A financial model is only as good as its assumptions.
We all know the infamous saying about making assumptions.
But in the context of planning our business futures, the assumption is critical and used to rally around a plausible but currently unknowable. As a process, we first need to visualize many plausible “events,” then create various assumptions on the probability of each (and of what percentages they may eventually accommodate with each other). Last, as with any master practitioner in his or her field, in the building of a Balance Driven Business, we are consistently tasked with finding a balance between science and art.
Accuracy in both the science and art of assumption is twofold. For the science, we use a combination of data and our own observations of the world to create assumptions that we can then apply to situations we deem similar enough in nature. The art of assumption is fashioned from breadth of experience and the ability to connect/assimilate those experiences into meaningful statements.
The balance comes from assigning appropriate weights to each as you build out the models. Effective models also account for where the accuracy of data is critical to replace an assumption and needs our frequent attention to update or where the replacement of an assumption is less critical but still required to bind the model together. Last, but not least, effective models provide the user(s) with the ability to determine a middle ground with high probability between the range of “best case” and “worst case” scenarios.
The practitioners typically tasked with the “science” portion of our business financials are our bookkeepers, controllers, or accountants because they catalogue, organize, and report on events that have already happened. In a growth-oriented business, the art of finances is then relegated to the Chief Financial Officer who is charged with infusing up-to-date market, societal, and current event knowledge to regularly review and formulate hypotheses about the health of the business over future periods of time.
Interestingly, a high proportion of entrepreneurship writing focuses on the "survivability" of business within the first couple of years but engenders a disproportionate amount of anxiety for the “could be” business owner. In short, the most recent reporting by the Bureau of Labor Statistics encouragingly found that you if you start a business today with a relatively good market fit and cash management, we actually have an 80 or so percent chance of surviving your first year and a 70 percent chance of surviving our second. The more interesting statistics are, at five years, you’re down to a 50/50 chance of still pushing product and, most alarmingly, only a 30% chance at ten years. Although I’m not yet old enough to have sufficient experience in relaying why the ten-year attrition rate is so high (although I could make some assumptions), we can focus here on the businesses falling into that five- to ten-year range.
Even so, 50/50 was initially a surprising probability to me, but thinking about it in the context of this writing, it does make sense. By the time we get to 5 years, most businesses have established a decent, saleable product with descent, workable processes, as well as teams to facilitate ongoing, reliable delivery. It is also the point where there is enough cash flow to “offset/hide” any current deficiencies in people management, systems, and/or general efficiencies. Often, we are then at the point where we are afforded the choice (or confidence) to really scale the business. It is when the choice to scale is made (whether by plan or reaction), that the deficiencies in our business models are exposed and exacerbated in direct proportion to the speed of our growth. So why 50/50? Because failure to properly model for, prepare, and execute for that growth into the next stages of your business amounts to no more than guessing.
To elevate guesswork to the status of plausible assumption, we first need to mentally assign the proper contribution-roles to our financial professionals and balance the information we receive from each. Generally for positive financials, accounting-side decision making sans CFO contributions can often be overly optimistic and, conversely, with negative financials overly pessimistic. On the other hand, CFO-side decision making sans robust and accurate input from accounting is, at default, just plain pessimistic.
Back to balance. If we want better chances of being around after five years than the flip of coin, then we must learn (or obtain the ability) to balance our historical data from accounting with the prognostic charge of the CFO.
My assumption is that the fifty percent of businesses that did not survive their fifth-year anniversaries are those that failed to do so.
As the saying goes, two heads are better than one, and committing to a Balance Driven Business keeps you at pace in this new world of business— the ever-increasing speed in which business adaptations need to occur to realign people, product, and profit. Col. Sudip Mukerjee of Reserv3 Consulting and Sean Lewis of SLC Advisory Group combine their specialties for the deep dive needed to bring your business up-to-date with the finance and people challenges of the New World, and to lay the groundwork for staying competitive well into the future.