1308: Building Forecasts from the Bottom Up by Dr. Jeff Cornwall on Thoughtful Business Growth

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[00:00:30] This is the Work Daily Episode 1308, Building Forecasts From The Bottom Up, by Dr. Jeff Cornwall of Dr.JeffCornwall.com.

[00:00:38] And I'm Dan, your host and narrator here on OWD. Thank you so much for being here.

[00:00:43] And I am, of course, with you every single day reading from these great blogs that we find that discuss work, entrepreneurship, and all sorts of related topics.

[00:00:52] So with that, let's jump right into our article today and optimize your life.

[00:00:56] Building Forecasts From The Bottom Up, by Dr. Jeff Cornwall of Dr.JeffCornwall.com

[00:01:06] Once revenues start rolling in, entrepreneurs have nothing to worry about, right?

[00:01:11] After all, the market has verified that their business model is sound, but could possibly go wrong.

[00:01:16] Well, actually, many things can go wrong.

[00:01:19] One of my late father's favorite sayings was, the single biggest cause of business failure is success.

[00:01:26] Entrepreneurs who are unprepared for the challenges of growing a business can often derail even the most promising business model.

[00:01:33] So, how should you plan for growth?

[00:01:35] The first step is to make sure how big you really want and need your business to become.

[00:01:43] The best tool that I have found to engage in smart planning for growth is to use what I call a bottom up income statement.

[00:01:50] Rita McGrath and Ian McMillan called the process Discovery Driven Planning in their classic article about this technique

[00:01:57] first published in HBR in 1995.

[00:02:00] I learned it from my late father back in the 1970s.

[00:02:03] The basic logic is this, start with how much you want to make when planning for the growth of your business.

[00:02:09] Let me offer an example based on using this tool to help my daughter Maggie and son-in-law Matt

[00:02:14] when trying to figure out how big to grow their commercial painting business, Harpeth Painting.

[00:02:20] Bootstrapped beginnings

[00:02:22] Matt had bootstrapped Harpeth Painting.

[00:02:24] Initially, Matt kept his day job with a commercial construction company to support their family.

[00:02:29] He worked on the new business mornings, lunch hours, nights and weekends.

[00:02:33] Having identified a niche in the market and executing the startup well,

[00:02:37] the business grew steadily during its first year.

[00:02:39] Right around the first anniversary of the launch of Harpeth Painting, our daughter gave birth to their third child.

[00:02:45] Harpeth Painting was doing well.

[00:02:47] Its cash flow could make up for the salary he'd been earning

[00:02:50] and they had accumulated a good cash balance in the new company.

[00:02:53] Maggie said,

[00:02:54] We now have three kids including a new baby.

[00:02:57] It's time for you to work only one job.

[00:02:59] So Matt took the leap of faith and quit his day job.

[00:03:03] How big is big enough?

[00:03:05] Three years into the growth of the company,

[00:03:07] Maggie came to me wanting help to determine how big they needed to grow the business.

[00:03:11] It was doing well, but they just weren't sure how far to take its growth.

[00:03:15] They had no real aspirations to build an empire or even a big company.

[00:03:19] They just wanted to earn a financially stable living from it.

[00:03:22] The business had grown to about 25 painters.

[00:03:25] Any bigger would require that they start to invest in some administrative positions to help them out.

[00:03:30] Maggie and I met in my office and began to whiteboard a financial model for their business.

[00:03:35] Step 1

[00:03:36] What are your financial needs and goals?

[00:03:39] I asked Maggie how much they needed to take home each month to live comfortably.

[00:03:43] The business was already generating enough income so that number was their current personal budget.

[00:03:48] We only added a bit to this number for cushion.

[00:03:51] Next we added income tax to that number as their company is an LLC.

[00:03:55] We put a little extra in this estimate as well.

[00:03:58] Finally, I asked what they intended to save each month.

[00:04:01] Their business is one that will not have much if any value when they're ready to retire.

[00:04:06] If they have equipment or even a building of their own someday, this will have value.

[00:04:10] But Matt is the business.

[00:04:12] All of the work they get is built off of his relationships.

[00:04:15] So that means that any savings for retirement, college, etc.

[00:04:19] has to come from the cash flow of the business over time.

[00:04:22] Maggie gave me their target savings which was a reasonable amount.

[00:04:26] I doubled it.

[00:04:27] We now had the foundation of the financial plan to guide the growth of their company.

[00:04:31] Step 2

[00:04:33] Overhead

[00:04:34] Their business has a fairly simple overhead structure.

[00:04:37] Matt and Maggie both draw a paycheck.

[00:04:39] The company rents space for trucks, equipment, inventory, and an office for Matt.

[00:04:44] They have a couple of people on salary.

[00:04:46] We also added in marketing, insurance, and so forth.

[00:04:49] They are both dedicated bootstrapers.

[00:04:52] The apple doesn't fall far from the tree for either of them.

[00:04:54] So their overhead was all quite reasonable.

[00:04:57] Sometimes when I do this technique I find lots of bloated expenses in the business.

[00:05:01] Not this time.

[00:05:02] With overhead and what they need to make from the business,

[00:05:05] we now know how much gross profit, sales minus variable expenses, cogs,

[00:05:10] the company needs to earn, add everything up we have so far,

[00:05:14] and we have that target for a required gross margin.

[00:05:17] Step 3

[00:05:18] Required Sales

[00:05:20] To determine sales required to reach the financial aspirations of the owners,

[00:05:24] we use this formula.

[00:05:25] Required sales equals required gross margin slash gross profit margin.

[00:05:30] Let's look at this with completely hypothetical numbers.

[00:05:33] Overhead equals $20,000 a month.

[00:05:36] Required earnings for the owners equals $10,000 a month.

[00:05:39] Estimated income tax from pass-through income from the LLC equals $5,000 a month.

[00:05:45] Estimated monthly personal savings goal for owners equals $5,000 a month.

[00:05:50] Required gross margin equals overhead plus earnings goal plus pass-through taxes

[00:05:56] plus savings goal which equals $40,000.

[00:06:00] Gross profit margin equals 20%.

[00:06:03] Required sales equals $39,000 divided by .20 or $200,000 a month in revenues.

[00:06:10] So for this hypothetical example, the company would need to maintain

[00:06:14] annual revenues of about $2.4 million to reach all of the owner's personal goals from the business.

[00:06:21] So we don't need to grow anymore?

[00:06:23] When I did this with Harpeth Painting's actual numbers, Maggie was delighted.

[00:06:27] As it turns out, the current size of the business is at 50% more than they need to hit their targets.

[00:06:33] That was great news as they had just met with their two supervisors and all of them agreed

[00:06:37] they loved the current size of the company.

[00:06:40] Step 4.

[00:06:41] How much cash?

[00:06:43] Maggie's next thought was that she was not sure they wanted to take out enough cash

[00:06:47] to meet their savings goal quite yet.

[00:06:49] Their business model required putting out cash up front for jobs,

[00:06:52] and they would rather not do this with their line of credit unless absolutely necessary.

[00:06:57] So the last step was to determine how much cash they needed to have as an average balance

[00:07:01] to meet the working capital needs of the company.

[00:07:04] My rule of thumb is that every business needs to have a goal of at least 30 days operating cash on hand.

[00:07:10] That means that if no cash comes in for 30 days, there's enough cash in the bank to cover that period of time.

[00:07:15] Given the cash flow challenges of a commercial painting company,

[00:07:19] I recommended at least 60 days cash on hand and 90 wouldn't hurt.

[00:07:23] I believe personally that 6 months would not be an excessive amount.

[00:07:26] Some argue that this is poor asset management as cash really earns nothing.

[00:07:31] For me, having cash in the bank helps me sleep well at night.

[00:07:34] That is a value much higher than any interest I might be able to earn.

[00:07:38] Moral of the story

[00:07:40] Rather than growing the business simply because you can,

[00:07:43] know how big you need it to be to meet your short and long term needs.

[00:07:47] Life is short, there's more to life than running a business.

[00:07:50] Don't get me wrong, I love being an entrepreneur.

[00:07:53] However, I also love being a husband, a father, and a grandfather.

[00:07:56] We love to travel, hopefully someday soon.

[00:07:59] I love to golf, and I love to spend time with Anne.

[00:08:02] All of that takes planning when you're an entrepreneur

[00:08:05] and the bottom up income statement can help.

[00:08:08] You just listened to the post titled

[00:08:14] Building Forecasts from the bottom up by Dr. Jeff Cornwall of drjefcornwall.com

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[00:09:20] And thank you to Dr. Jeff.

[00:09:22] Growing up, entrepreneurship and small business was normal dinner time conversation at the Cornwall household.

[00:09:28] This set the stage for a decades long career pursuing entrepreneurial ventures

[00:09:32] and sharing his knowledge in the classroom.

[00:09:35] Jeff has spent more than 40 years now as a serial entrepreneur.

[00:09:39] In the 1970s, he started several small businesses and was involved in various family ventures as well.

[00:09:45] In the late 80s following several years in academics,

[00:09:48] Dr. Cornwall co-founded Atlantic Behavioral Health Systems in Raleigh, North Carolina

[00:09:53] and spent nearly a decade leading the company as president and CEO.

[00:09:57] After growing the business to more than 300 employees,

[00:10:00] he and his partners sold most of their healthcare holdings

[00:10:03] and after the sale Dr. Cornwall decided it was time to return to the classroom

[00:10:07] to share his experience and knowledge with aspiring entrepreneurs.

[00:10:11] He is now the president and CEO of the entrepreneurial mind

[00:10:14] and his blog was named one of the 100 best websites for entrepreneurs by Forbes magazine

[00:10:19] so definitely worth checking that out.

[00:10:21] Come by Dr. Jeff Cornwall for a lot more articles that's drjefcornwall.com

[00:10:28] But that is it for this episode of Optimal Work Daily.

[00:10:31] I do hope you enjoyed it and thank you so much for being here.

[00:10:33] You know that is of course how we keep this show going.

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[00:10:40] and telling friends and family about it when you get a chance as well.

[00:10:43] So, hope you have a great rest of your day and I'll see you again tomorrow

[00:10:47] where your optimal life awaits.