It doesn’t take a black swan event for a company to face a restructuring or financial turnaround situation. Companies can face failure regardless of the broader economic environment, even those companies that have been very successful and profitable for decades. (Think Kodak.) So, what do business leaders need to do to stay relevant and profitable? What do they need to do if they find their business edging toward a turnaround situation? In both cases, evaluating business assumptions is critical.
The Importance of Regular Business Assumption Evaluation
It is important for business leaders to look at the following on a regular basis in order to create an early warning detection system:
- What are the key assumptions in your business model that make it successful?
- What financial ratios or key performance indicators (KPIs) do you run that highlight the business model?
- What are the threats to the business model?
- What benchmarks are you reviewing for this reporting?
- What are the secondary consequences for changing any of the assumptions?
Every startup has a business plan, and those plans contain key business assumptions. But what if you have been operating for one or more decades and haven’t revisited the plan recently, or ever? Do assumptions about your customer base, sales channels, pricing strategy, and marketing strategy still hold true? Are all other assumptions still valid?
Revisiting business assumptions may seem simple, but many factors contribute to a company’s success. For example:
- Is it your company’s speed to market?
- Is it your marketing campaign driving customers to your website?
- Is it your product quality or superb customer service?
- Or is it all the above, working in harmony?
Developing KPIs that Help with Evaluating Business Assumptions
All industries and businesses have KPIs that are unique. To develop KPIs which will then help you identify the key assumptions making your business model successful:
- Model the business cycle/process, understanding all functions, and what is important to those operating in them.
- Understand the details of the current state of business.
- Create metrics for department performance outside of financial data such as days sales outstanding (DSO), container turnover, and operational data as well as cost data.
- Create customer statistics such as customer lifetime value and customer acquisition cost.
- List the drivers of the assumptions by department since financial systems only tell you the impact of the operational systems.
As business assumption evaluation progresses, it is important to consider the threats to key assumptions. Some examples include supply chain disruption, large customer bankruptcies or new trends within your sales channels. Understanding all of this will allow you to forecast different scenarios as well as perform sensitivity analysis with regards to scalability.
After key business assumptions and their drivers and threats are identified, utilize this information to forecast your financial statements. Most companies create a budget for each year and compare it to the previous year, but it is also necessary to re-forecast the financial statements as new information arises that may impact profitability.
Incorporating the balance sheet and cash flow in your forecasting models is just as important. Not doing this could lead to blowing a covenant in your credit facility without knowing until it’s too late to mitigate. Furthermore, this cannot be stressed enough: Do not wait until the company is cash strapped to create a 13-week cash flow forecast because cash is king.
Looking for Trends
Business assumption evaluation and financial planning is about looking at the past, present, and future. Financial Planning and Analysis (FP&A) teams look at the past for benchmarks and the present for current trends in order to forecast the future. Some of the many things the FP&A team should consider include:
- Decreases in profit margins and the drivers
- Decreases in operating margins and the drivers
- Changes in customer acquisition costs and/or lifetime customer value
- Decreases in cash on hand
- Trends in customer churn
Without a strong FP&A team, either in-house or via consultants, business leaders are flying blind and making decisions based on hunches or gut feelings instead of skilled, careful analysis.
What Do You Do If the Company is Already Low on Cash?
If there’s ever a good time to abandon the idea of “this is the way we’ve always done it,” now is definitely that time. Perhaps, for example, the company overspent in good times or continues to direct marketing spend to a struggling sales channel. Even if what was working before isn’t working now, it may not be too late to pivot.
If you’re not already, start holding weekly cross-functional meetings to discuss each department’s challenges and review the key metrics that have been identified for the business model’s success. Maybe a previously unprofitable sales channel is growing and needs to be revisited or a pricing strategy that was unthinkable is now viable.
When the cross-functional team discusses possible changes to previous key assumptions that made the business model initially successful, the team also needs to discuss the consequences of making those changes. If the team decides on selling direct to consumers when the company has always sold wholesale, how will this impact your wholesale market? If the team decides a volume pricing strategy will help to draw more new customers, how will this affect your existing customer base?
Employing a strong FP&A team will give leaders the story behind the numbers and the right expertise and tools for thorough business assumption evaluation. Turnaround situations can be avoided, and profitability can continue even in changing or challenging times.
When was the last time you reviewed the assumptions in your business plan? If you can’t remember or it’s been many years, consider a business assumption evaluation. Reach out to 8020 here, and one of our experienced consultants can help you take an objective closer look.
You can also learn more about related support offerings in our business stabilization explainer, which includes a detailed rundown of our financial forecasting and re-forecasting services.
About the Author
Jennifer is a senior-level Finance professional with more than 20 years of finance and accounting experience and more than 15 years in the consumer product manufacturing industry. Prior to joining 8020 Consulting, she was Head of Finance for Buscemi LLC, a luxury shoe brand. At Buscemi, Jennifer led the implementation of NetSuite as the complete system of record within 4 months. Prior to Buscemi, Jennifer was the Corporate Controller of Dogswell, a premium pet treat manufacturer. She joined Dogswell as part of a turnaround team post restructuring, which was successfully turned around and sold within 1 year. The majority of Jennifer’s career was spent at JAKKS Pacific, a $900 million publicly traded toy design and manufacturing company, where she was Vice President of Finance. At JAKKS, Jennifer was head of the FP&A and Royalties departments and acted as Interim Controller for over a year. Her work included both internal and external financial reporting, royalty audits and preparing Board of Director presentations. She has expertise in building complex financial models, strategic planning, motivating the finance team, and improving efficiency. Jennifer holds a Bachelor of Arts degree in Business Economics with an Accounting emphasis from UCSB, an MBA from UCLA Anderson School of Management and has passed all four parts of the CPA exam.