Over the past 10 years I’ve worked on a lot of business plans.  First as a student, then as a product manager and as a coach to young entrepreneurs.

In every business plan that I’ve worked on or reviewed, there has been one common theme: the financial model was completed last and got the least amount of attention.

This past weekend I was re-reading some portions of McGrath’s Product Strategy in High Technology Companies and he reminds us that treating the financial model as an afterthought is, of course, not the right way to do it.

McGrath describes the financial portion of a business plan in an interesting way – he sees it as a mathematical proof that the business described in the plan will generate positive return over time.

As you’re writing the business plan (not after) you should calculate things like the cost of acquiring a new customer, the cost of serving an existing customer, the lifetime revenue of a new customer, average tenure of a new customer by segment, etc. etc.  These figures come together at the end of the business plan and show what kind of business you could have.  If the financial result doesn’t meet the required return to garner resource allocation – you can then trace back and find the parts of the business plan that need to be changed so that the return meets the required benchmark.

It’s a common misconception, especially among students, that the key to a good business plan is a good idea.  The truth is – there are plenty of good ideas (some of them even good ideas that will make revenue) that end up being lousy businesses.  You need to look at the whole financial equation before you can tell what kind of business you will have.

The bar for success in writing a business plan isn’t that you have a good idea and can get someone to pay you – the real bar is that you’re creating a sustainably profitable business.

Business Plan Financial Models: A Mathematical Proof
  • Bren Eifler

    Truth. ..The main thing that has log jammed me on this in the past is knowing where to get the numbers. Until one has run a business for a while, it’s hard to tell what costs are actually involved. How would you go about gathering these cost/profit metrics?

  • Yeah – it can be hard. Here are some useful tricks I’ve used in the past.

    For revenue:
    – first estimate the size of the market (all of the folks paying for the product or service your offering combined).

    – then estimate the growth rate of the market and competitors share

    – then project the share you think you can make in yrs 1, 2, 3: along with all the details about how many customers you would need (including avg size customer), assumptions about sales success, etc. key here is to lay out all assumptions and then try to quickly prove or disprove the assumptions.

    On cost side: estimate avg fully loaded cost of headcount, then estimate the number of people you need per account, sales, service, etc.

    Engineering headcount can be harder. That’s usually a finger in the air- as far as I’ve seen.

    That’s usually where I start – but then again in tech businesses headcount is usually the greatest cost. Can be different in other businesses.