When preparing a financial road map for your business, would you rather use a budget or a Predetermined Profit Plan (PPP)? The choice you make will make a difference in your financial success.
The problem with most budgets is that once they are prepared, they are filed away and seldom used. This is the result of how they are developed: If the budget is nothing more than a mathematical exercise based on last years results and remains static regardless of the current year's performance, it is not an effective tool for guiding the company in the coming year.
Not only are most budgets static, they are seldom based on the very performance metrics that the business must reach to hit the budget. Therefore, the budget is based on a different set of criteria then the operations of the business. For example, if the business is operating at 75% productivity and the budget unknowingly assumes 80%, actual performance will never match the budget. Sadly, the owners may never know why.
Choosing a PPP
In a PPP, the various performance metrics that the business has set for itself become the backbone of the plan. The owners can see the financial result of their performance and are able to adjust their performance metrics if they don't produce the desired results. In a PPP, profit is not just the result of subtracting expenses from revenue; it is the goal.
A PPP assumes that profit is the single most important goal of operating the business. Without profit, nothing is possible. With profit, owners can make a wide range of decisions to positively impact the business and all involved with it.
Developing a PPP starts with determining sales and "return on effort." Through calculations that include risk, industry type, economic conditions, and the like, we derive a figure for profit. Once sales and profit are determined, the rest of the PPP can be filled in as a result.
A PPP allows for monitoring of key metrics that measure the business's performance. For example, based on the amount of sales, we can set performance levels for all departments in the company that are key to reaching the profit goal.
On a weekly basis, "Flash Reports" will monitor progress toward meeting the performance metrics so when monthly financial statements are prepared, the owners and managers will already know what to expect and the results will not be a surprise. On a monthly basis, the PPP must be measured against actual results as reported in the financial statements.
However, in order to know if the business is performing according to the PPP, actual results must be "converted" using the assumptions in the PPP. Financial performance must be compared on an "apples to apples" basis using a dynamic common point of reference.
Now back to the original question... When preparing a financial road map for your business would you rather use a Budget or a Predetermined Profit Plan?
Personally, I think the answer is clear. It is impossible to reach any specified goal without a real plan. In order to have a financial plan that provides real value, becomes incorporated into the daily routine of managing the business for profit, and truly guides you to your goal, a Predetermined Profit Plan is the only way to go.
