 million in 2012) to Point B ($20 million in 2015)? Many roads lead to the desired destination.

Let’s say the management team decides to double sales by hiring three new salespeople and acquiring the assets of a bankrupt competitor. These assumptions will drive the projected income statement, balance sheet and cash flow statement.

When projecting the income statement, management makes assumptions about variable and fixed costs. Direct materials are generally considered variable. Salaries and rent are generally fixed. But many fixed costs can be variable over the long term. Consider rent: Once a lease expires, management can relocate to a different facility to accommodate changes in size.

Balance sheet items — receivables, inventory, payables and so on — are generally expected to grow in tandem with revenues. Management makes assumptions about its minimum cash balance and then debt will increase or decrease to keep the balance sheet balanced. In other words, your bank will be expected to fund any cash shortfalls that take place as the company grows.

The financials outline how much financing the borrower will need, how it plans to use those funds and when the borrower expects to repay its loans. As the lender, it’s your job to assess whether a borrower’s plan appears realistic.

Worthwhile reading material

The rest of the business plan describes your borrower’s internal and external environment. It can be informative reading material, even if you think you know an existing borrower. These sections demonstrate that management has done its market research and risk analysis — and truly understands the marketplace.

The CPA’s role

No responsible adult drives cross-country without GPS or maps. Drivers need to know where they are, what alternate routes or side trips exist along the way, and how close they are to the final destination.

Wouldn’t you feel better knowing that your customers are proactive, rather than reactive? Business plans can help lenders understand a borrower’s goals and financing needs.

A CPA or turnaround consultant can’t mandate a business plan. Unless management initiates the plan, it’s doomed to fail. An experienced outside advisor can help the management team stay focused, crunch the numbers and serve as devil’s advocate when preparing this essential document.