In the pursuit of multi-million dollar outsourcing contracts, the company I worked for required me to defend my financial projections. The auditor who usually ran these reviews was one of the kindest, yet toughest, auditors I’ve ever worked with. He’d always start with the same question, ‘What are the eaches?’ He wanted to know how many hours, square feet or cubic yards of something we had to sell to reach a specific revenue or profit goal. This experience taught me that looking at a business in terms of units made or sold provides critical clues about the viability of it.
Many projections and budgets lack any real precision. Typically, a desired revenue number is plucked from the air, or other suitable location, as a starting point. Some ‘standard’ percentage is applied to this number for cost of goods to arrive at gross profit, which then has some ‘standard’ expense number applied to it to determine at operating revenue and so on, all the way to the bottom line. If the profit number isn’t satisfying then lather, rinse, repeat.
This method has two basic problems. First, implies that there is a ‘standard’ anything. The smaller a business is, the more subject it is to variations in revenue, cost and expense. Its prices are constrained by and its costs are generally greater than, larger better capitalized companies. There can also be wide variation in prices paid for labor and materials depending on location, time of year and a company’s financial health.