While visiting a friend, he asked a favor of me. He whipped out this humongous business plan consisting of two full 3-inch loose-leaf binders. Someone he knew had paid a whopping $250,000 to have this business plan prepared and my friend was interested in my opinion of it.
At first I considered telling him I had something else to do and couldn't spend the next ten hours reading a "Gone-With-The-Wind" business plan. Had I been an actual potential investor presented with this monster, I would have simply dumped it in the trash and told the entrepreneur, "Thank you for considering me as a potential investor, but it doesn't fit my current criteria."
Nevertheless, I relented and agreed to look it over. My thought was, "OK, give it to me and I'll look it over as soon as I can." No such luck. He sat down at the table next to me with a child-like grin of anticipation on his face. He wanted me to look it over and give my opinion now! I thought, how can he expect me to digest this while he is looking at me like a puppy waiting for me to toss him a ball?
So, I dug in. Little did I know that this would turn out to be one of the fastest appraisals I would ever make.
Just like an investor, I turned to the financials in the back. (Note--investors typically don't read a business plan from the front to the back. They start by looking at the financials in the back!)
On the first page of the financials section, I saw a summary showing two graphs represented by the following tables (the actual numbers and dates have been changed to protect the guilty):
Year 1 Projected Revenues
Month Revenue
----- -----------
1 $ 7,457
2 11,185
3 16,778
4 25,167
5 37,750
6 56,626
7 84,938
8 127,407
9 191,111
10 286,667
11 430,000
12 645,000
----- -----------
Total $ 1,920,086
Annual Projected Revenues
Year Revenue
---- -----------
1 $ 1,920,086
2 2,400,000
3 3,000,000
4 3,750,000
5 4,688,000
This summary proudly boasted a projected growth rate of 25% annually.
Noticing that the business plan writer had switched from a monthly chart to an annual chart alerted me to a potential trap. Sure enough, they had fallen in--big time!
Let me explain. (I am letting you in on my thinking at this time--I hadn't said anything yet to my friend.)
They projected an annual growth rate of 25%. But look at this: doesn't the last month of the first year have sales in excess of $600,000? Look in the first table. Sure enough--$645,000 to be exact.
Now, if there were NO SALES GROWTH (0%) from that last month's level, what would be the revenue for the next year? Twelve times $645,000, right? That comes to a whopping $7,740,000!
$7,740,000 is over $3,000,000 more than they projected for the fifth year. That's after four years of "25%" annual growth, according to them!
Remember, I said NO GROWTH--zero--nada--zip!
I asked my friend why the company was projecting to lose sales! He had a look of astonishment and confusion.
I continued by asking him if the company expected to start the next year at low levels again and build up again, or would they start at the level of the last month and drop down during the year, or what?
It finally dawned on him that, by changing the projection time frame, the writers had missed the mathematical relationships. Seeing this flaw in the logic, he made my appraisal for me. He recognized that the rest of the projections were obviously in error and the entire plan was essentially worthless. At best, a major review of the numbers was needed.
The result: $250,000 blown in 5 minutes because of a phantom growth rate!
By the way, you may think this was a single, isolated case. Believe me, it wasnt. I have found this logic error in the majority of plans. In every case, the business plan writer is astonished and completely deflated. While that is never my intention, it does remind us how easy it can be to succumb to these kinds of traps.
(c) Copyright 2006, Leonard M. Stillman Jr., All Rights Reserved. |
