Stress test your business plan

Most budget forecasts are wrong from the day they are written. The federal budget – which turned last year’s forecast of a $20 billion surplus into a $57.6 billion deficit – is testimony to that.  

Two years ago, a forecast might have been reasonably accurate. These days, it’s unpredictable. Sales have vaporised, the dollar is more volatile, and input costs are rising – and no one is absolutely certain where the world is heading.

In his 2005 book “Winning”, former GE chief Jack Welch ripped into budgeting and forecasts. “Not to beat around the bush, but the budget writing process at most companies has to be the most ineffective practice in management,” Welch wrote.

With the markets in turmoil and forecasts way off beam, most companies now would agree. Many budget forecasts in this climate are next to worthless and not worth the memory stick they’re stored on.

“It’s a bit of a crap shoot as to what’s going to happen with the Australian dollar, unemployment, interest rates and venture capital,” says John Downes, a partner at Deloitte who runs the firm’s small to medium enterprise consulting business.

“It’s also very difficult to understand what’s happening with consumer confidence and business confidence, which is driving buying decisions and which, in some cases, is quite delayed.”

Still, the only way to remain in business in this climate is to plan. Scenario planning and stress testing become more important than ever before.

Building the plan

Downes recommends his clients run a series of forecasts for the next two years. A business-as-usual scenario, for example, might have flat growth. He then advises clients to impose other scenarios on their business plan, like a 10% drop in revenue and a 20% increase in input costs as a result of a stronger Australian dollar.

“The reason for doing that is that it allows the business decision maker to look at his business under a range of scenarios, none of which he can guarantee are going to happen,” Downes says. “What it does allow him to do though is then actually identify the trigger points in his monthly reporting as he goes through the year.”

Downes says that allows the business to develop and implement an “agility plan” to mitigate those forces.

“If they are forecasting a 10% reduction in one scenario, they may have in place a set of decisions already modelled which say if we have two consecutive or three consecutive months of declining revenue, we have to drive for a harder sales program, but if we feel that’s not delivering, then we may have to look at some significant cost reduction activities.”

That might mean developing contingency plans to consolidate sites, or reduce marginal growth services or those that are likely to suffer more when demand crashes. If the worst happens, the company is not caught off-guard and is quick to act. 

“The reality is we can’t guarantee what’s going to happen over the next 12 to 24 months, so it’s about being forewarned and forearmed. It’s prudent to model some of those scenarios that they can reasonably expect might happen, and establishing some plans should they occur,” he says.

Scenario plans need to look at what happens if the company loses customers and suppliers. It is more than likely that some will not be there two years from now.

Downes says: “Having those scenarios modelled and action plans written down give you the ability to make those decisions in an informed and considered manner as opposed to getting the fax on the Monday morning from the receiver saying ‘we have been appointed to one of your key clients’ and that you are likely to get X cents in the dollar in two years time and ‘we are not going to continue looking to you as a supplier’. That’s when you get knee-jerk reactions.”

How customers and suppliers can help

What else can business owners do to track customers and suppliers? Downes has a simple enough solution. “The key place you get it from is from speaking to your customers and suppliers and actually having the heart-to-heart conversation with them about what’s actually happening in their business and how is their business going,” he says.

“If you have two or three key suppliers, or two or three key customers, then you need to be having those same conversations, just the same way you would be having those conversations with your bankers.”

The business plan, covering such areas as market analysis, company description, organisation and management, strategic analysis, marketing and sales management, service or product line, the amount of funding needed to start or expand the business, and financials is critical. The best business plans are updated every three months.

One reason why many small companies do not have plans is lack of time. Faced with the choice of serving a paying customer or writing a plan, any small business would go for the money. The answer for some businesses is to prepare the plan on the weekend. It might take an entire Saturday, but those that do it say it’s a worthwhile exercise.

Many small businesses think they don’t have the tools to prepare one. But Toby O’Brien, a director and co-founder of BPM Financial Modelling says it is not that difficult to pick up information and develop tools.

Clients and suppliers, for example, might offer good insights. Financial services clients, for example, could offer information about the economy; retail clients about customer demand and service; IT clients about the latest trends in technology; and insurance industry clients would know all about risk.