Our topic this month focuses on developing a longer term strategy for your company. However, in order to develop a strategy it is important that your company first understands its position in the market (see August’s Topic on Market Positioning.) While there are many different views of how to develop a strategy or “strategic plan” for a business, Cathedral’s approach is designed to be shortened and workable, focusing on the annual cycle. Since a strategic plan is a living document, this focus on the annual cycle is useful because next year’s plan will build off of this year’s plan. With this in mind we recommend a three year strategic plan.
Step 1: The Mission Statement
A strategy focuses the business on what it hopes to achieve and restrains it from pursuing opportunities that are otherwise inconsistent with its strategy. In order to provide focus, companies often begin by developing a vision or mission statement. The vision or mission statement provides clarity and focus to all goals and activities of the company and, accordingly, should be revisited and affirmed from time to time.
Both large and small companies may think that each employee is aware of their vision, but this is often not the case. A written statement of the company’s vision that is clearly communicated through the company will not only ensure consistency of the vision both now and in the future, but also provide a meaningful context for the employee and the job they perform for the company.
Step 2: Establish a Target
The “target” is what you believe the business should be in three years. To establish a target, it is useful to consider two questions:
- What do you see the business as in three years?
- What would the business look like if it doubled in three years?
These questions are related in that most owners view the business future in an incremental growth fashion, therefore the doubling question causes an “out of the box” evaluation of the business and its opportunities. When addressing these questions start with a focus on revenue over the next three years, and then add the operational actions to support the targeted revenue for the corresponding years.
August’s marketing positioning analysis is very helpful in thinking through the answers to these questions. For example, if a competitor is going out of business, the potential for growth may be enhanced. New products may create additional opportunities. Pricing changes affect revenue and cost growth. Inflation or commodity price changes may impact the profitability of operations in certain industries, and so on.
Step 3: Identify Annual Steps to Achieve the Target
After a target has been set for what the business should look like in three years, the current state of the business is compared to that target. The difference or “gap” between where your business is at now and where you want it to be in three years must be analyzed to determine what changes must be made over the next three years to achieve your target. Cathedral offers a Business Review which utilizes a SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis to help the company determine their current position. Building on strengths and opportunities while addressing the other factors, this knowledge lays a solid foundation for identifying the necessary steps to be taken each year to reach the target desired.
Proposed organizational changes need to be written down and the steps to accomplish each one described briefly. One visual way that future growth can be outlined is by showing the changes in a matrix year by year. The matrix can demonstrate growth areas through staff or product/service offering additions. Without framing the necessary steps for each goal, the target is unlikely to be reached. An illustration for example is shown at the end of this article in Exhibit A. Note that it is a simple model for illustration purposes.
Step 4: The Financial Model
Once the components of the strategy are identified, the next critical step is the development of the financial model for the next three years. The model brings the strategy to life. A good model will follow the standard financial statement format: balance sheet, income statement and statement of cash flows. The level of detail in the financial model will vary depending on the size of the company and the financial acumen available. For a first time model, it is useful to follow a simplified approach focusing on the income statement. For example:
- Revenue for the year
- A sub-schedule with customers or products to show the sourcing of the revenue is helpful.
- Marketing or other revenue-generating resources are considered here, but will be captured in the costs section below.
- Cost of goods sold (“COGS”)
- The impact on margins should be considered – that is, whether margins are expected to change over the next three years given the increased levels of revenue. See March topic for margin questions.
- COGS links to the balance sheet through the inventory. It is important to ascertain whether the growth in revenue each year will require additional inventory. If so, additional investment will be required. Thus the balance sheet is critical.
- Sales, General and Administration
- Consideration should be given to whether any additional marketing resources, expanded facilities, or additional administrative support will be necessary for the forecasted level the growth.
- Operating income
- Taxes are important to include in the model. Even pass-through entities such as S-corps, LLCs and partnerships should provide sufficient cash to their investors/owners to pay taxes.
- Net income
The income statement then flows through a balance sheet and cash flow statement. The key here is to identify what added investment (both amount and timing) is required to support the growth. Even without added facilities, additional working capital investment may be required for Accounts Receivable, Inventories, etc., reduced by any growth in Accounts Payable. Establishing the working capital investment required can be developed by estimating the ending balances of these accounts, in reference to the average amounts for the current level of revenue.
The three year financial model should then form the basis of your annual budget. That is, the revenue necessary to support operations and capital investment is a quantifiable amount for years one, two and three, as are the related COGS and other expenses. Achieving the annual budget in each of these years will be important in order to reach your “target” or strategic plan by year three. Since the strategic plan is a living document, modifications to the plan can be made as and when required to reflect changes in the market or other factors.
Strategy: Communication and Accountability
A written down “strategic plan” should be communicated to the employees, reviewed regularly for progress against the plan, used to evaluate opportunities, and adapted or modified as market conditions change.
A strategic plan is nothing more than an interesting document if no one in particular is responsible for achieving the plan, or if the plan is not communicated to the employees. The strategic plan should be developed with input from key members of your leadership team because they, together with the president, are responsible for the execution of the plan and should be accountable for achieving (or not achieving) the plan. While most of your employees are focused on their day-to-day job responsibilities, they too need to understand the strategic plan and their role in the execution of the plan. Most companies find that there tends to be more “buy-in” to the strategic plan if a component of leadership and employee remuneration is tied to reaching specific goals embedded in the plan.
Tutorials & Articles for Further Reading:
- “Persuasive Projections.” This article discusses the necessary elements of financial projections particularly focusing on what loan officers and investors are looking for. http://www.inc.com/magazine/20000401/18118.html
- Living Business Plans help Businesses Flow with Future. This article tells the story of a company who was able to adjust their strategic plan quickly when learning that their business was seasonal in nature. http://www.inc.com/articles/2000/03/18184.html
- “Making Your Financials Add Up.” This article focuses on developing an accurate financial forecast for revenues rather than broad guesses and general percentage increases. http://www.inc.com/articles/2002/03/24019.html
- “Integrated Measurement Systems.” This article explains the purpose of the balance scorecard management tool and how to create one for your company. http://www.toolpack.com/scorecard.html
- “Small Business Management Audit.” This 9 question article helps you quickly audit your firm regarding strategic planning. http://www.prenhall.com/scarbzim/html/audits/audit2.html
Exhibit A: Strategic Plan Model Example
- Current business does $2.5 million, has a profit of $50,000.
- Target for year three is $4.5 million with a profit of $250,000
- Target is set based upon adding new customers and developing existing customer base.
- Added profit is based on maintaining a 10% profit margin on the added revenue.
- Needed investment is viewed as minimal due to adequate inventories. Result will be higher inventory turns.
- Added resources for marketing and customer services will be needed to handle added activity.
- No added administration staff will be needed.