How to Build a Profit Plan for Your Business
By Eric Dickmann
February 6, 2023
In order to achieve business goals, a profit plan is crucial. It serves as a financial roadmap for the company. However, with competing demands, it can be challenging to begin. Market demand and competitive factors, along with seasonal cash-flow changes, can be unpredictable.
To build a profit plan, start by understanding your business goals. Get all key stakeholders involved to align the plan with those goals. Decide on key metrics to track and what tools to use for tracking. Ensure you're relying on relevant and legitimate data sources. Everyone should agree on the validity of the numbers. Analytical tools can help track and measure progress against goals.
What is a Profit Plan?
A profit plan is a detailed financial plan that outlines a company's strategies and goals for generating revenue and managing expenses in order to achieve a specific level of profitability. The profit plan typically includes a detailed budget that outlines projected revenues and expenses, as well as a forecast of the company's cash flow, balance sheet, and income statement. The profit plan is an essential tool for any business, as it helps managers make informed decisions about how to allocate resources, invest in growth opportunities, and manage risk. It also serves as a roadmap for the company's financial future, providing a framework for monitoring performance and making adjustments as necessary. A typical profit plan will include the following components:
- Revenue Projections: This includes estimates of sales, pricing, and volume for the coming year.
- Cost Projections: This includes estimates of all direct and indirect costs associated with producing and delivering goods and services, such as labor, materials, overhead, and marketing expenses.
- Cash Flow Analysis: This includes projections of cash inflows and outflows, as well as a plan for managing cash reserves.
- Balance Sheet Projections: This includes estimates of the company's assets, liabilities, and equity over the coming year.
- Income Statement Projections: This includes estimates of the company's revenue, expenses, and net income for the coming year.
By creating a comprehensive profit plan, a business can set realistic goals and targets, monitor progress toward those goals, and make informed decisions about how to allocate resources and manage risk. It can also help to identify potential areas for improvement and optimization, which can ultimately help the business to achieve greater profitability and success over time.
Benefits of a Profit Plan
A formal profit plan prepares a company for possible challenges and ensures maximum profit. CPAsNet noted that profit plans are beneficial to:
- Help owners achieve their financial goals
- Improve and measure performance
- Establish a framework for making decisions
- Educate and motivate key employees
Building a Profit Plan for Your Business
It is important to consider profit when making plans for your business because profit is the ultimate goal of any business. Without profit, a business cannot sustain itself, pay its employees, or invest in growth and development. Profit is also a key indicator of a business's success and can attract investors and potential partners. By considering profit in their plans, business owners can make informed decisions about pricing, marketing, and investment strategies that will help them maximize their revenue and achieve their goals. Ultimately, profit is the lifeblood of any business, and considering it in every decision is crucial for long-term success.
Profit doesn’t happen by itself. Look over your processes and envision how you want it all to unfold. Here are some suggested steps to consider when making your plan:
- Set a Profit Goal- Set clear targets and make a plan for how you should get there. A target profit gives your business a set of goals to work throughout the year. Consider the number of units sold with its fixed and variable cost. When it comes to expected profit, slightly underestimate rather than overestimate.
- Create a Budget- Make a detailed budget plan. Have a look at financing options for your business. Set a potential plan B in case “things” happen. Estimate just how much you perceive your business is going to spend in a certain amount of time.
- List Expenses- Be sure to write down every single expense the business makes during its operations. It lets you know where you are spending too much. Use costing sheets to track all cost associated with each product. In this way, you can calculate the gross profit.
- Calculate the Profit Margin- A margin is what keeps you in business. It is equal to the gross profit divided by the revenue and multiplied by 100. It will vary per industry, but according to The Corporate Finance Institute , a 10% net profit margin is considered average.
- Keep the Costs Down- Entrepreneurs don’t need to spend a lot of money. Find smart ways to start with less money. Set a margin that covers your costs including overhead. Make a realistic budget to help you achieve your goals.
The best way to start profit planning is to understand your business goals. Then make a detailed budget plan based on those goals. List down the income and expenses and keep your costs down as much as possible. The higher the profit margin, the more it can sustain your business and put you on the road to success.
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About the author
Eric Dickmann is the Founder / CMO of The Five Echelon Group, host of the weekly podcast "The Virtual CMO" and YouTube series "Work-Life" and a fractional CMO for a variety of small and midsize companies. An executive leader with over 30 years of experience in marketing, product development, and digital transformation, he has worked with large, global companies and small startups to develop and execute marketing strategies to bring innovative products to the market.
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Tim berry on business planning, starting and growing your business, and having a life in the meantime., standard business plan financials: projected profit and loss.
Continuing with my series here on standard business plan financials, all taken from my Lean Business Planning site, the Profit and Loss, also called Income Statement, is probably the most standard of all financial statements. And the projected profit and loss, or projected income (or pro-forma profit and loss or pro-forma income) is also the most standard of the financial projections in a business plan.
- It starts with Sales, which is why business people who like buzzwords will sometimes refer to sales as “the top line.”
- It then shows Direct Costs (or COGS, or Unit Costs).
- Then Gross Margin, Sales less Direct Costs.
- Then operating expenses.
- Gross margin less operating expenses is gross profit, also called EBITDA for “earnings before interest, taxes, depreciation and amortization.” I use EBITDA instead of the more traditional EBIT (earnings before interest and taxes). I explained that choice and depreciation and amortization as well in Financial Projection Tips and Traps , in the previous section.
- Then it shows depreciation, interest expenses, and then taxes…
- Then, at the very bottom, Net Profit; this is why so many people refer to net profit as “the bottom line,” which has also come to mean the conclusion, or main point, in a discussion.
The following illustration shows a simple Projected Profit and Loss for the bicycle store I’ve been using as an example. This example doesn’t divide operating expenses into categories. The format and math start with sales at the top. You’ll find that same basic layout in everything from small business accounting statements to the financial disclosures of large enterprises whose stock is traded on public markets. Companies vary widely on how much detail they include. And projections are always different from statements, because of Planning not accounting . But still this is standard.
A lean business plan will normally include sales, costs of sales, and expenses. To take it from there to a more formal projected Profit and Loss is a matter of collecting forecasts from the lean plan. The sales and costs of sales go at the top, then operating expenses. Calculating net profit is simple math.
Keep your assumptions simple. Remember our principle about planning and accounting. Don’t try to calculate interest based on a complex series of debt instruments; just average your interest over the projected debt. Don’t try to do graduated tax rates; use an average tax percentage for a profitable company.
Notice that the Profit and Loss involves only four of the Six Key Financial Terms . While a Profit and Loss Statement or Projected Profit and Loss affects the Balance Sheet because earnings are part of capital, it includes only sales, costs, expenses, and profit.
Hi, In case of bank financing for machineries and working capital, how can it be broken down in to the expense stream? ( capital + interest)
When you spend on assets is not deductible from income, and is therefore not an expense. What you spent to repay the principle of a loan is not deductible, and therefore not an expense. The interest on a loan is deductible, and is an expense.
Excuse me, may I know if the project profit & loss should plan for the first year only or for year 1-3 in business plan of a new company?
Kattie Wan, I recommend for normal cases the projected profit and loss monthly for the first 12 months, and two years annually after that. There are always special cases, though; every business is different.
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What is a Profit Plan and Why Does your Business Need One?
“It takes as much energy to wish as it does to plan.”
– Eleanor Roosevelt
Business success is not achieved just by wishing for it. Businesses need money to grow and sustain. Successful entrepreneurs know the importance of planning. Whether you are just starting a business or have been in business for decades, profit planning can help you run a successful business.
A profit plan considers how your business will earn today and how it will earn in the future. This is accomplished through setting financial business goals and planning how to reach them. Specifically, these plans can help establish a baseline to measure success, use data to make sound management decisions, and educate employees. You are not required to have a complicated profit plan; you simply need a couple of goals to get started. The crucial part is ensuring these goals are written down, monitored, and implemented in your business. There are several different ways that businesses can plan for profit. One way is to increase revenue by offering new or improved products or services, expanding into new markets, or implementing effective marketing and sales strategies. Another way to plan for profit is to reduce expenses. This can be accomplished by streamlining operations, negotiating better deals with suppliers, or finding more efficient ways of doing things. It is essential to consider the cost of the revenue you will be generating in your business as you create your profit plan. Business owners must know how much of each dollar is needed to produce products and provide services and for their operational capacity. This way, you can plan to scale operations to support business growth. Don’t know where to start or how to obtain this information? Have no fear; the TSBDC is here. Regardless of our consultants’ areas of expertise, helping you increase your profits is something we all do.
Once the data is gathered, next is setting clear, measurable goals. These goals should be specific, attainable, and aligned with the overall vision and mission of the business. For example, a business might set a goal to increase profits by 10% over the next year by expanding into a new market and launching a new product line. Some other questions to consider when creating a profit plan include: How many items/services will I need to sell to achieve my goal? What are my fixed and variable costs associated with a product and/or service? Which products have the most profitability? The least? What is my operational capacity? What does my cash flow look like month-to-month? How much should I charge for my products and services?
So, you have set your goals; what’s next? Now you need to create a plan for achieving these goals. This plan should include specific strategies and actions that will be taken to reach the goals. For example, a goal to expand into a new market might consist of conducting market research, developing a marketing plan, and setting up a distribution network. Guess what? The TSBDC can help with this process too.
Another important aspect of planning for profit is monitoring and evaluating progress regularly. This can be done by tracking key performance indicators (KPIs) such as revenue, expenses, and profit margin. By regularly reviewing these metrics, businesses can identify areas where they must catch up to their goals and adjust as needed. Some of our most successful clients meet with our consultants monthly, quarterly, or semi-annually to discuss, plan, set goals, and monitor progress using data and benchmarking tools.
It is vital to involve all relevant stakeholders in the planning and implementation processes, including management, employees, and shareholders. This ensures everyone is on the same page and working towards the same goals. It is also essential to be realistic and flexible in the planning process. Plans should be based on reliable data and realistic assumptions and adjusted as needed in response to changing market conditions. Communication of the profit plan with all stakeholders is vital, so everyone understands their role in achieving the goals.
In conclusion, profit planning is essential for the success of any business. By setting clear goals, creating a plan to achieve them, and regularly monitoring and evaluating progress, businesses can increase their chances of generating profits and achieving long-term growth and sustainability. Remember, entrepreneurs; you do not have to go it alone. Our teams of experts at the TSBDC are excited to help you with profit planning and any of your other business needs.
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What is Profit Planning?
Profit planning can be defined as setting a number of actions that need to be taken in order to achieve a targeted amount of profit for your firm.
Learning about profit planning is very useful for every industry, including architecture.
And while great design seems like the most important thing for us architects, all businesses need to be profitable to survive.
In fact , 20% of new businesses fail during the first 2 years, followed by 45% during the first 5 and 65% during the first 10 years.
On that note, problems with the business plan and lack of financing are some of the main reasons that lead to failure .
All of this might seem a bit overwhelming at first, but don't worry.
We are here to help you understand the basics of profit planning.
What is Profit?
Profit is a financial gain that equals the difference between the amount earned and the amount spent on operational costs.
Your architecture firm’s profit is the amount you have left after covering all company expenses.
Profits are required so that your firm can provide employee bonuses, fund capital expenditures, and make new investments.
Typically, you won't know your exact profit until your tax return is completed.
However, by including profit planning into your business plan you can predict how much you are likely to earn.
“Profit is a requirement for business. It's not a dirty word. You’re not taking advantage of your client if you're profitable. It's a requirement to do what you're doing. In fact, it's the reward for doing your job really well and serving your clients really well.”
- Mark LePage, Entrearchitect on How to Build a Successful Architecture Firm
What is profit planning and why is it important.
The goal of profit planning is to set a profit objective for a budgeting period.
The actual process of profit planning involves making certain management decisions beforehand in order to help your firm earn more profit.
For example , you can decide to expand the range of services your firm provides in order to gain more profit.
This could mean offering additional services like feasibility study or FF&E, instead of providing the basic architectural services .
Profit Planning Helps Your Firm Stay on Track
Your profit plan will not only tell you how your firm currently earns profit, but it will also give you a roadmap to follow for future growth.
“The first step is figuring out where you want to go. If you don't have a map, you'll never get there. You'll just keep driving around in circles. The second step after you know where you want to go is to understand the basics. It doesn't have to be super difficult. That business plan could be on one page. The same thing with your financial management plan.”
Imagine that you successfully reached your profit goals for the previous year by following your profit plan.
Now, you can take a step back and use that data to understand which decisions had the largest impact on your profitability.
For example , let’s say that one larger project brought you far more profit than several small projects which also took more of your time.
With this in mind, you will know that prioritizing large projects can bring your firm more profit.
Profit Planning Provides Answers About Your Business
When creating your first business plan, you need to ask yourself these 3 questions:
- What are your initial business goals?
- How much do you need to earn to break even?
- Would you rather start strong or grow year after year?
The good news is - all of this can be answered with profit planning.
For example , you can find out how much you need to earn to break even by calculating all of your operational costs for the year.
That way you will know the amount your firm needs to earn to cover those expenses.
Or, you can calculate the amount that you will need to earn in the next few budgeting periods to see whether your plan for growth is realistic.
Profit Planning Lets You Put People First
Most of the time, we’re so focused on delivering great designs to our clients that we forget about our team members who work really hard on those great designs.
But in order to take care of your employees, you need to make enough profit to actually invest in them.
Having a profit plan in place allows you to allocate money into training and education for your team members. It then not only helps them grow their career, but it also helps your firm to have employees who want to stay and learn.
“But what needs to change is that for that company to remain in an architectural field or profession, for that organization to thrive and make enough profit to invest in their people, get them more vacation time and all the things that they want, the learning and education on the side so they can continue to grow, that company has to care for their people.”
- Randy Deutsch FAIA, University of Illinois on How to Think and Adapt like an Architect
4 easy steps to get started on profit planning.
We covered 3 big reasons why profit planning is important for your architecture firm.
Now, let’s take a look at these 4 steps that you can take to start planning your profit.
1 - Set Your Profit Goal
Set a clear target for your annual profit and a few objectives that you need to fulfill through the year.
How much would you like to make in a year?
Then you can set monthly or quarterly profit goals.
This way, you can have a more realistic idea of how much work needs to get done in that period for these objectives to be met.
It’s always better to slightly underestimate rather than overestimate your expected profit.
2 - Make a List of Your Expenses
Getting into detail is the key to successful profit planning.
So, be sure to write down all the operational expenses of your business.
This means that you need to calculate your direct labor costs and overhead costs.
These costs include the annual salaries for your employees and all additional expenses such as software, rent and utilities.
This way, you can know if you are spending more than the estimated budget allows you to.
If that's the case, you can either cut down on costs or adjust your price model.
You can usually do this easily in a profit and loss statement .
3 - Calculate Your Profit Margin
A profit margin is the amount by which the revenue from your services exceeds the costs of the firm.
Your profit margin is really important, since it keeps your business alive.
The average net profit margin across different industries is 7.71%.
However, most Architecture firms have only around 6% profitability.
You can calculate your net profit margin using this formula:
(Net profit ÷ Revenue) x 100 = Net profit margin
This will help you understand how much you need to increase your revenue or lower your costs to keep the desired profit margin.
4 - Visualize Your Profitability
At Monograph, we know how difficult it can be to understand financial data.
This is why our project management software now includes a feature that can help you visualize your profitability.
Planned Profit Report can let you see your profit month by month based on all the projects across your firm.
This way, you can see your profits from the past to the future on a report and understand when and where you need to intervene.
The software lets you filter your profitability based on the status of your firm’s projects (active, proposals, etc.) and the phase fee types.
On the other hand, Profit Drivers lets you see which projects, team members, phases and clients drive your profitability.
So you can make good decisions that drive good profit.
Having all of this data shown in the form of simple graphs can help you learn how to improve your firm’s financial health, without having a degree in finance.
If you want to take control of your profitability, get started with Monograph today.
3 Advantages of Profit Planning
As we mentioned earlier, profit planning will provide you with an efficient way to set and achieve your profit goals.
However, it brings even more advantages for your firm.
1 - You Can Set Clear Objectives Across the Firm
Creating a detailed profit plan will make your business strategy much clearer for everyone involved in order to make your architecture firm profitable .
By setting a common goal, you can provide clear objectives for both owners and architects and get everyone in your firm on the same page.
Your profit planning is not only about cash in and cash out. You also want to decide which projects were most enjoyable and successful - and then plan how to get more of the same.
By having a profit plan, it will be easier for you to make informed decisions on how many and what types of projects you should pursue to achieve your financial goals.
For example , let’s say that on the Profit Drivers you can see that working on educational buildings can increase your profits.
By knowing this, you can set an objective to make more proposals for that project type. And your team can follow this goal quarter by quarter.
2 - You Can Evaluate Your Efficiency and Make the Right Changes
If you don’t set specific profit goals, you will never be sure whether your returns are satisfactory.
And in case you actually do fall short from your projections, you will probably want to know why.
To figure this out, you can evaluate your projects, teams, clients and design phases and learn what needs to be improved.
For example , schematic design is usually the phase where people burn all their fees because project teams are spending too much time iterating on concepts.
While large firms with high fees can usually get away with endless cycles of iterations to get a design right, small firms can’t.
So Adam Ruffin, Partner at ARCHITECTUREFIRM took a more straightforward design approach because they don’t have enough time or profit margin to indulge in lots of iteration.
“It does help us get to the point more quickly and start thinking about details and materiality more quickly, and start thinking about the way light moves through a space immediately rather than have to worry about the hundredth iteration being the perfect form. The building never gets done. We've failed. And we have deadlines. We have milestones and we have things to meet in a certain amount of time and for a certain amount of money.”
- Adam Ruffin, Partner at ARCHITECTUREFIRM on How To Lead Award-Winning Projects
3 - you can make smart investments.
To run a successful firm, we need to invest in marketing and business development - activities that actually drive profits.
But how do we know what we can budget in for marketing?
Tracking your profits and hours is the first step to setting a sustainable marketing budget.
“Are you profitable as a firm? And if you're not sure, that's the problem you need to solve first.
You need to make sure that the numbers are good. You need to know what's going on in your firm. You need to know how much billable versus non-billable hours that you and your team are putting in. And you need to know it precisely.”
- Hope Trory, Founder of HOPEWORKSDESIGN
Without a keen eye on your books, it’s impossible to manage a sustainable marketing plan worth paying for.
Are There Any Disadvantages to Profit Planning?
There are no disadvantages to profit planning.
In fact, planning profit is definitely useful for both larger and smaller businesses and architecture firms.
However, remember that there are limits on what can be accomplished.
You should know that the effectiveness of the planning process is only as good as the data you use.
Incorrect or incomplete data regarding your firm's expenses and gains will not provide you with correct results.
Keep this in mind while working on your profit plan to get the best results.
Are You Profit Planning?
To sum it up, profit planning can definitely help your practice stay on track.
It can also bring many additional advantages for your firm.
To profit plan more effectively, get started with Monograph today.
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How to Forecast Profits for a Business Plan
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- For Profit Businesses
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The Role of Finance in Formulating Business Strategies
How do changes in the business environment affect the cost and profit analysis, how to calculate budgeted revenue.
- How to Estimate Revenue & Net Income of a Company Based on Previous Financials
- Factors That Influence Contingency Planning
The goal of every small-business owner is to make a profit and hopefully earn greater profits each year. The company’s business plan describes the actions the company’s management team intends to take to generate sales and keep expenditures at reasonable levels so the net result is a profit.
The financial forecast is the numerical expression of the strategies described in the business plan, showing the revenues the company expects to generate, minus the costs of generating the revenues and operating the business, to arrive at profits.
Analyze the Marketplace
In the planning process, the business owner develops assumptions regarding the economic and competitive environments he expects the company will be operating in over the time horizon the plan addresses. This could be one year or three to five years. These assumptions shape the forecasting process.
If he believes competition will intensify for example, he may increase his marketing budget so his company will not lose market share to current or new competitors. He would also keep his revenue forecast conservative, reflecting that it may be difficult to acquire new customers.
Build Revenue Models
With the assumptions in place, the next step is to construct financial models and forecast revenues. These models can be most easily created using spreadsheet software, or you can purchase and use a small-business accounting software program, explains NOLO.com . The business owner builds formulas that depict the steps involved in making a sale. He then creates assumptions for each of the variables in the formulas.
Using spreadsheet software allows him to vary the assumptions and see how this affects revenues. His goal is to reach the point he is confident his revenue projections are reasonable and attainable.
Project Marketing Costs
For many small businesses, the marketing budget is one of the largest categories of expense. Marketing costs can be difficult to forecast because they are discretionary -- the business owner can elect to spend more or less on advertising in the upcoming year for example. The company’s marketing strategies are broken down into specific steps or tasks that must be completed to implement them.
The cost of each of these steps must be estimated carefully so that the overall marketing plan shows what actually must be spent to implement the strategies and achieve the company’s revenue goals. Inaccurate estimates of marketing costs results in a profit shortfall relative to plan – the company will end up spending more for marketing than was incorporated in the forecast.
Forecast Operating Costs
The business plan specifies other actions the company intends to take, such as hiring additional staff and opening additional retail locations. The cost of these are estimated and included in the expense forecast in the business plan. Accurate expense projections are so important, Entrepreneur magazine recommends forecasting them first .
A challenge faced by a small business owner is making sure he has sufficient staff to support the business activity he forecasts in the revenues section of the plan. If his staff level is inadequate, customer service can fall below acceptable levels and workloads may be so high that employee morale suffers.
Review, Discuss and Adjust
The revenue and expense forecasts are combined to reveal the projected profit forecast for the company. The forecasting process is not over at this point. The business owner and his management team must go over the entire financial plan and make adjustments where necessary.
The first draft of the forecast may show profits that are lower than the business owner had expected. He may decide to trim certain operating costs to produce a healthier bottom line. Cost cutting in a budget must be done thoughtfully, because marketing expenditures, for example, help drive revenue growth.
- NOLO: Basic Profit and Loss Forecast
- Entrepreneur: How to Forecast Revenue and Growth
What is a revenue model, how to put a business plan in motion, how to make a projected sales budget, the purpose of analytical business reports, developing a financial plan for a small business, advantages & disadvantages of a rolling budget, the importance of revenue variances, how to write a department business plan, how to do income statement projections with historical data, most popular.
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What Is a Business Model?
Understanding business models, evaluating successful business models, how to create a business model.
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The Bottom Line
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Investopedia / Laura Porter
The term business model refers to a company's plan for making a profit . It identifies the products or services the business plans to sell, its identified target market , and any anticipated expenses . Business models are important for both new and established businesses. They help new, developing companies attract investment, recruit talent, and motivate management and staff.
Established businesses should regularly update their business model or they'll fail to anticipate trends and challenges ahead. Business models also help investors evaluate companies that interest them and employees understand the future of a company they may aspire to join.
- A business model is a company's core strategy for profitably doing business.
- Models generally include information like products or services the business plans to sell, target markets, and any anticipated expenses.
- There are dozens of types of business models including retailers, manufacturers, fee-for-service, or freemium providers.
- The two levers of a business model are pricing and costs.
- When evaluating a business model as an investor, consider whether the product being offer matches a true need in the market.
A business model is a high-level plan for profitably operating a business in a specific marketplace. A primary component of the business model is the value proposition . This is a description of the goods or services that a company offers and why they are desirable to customers or clients, ideally stated in a way that differentiates the product or service from its competitors.
A new enterprise's business model should also cover projected startup costs and financing sources, the target customer base for the business, marketing strategy , a review of the competition, and projections of revenues and expenses. The plan may also define opportunities in which the business can partner with other established companies. For example, the business model for an advertising business may identify benefits from an arrangement for referrals to and from a printing company.
Successful businesses have business models that allow them to fulfill client needs at a competitive price and a sustainable cost. Over time, many businesses revise their business models from time to time to reflect changing business environments and market demands .
When evaluating a company as a possible investment, the investor should find out exactly how it makes its money. This means looking through the company's business model. Admittedly, the business model may not tell you everything about a company's prospects. But the investor who understands the business model can make better sense of the financial data.
A common mistake many companies make when they create their business models is to underestimate the costs of funding the business until it becomes profitable. Counting costs to the introduction of a product is not enough. A company has to keep the business running until its revenues exceed its expenses.
One way analysts and investors evaluate the success of a business model is by looking at the company's gross profit . Gross profit is a company's total revenue minus the cost of goods sold (COGS). Comparing a company's gross profit to that of its main competitor or its industry sheds light on the efficiency and effectiveness of its business model. Gross profit alone can be misleading, however. Analysts also want to see cash flow or net income . That is gross profit minus operating expenses and is an indication of just how much real profit the business is generating.
The two primary levers of a company's business model are pricing and costs. A company can raise prices, and it can find inventory at reduced costs. Both actions increase gross profit. Many analysts consider gross profit to be more important in evaluating a business plan. A good gross profit suggests a sound business plan. If expenses are out of control, the management team could be at fault, and the problems are correctable. As this suggests, many analysts believe that companies that run on the best business models can run themselves.
When evaluating a company as a possible investment, find out exactly how it makes its money (not just what it sells but how it sells it). That's the company's business model.
Types of Business Models
There are as many types of business models as there are types of business. For instance, direct sales, franchising , advertising-based, and brick-and-mortar stores are all examples of traditional business models. There are hybrid models as well, such as businesses that combine internet retail with brick-and-mortar stores or with sporting organizations like the NBA .
Below are some common types of business models; note that the examples given may fall into multiple categories.
One of the more common business models most people interact with regularly is the retailer model. A retailer is the last entity along a supply chain. They often buy finished goods from manufacturers or distributors and interface directly with customers.
Example: Costco Wholesale
A manufacturer is responsible for sourcing raw materials and producing finished products by leveraging internal labor, machinery, and equipment. A manufacturer may make custom goods or highly replicated, mass produced products. A manufacturer can also sell goods to distributors, retailers, or directly to customers.
Example: Ford Motor Company
Instead of selling products, fee-for-service business models are centered around labor and providing services. A fee-for-service business model may charge by an hourly rate or a fixed cost for a specific agreement. Fee-for-service companies are often specialized, offering insight that may not be common knowledge or may require specific training.
Example: DLA Piper LLP
Subscription-based business models strive to attract clients in the hopes of luring them into long-time, loyal patrons. This is done by offering a product that requires ongoing payment, usually in return for a fixed duration of benefit. Though largely offered by digital companies for access to software, subscription business models are also popular for physical goods such as monthly reoccurring agriculture/produce subscription box deliveries.
Freemium business models attract customers by introducing them to basic, limited-scope products. Then, with the client using their service, the company attempts to convert them to a more premium, advance product that requires payment. Although a customer may theoretically stay on freemium forever, a company tries to show the benefit of what becoming an upgraded member can hold.
Example: LinkedIn/LinkedIn Premium
Some companies can reside within multiple business model types at the same time for the same product. For example, Spotify (a subscription-based model) also offers free version and a premium version.
If a company is concerned about the cost of attracting a single customer, it may attempt to bundle products to sell multiple goods to a single client. Bundling capitalizes on existing customers by attempting to sell them different products. This can be incentivized by offering pricing discounts for buying multiple products.
Marketplaces are somewhat straight-forward: in exchange for hosting a platform for business to be conducted, the marketplace receives compensation. Although transactions could occur without a marketplace, this business models attempts to make transacting easier, safer, and faster.
Affiliate business models are based on marketing and the broad reach of a specific entity or person's platform. Companies pay an entity to promote a good, and that entity often receives compensation in exchange for their promotion. That compensation may be a fixed payment, a percentage of sales derived from their promotion, or both.
Example: social media influencers such as Lele Pons, Zach King, or Chiara Ferragni.
Aptly named after the product that invented the model, this business model aims to sell a durable product below cost to then generate high-margin sales of a disposable component of that product. Also referred to as the "razor and blade model", razor blade companies may give away expensive blade handles with the premise that consumers need to continually buy razor blades in the long run.
Example: HP (printers and ink)
"Tying" is an illegal razor blade model strategy that requires the purchase of an unrelated good prior to being able to buy a different (and often required) good. For example, imagine Gillette released a line of lotion and required all customers to buy three bottles before they were allowed to purchase disposable razor blades.
Reverse Razor Blade
Instead of relying on high-margin companion products, a reverse razor blade business model tries to sell a high-margin product upfront. Then, to use the product, low or free companion products are provided. This model aims to promote that upfront sale, as further use of the product is not highly profitable.
Example: Apple (iPhones + applications)
The franchise business model leverages existing business plans to expand and reproduce a company at a different location. Often food, hardware, or fitness companies, franchisers work with incoming franchisees to finance the business, promote the new location, and oversee operations. In return, the franchisor receives a percentage of earnings from the franchisee.
Example: Domino's Pizza
Instead of charging a fixed fee, some companies may implement a pay-as-you-go business model where the amount charged depends on how much of the product or service was used. The company may charge a fixed fee for offering the service in addition to an amount that changes each month based on what was consumed.
Example: Utility companies
A brokerage business model connects buyers and sellers without directly selling a good themselves. Brokerage companies often receive a percentage of the amount paid when a deal is finalized. Most common in real estate, brokers are also prominent in construction/development or freight.
There is no "one size fits all" when making a business model. Different professionals may suggest taking different steps when creating a business and planning your business model. Here are some broad steps one can take to create their plan:
- Identify your audience. Most business model plans will start with either defining the problem or identifying your audience and target market . A strong business model will understand who you are trying to target so you can craft your product, messaging, and approach to connecting with that audience.
- Define the problem. In addition to understanding your audience, you must know what problem you are trying to solve. A hardware company sells products for home repairs. A restaurant feeds the community. Without a problem or a need, your business may struggle to find its footing if there isn't a demand for your services or products.
- Understand your offerings. With your audience and problem in mind, consider what you are able to offer. What products are you interested in selling, and how does your expertise match that product? In this stage of the business model, the product is tweaked to adapt to what the market needs and what you're able to provide.
- Document your needs. With your product selected, consider the hurdles your company will face. This includes product-specific challenges as well as operational difficulties. Make sure to document each of these needs to assess whether you are ready to launch in the future.
- Find key partners. Most businesses will leverage other partners in driving company success. For example, a wedding planner may forge relationships with venues, caterers, florists, and tailors to enhance their offering. For manufacturers, consider who will provide your materials and how critical your relationship with that provider will be.
- Set monetization solutions. Until now, we haven't talked about how your company will make money. A business model isn't complete until it identifies how it will make money. This includes selecting the strategy or strategies above in determining your business model type. This might have been a type you had in mind but after reviewing your clients needs, a different type might now make more sense.
- Test your model. When your full plan is in place, perform test surveys or soft launches. Ask how people would feel paying your prices for your services. Offer discounts to new customers in exchange for reviews and feedback. You can always adjust your business model, but you should always consider leveraging direct feedback from the market when doing so.
Instead of reinventing the wheel, consider what competing companies are doing and how you can position yourself in the market. You may be able to easily spot gaps in the business model of others.
Criticism of Business Models
Joan Magretta, the former editor of the Harvard Business Review, suggests there are two critical factors in sizing up business models. When business models don't work, she states, it's because the story doesn't make sense and/or the numbers just don't add up to profits. The airline industry is a good place to look to find a business model that stopped making sense. It includes companies that have suffered heavy losses and even bankruptcy .
For years, major carriers such as American Airlines, Delta, and Continental built their businesses around a hub-and-spoke structure , in which all flights were routed through a handful of major airports. By ensuring that most seats were filled most of the time, the business model produced big profits.
However, a competing business model arose that made the strength of the major carriers a burden. Carriers like Southwest and JetBlue shuttled planes between smaller airports at a lower cost. They avoided some of the operational inefficiencies of the hub-and-spoke model while forcing labor costs down. That allowed them to cut prices, increasing demand for short flights between cities.
As these newer competitors drew more customers away, the old carriers were left to support their large, extended networks with fewer passengers. The problem became even worse when traffic fell sharply following the September 11 terrorist attacks in 2001 . To fill seats, these airlines had to offer more discounts at even deeper levels. The hub-and-spoke business model no longer made sense.
Example of Business Models
Consider the vast portfolio of Microsoft. Over the past several decades, the company has expanded its product line across digital services, software, gaming, and more. Various business models, all within Microsoft, include but are not limited to:
- Productivity and Business Processes: Microsoft offers subscriptions to Office products and LinkedIn. These subscriptions may be based off product usage (i.e. the amount of data being uploaded to SharePoint).
- Intelligent Cloud: Microsoft offers server products and cloud services for a subscription. This also provide services and consulting.
- More Personal Computing: Microsoft sells physically manufactured products such as Surface, PC components, and Xbox hardware. Residual Xbox sales include content, services, subscriptions, royalties, and advertising revenue.
A business model is a strategic plan of how a company will make money. The model describes the way a business will take its product, offer it to the market, and drive sales. A business model determines what products make sense for a company to sell, how it wants to promote its products, what type of people it should try to cater to, and what revenue streams it may expect.
What Is an Example of a Business Model?
Best Buy, Target, and Walmart are some of the largest examples of retail companies. These companies acquire goods from manufacturers or distributors to sell directly to the public. Retailers interface with their clients and sell goods, though retails may or may not make the actual goods they sell.
What Are the Main Types of Business Models?
Retailers and manufacturers are among the primary types of business models. Manufacturers product their own goods and may or may not sell them directly to the public. Meanwhile, retails buy goods to later resell to the public.
How Do I Build a Business Model?
There are many steps to building a business model, and there is no single consistent process among business experts. In general, a business model should identify your customers, understand the problem you are trying to solve, select a business model type to determine how your clients will buy your product, and determine the ways your company will make money. It is also important to periodically review your business model; once you've launched, feel free to evaluate your plan and adjust your target audience, product line, or pricing as needed.
A company isn't just an entity that sells goods. It's an ecosystem that must have a plan in plan on who to sell to, what to sell, what to charge, and what value it is creating. A business model describes what an organization does to systematically create long-term value for its customers. After building a business model, a company should have stronger direction on how it wants to operate and what its financial future appears to be.
Harvard Business Review. " Why Business Models Matter ."
Bureau of Transportation Statistics. " Airline Travel Since 9/11 ."
Microsoft. " Annual Report 2021 ."
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Run » finance, concerned about your business's financial health here are 6 methods for measuring profitability.
Track your business’s profitability and overall financial health with these six useful methods.
A business’s financial health is determined by various factors, one of which being the amount of profit generated. That’s why it’s so important for business owners to understand their current, past, and future profitability.
Here’s why profitability matters so much, especially for small businesses, and how you can effectively measure yours.
What is profitability?
Profitability is the ratio between a business’s income and its expenses. A business determines its income by calculating the money the business generates through its operations and activities. A business determines its expenses by calculating the number of resources (money, time, and inventory) consumed during the course of its operations.
Leaders can use this data to determine their business’s profitability through an income statement. An income statement is a report detailing a business’s income and expenses during a particular accounting period.
To measure future profitability, a business may use a pro forma income statement, which measures income and expenses for an upcoming accounting period. Some businesses may generate project income statements to determine the profitability of a particular business change or upcoming business project.
[Read more: How to Calculate Small Business Profit ]
Business managers and owners should keep a close eye on their gross profit margin ratio to ensure it stays stable over time.
Ways to measure profitability
Businesses can measure how profitable they are with a few different types of financial calculations.
Gross profit margin ratio
A gross profit margin ratio is vital information as it analyzes a business’s money flow. To first calculate your gross profit, subtract the cost of goods sold (COGS) from net sales. Next, calculate the gross profit margin ratio by dividing your gross profit by net sales, then multiplying that number by 100.
Business managers and owners should keep a close eye on their gross profit margin ratio to ensure it stays stable over time. The ratio should only fluctuate when pricing policies or the price of goods changes.
Operating profit margin ratio
An operating profit margin ratio illustrates a business’s earning potential from its current operations. You can calculate your operating profit margin ratio by dividing operating income by net sales, then multiplying that number by 100.
A healthy operating profit margin ratio is one that increases from one accounting period to the next. Businesses use this profitability measurement to calculate their competitive position within an industry.
Net profit margin ratio
A net profit margin ratio calculates the amount of profit a business can extract from its total revenue stream. To calculate, divide net income by net sales, then multiply that number by 100 to create a ratio.
Each industry has a different average net profit margin ratio, so business owners should compare their business’s net profit margin ratio to the industry average to assess yearly performance. A net profit margin is different from an operating profit margin ratio because it accounts for earnings after taxes.
A break-even analysis involves determining the point at which a business’s revenues equal expenses. To calculate, a business will need to determine its fixed expenses, variable expenses, and sales. A variable expense is an expense that fluctuates based on sales numbers. The break-even point is when sales equal fixed expenses plus variable expenses.
The break-even point can be expressed in either dollar amounts or units sold and is useful in determining how your business will react when sales slump. This method is incredibly valuable when planning for a business’s future.
[Read more: How These Innovation Driven Startups Reached Profitability ]
Return on assets
A return on assets measurement demonstrates the comparison between assets and revenue. The higher the number, the more efficient the business. To calculate your return on assets, divide net income before taxes by total assets, then multiply that number by 100.
Return on investment
Return on investment allows a business owner to determine if the financial benefit of a project or investment is worth the initial and ongoing expenses. If you will ultimately spend more money than you’ll earn, the venture may not be worth it. To determine a business’s return on investment, divide net profit before taxes by net worth.
No matter which metrics you use to determine your overall profitability, it’s essential to be consistent about tracking your business’s financial performance and health. The sooner you can identify potential problems and negative trends, the sooner you can take action to get back on track.
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Whole Farm > Financial > Statements
Updated August, 2019 File C3-24
Profitability is the primary goal of all business ventures. Without profitability the business will not survive in the long run. So measuring current and past profitability and projecting future profitability is very important.
Profitability is measured with income and expenses. Income is money generated from the activities of the business. For example, if crops and livestock are produced and sold, income is generated. However, money coming into the business from activities like borrowing money do not create income. This is simply a cash transaction between the business and the lender to generate cash for operating the business or buying assets.
Expenses are the cost of resources used up or consumed by the activities of the business. For example, seed corn is an expense of a farm business because it is used up in the production process. Resources, such as a machine whose useful life is more than one year are used up over a period of years. Repayment of a loan is not an expense, it is merely a cash transfer between the business and the lender.
Profitability is measured with an "income statement". This is essentially a listing of income and expenses during a period of time (usually a year) for the entire business. Information File Your Farm Income Statement includes - a simple income statement analysis. An Income Statement is traditionally used to measure profitability of the business for the past accounting period. However, a "pro forma income statement" measures projected profitability of the business for the upcoming accounting period. A budget may be used when you want to project profitability for a particular project or a portion of a business.
Reasons for Computing Profitability
Whether you are recording profitability for the past period or projecting profitability for the coming period, measuring profitability is the most important measure of the success of the business. A business that is not profitable cannot survive. Conversely, a business that is highly profitable has the ability to reward its owners with a large return on their investment.
Increasing profitability is one of the most important tasks of business managers. Managers constantly look for ways to change the business to improve profitability. These potential changes can be analyzed with a pro forma income statement or a Partial Budget . Partial budgeting allows you to assess the impact on profitability of a small or incremental change in the business before it is implemented.
A variety of Profitability Ratios (Decision Tool) can be used to assess the financial health of a business. These ratios, created from the income statement, can be compared with industry benchmarks. Also, Five-Year Trend for Farm Financial Measures (Decision Tool) can be tracked over a period of years to identify emerging problems.
Cash Method of Accounting Traditionally farmers have used the “cash method” of accounting where income and expenses are reported on the income statement when products are sold or inputs are paid for. The cash method of accounting, used by most farmers, counts an item as an expense when it is purchased, not when it is used in the business. This has been used as a method of managing tax liability from year to year. However, many non-farm business accounting systems count an item as an expense only when it is actually used in the business activities.
However, net income can be distorted with the cash method of accounting by selling more than two years crops in one year, selling feeder livestock purchased in a previous year, and purchasing production inputs in the year before they are needed.
Accrual Method of Accounting To provide a more accurate picture of profitability, the accrual method of accounting can be used. With this method, income is reported when products are produced (not when they are sold) and expenses are reported when inputs are used (not when they are purchased). Accrual accounting uses the traditional cash method of accounting during the year but adds or subtracts inventories of farm products and production inputs on hand at the beginning and ending of the year.
A worksheet for computing Net Farm Income Statement (Decision Tool) with accrual accounting is available that allows you to prepare an accrual net income statement from income tax schedules and net worth statements. Information on creating and using a Net Farm Income Statement is also available.
Although seldom used in farming, Double Entry Accounting (Information File Understanding Double Entry Accounting ) will provide results similar to accrual accounting. Double entry accounting also updates the net worth statement every time an income or expense occurs.
Profitability can be defined as either accounting profits or economic profits.
Accounting Profits (Net Income) Traditionally, farm profits have been computed by using “accounting profits”. To understand accounting profits, think of your income tax return. Your Schedule F provides a listing of your taxable income and deductible expenses. These are the same items used in calculating accounting profits. However, your tax statement may not give you an accurate picture of profitability due to IRS rapid depreciation and other factors. To compute an accurate picture of profitability you may want to use a more accurate measure of depreciation.
Accounting profits provide an intermediate view of the viability of your business. Although one year of losses may not permanently harm your business, consecutive years of losses (or net income insufficient to cover living expenditures) may jeopardize the viability of your business.
Economic Profits In addition to deducting business expenses, opportunity costs are also deducted when computing “economic profits”. Opportunity costs relate to your money (net worth), your labor and your management ability. If you were not farming, you would have your money invested elsewhere and be employed in a different career. Opportunity cost is the investment returns given up by not having your money invested elsewhere and wages given up by not working elsewhere. These are deduced, along with ordinary business expenses, in calculating economic profit.
Economic profits provide a long-term perspective of your business. If you can consistently generate a higher level of personal income by using your money and labor elsewhere, you may want to examine whether you want to continue farming.
Profitability is not Cash Flow
People often mistakenly believe that a profitable business will not encounter cash flow problems. Although closely related, profitability and cash flow are different. An income statement lists income and expenses while the cash flow statement lists cash inflows and cash outflows. An income statement shows profitability while a cash flow statement shows liquidity .
Many income items are also cash inflows. The sale of crops and livestock are usually both income and cash inflows. The timing is also usually the same (cash method of accounting) as long as a check is received and deposited in your account at the time of the sale. Many expense items are also cash outflow items. The purchase of livestock feed is both an expense and a cash outflow item. The timing is also the same (cash method of accounting) if a check is written at the time of purchase.
However, there are many cash items that are not income and expense items, and vice versa. For example, the purchase of a tractor is a cash outflow if you pay cash at the time of purchase as shown in the example in Table 2. If money is borrowed for the purchase using a term loan, the down payment is a cash outflow at the time of purchase and the annual principal and interest payments are cash outflows each year as shown in Table 3.
The tractor is a capital asset and has a life of more than one year. It is included as an expense item in an income statement by the amount it declines in value due to wear and obsolescence. This is called “depreciation”. The depreciation expense is listed every year. In the tables below a $70,000 tractor is depreciated over seven years at the rate of $10,000 per year.
Depreciation calculated for income tax purposes can be used. However, to accurately calculate net income, a more realistic depreciation amount should be used to approximate the actual decline in the value of the machine during the year.
In Table 3, where the purchase is financed, the amount of interest paid on the loan is included as an expense, along with depreciation, because interest is the cost of borrowing money. However, the principal payments are not an expense but merely a cash transfer between you and your lender.
Other Financial Statements
An income statement is only one of several financial statements that can be used to measure the financial strength of a business. Other common statements include the balance sheet or net worth statement and the cash flow statement, although there are several other statements that may be included.
These statements fit together to form a comprehensive financial picture of the business. The balance sheet or Net Worth Statement shows the solvency of the business at a specific point in time. Statements are often prepared at the beginning and ending of the accounting period (i.e. January 1). The statement records the assets of the business and their value and the liabilities or financial claims against the business (i.e. debts). The amount by which assets exceed liabilities is the net worth of the business. The net worth reflects the amount of ownership of the business by the owners.
The Cash Flow Statement is also a dynamic statement that records the flow of cash into and out of the business during the accounting period. A positive (negative) cash flow will increase (decrease) the working capital of the business. Working capital is defined as the amount of money used to facilitate business operations and transactions. It is calculated as current assets (cash or near cash assets) less current liabilities (liabilities due during the upcoming accounting period – i.e. year).
A Complete set of Financial Statements (Decision Tool), including the beginning and ending net worth statements, the income statement, the cash flow statement, the statement of owner equity and the financial performance measures is available to do a comprehensive financial analysis of your business. A hand worksheet version of the Decision Tool is also available.
Ann M. Johanns
Extension program specialist 515-337-2766 view more from this author, originally prepared by, don hofstrand, retired extension agricultural business specialist view more from this author, use this decision tool to calculate a comprehensive set of financial statements including the beginning and ending net worth statements, the income statement, the cash-flow statement, the statement of owner equity, and the financial performance measures. also available as an example of farm financial statements ., worksheet prepares an accrual net income statement from income tax schedules and net worth statements..
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How to Write a Winning Business Plan
- Stanley R. Rich
- David E. Gumpert
The business plan admits the entrepreneur to the investment process. Without a plan furnished in advance, many investor groups won’t even grant an interview. And the plan must be outstanding if it is to win investment funds. Too many entrepreneurs, though, continue to believe that if they build a better mousetrap, the world will beat […]
The Idea in Brief
You’ve got a great idea for a new product or service—how can you persuade investors to support it? Flashy PowerPoint slides aren’t enough; you need a winning business plan. A compelling plan accurately reflects the viewpoints of your three key constituencies: the market , potential investors , and the producer (the entrepreneur or inventor of the new offering).
But too many plans are written solely from the perspective of the producer. The problem is that, unless you’ve got your own capital to finance your venture, the only way you’ll get the funding you need is to satisfy the market’s and investors’ needs.
Here’s how to grab their attention.
The Idea in Practice
Emphasize Market Needs
To make a convincing case that a substantial market exists, establish market interest and document your claims.
Establish market interest. Provide evidence that customers are intrigued by your claims about the benefits of the new product or service:
- Let some customers use a product prototype; then get written evaluations.
- Offer the product to a few potential customers at a deep discount if they pay part of the production cost. This lets you determine whether potential buyers even exist.
- Use “reference installations”—statements from initial users, sales reps, distributors, and would-be customers who have seen the product demonstrated.
Document your claims. You’ve established market interest. Now use data to support your assertions about potential growth rates of sales and profits.
- Specify the number of potential customers, the size of their businesses, and the size that is most appropriate to your offering. Remember: Bigger isn’t necessarily better; e.g., saving $10,000 per year in chemical use may mean a lot to a modest company but not to a Du Pont.
- Show the nature of the industry; e.g., franchised weight-loss clinics might grow fast, but they can decline rapidly when competition stiffens. State how you will continually innovate to survive.
- Project realistic growth rates at which customers will accept—and buy—your offering. From there, assemble a credible sales plan and project plant and staffing needs.
Address Investor Needs
Cashing out. Show when and how investors may liquidate their holdings. Venture capital firms usually want to cash out in three to seven years; professional investors look for a large capital appreciation.
Making sound projections. Give realistic, five-year forecasts of profitability. Don’t skimp on the numbers, get overly optimistic about them, or blanket your plan with a smog of figures covering every possible variation.
The price. To figure out how much to invest in your offering, investors calculate your company’s value on the basis of results expected five years after they invest. They’ll want a 35 to 40% return for mature companies—up to 60% for less mature ventures. To make a convincing case for a rich return, get a product in the hands of representative customers—and demonstrate substantial market interest.
A comprehensive, carefully thought-out business plan is essential to the success of entrepreneurs and corporate managers. Whether you are starting up a new business, seeking additional capital for existing product lines, or proposing a new activity in a corporate division, you will never face a more challenging writing assignment than the preparation of a business plan.
- SR Mr. Rich has helped found seven technologically based businesses, the most recent being Advanced Energy Dynamics Inc. of Natick, Massachusetts. He is also a cofounder and has been chairman of the MIT Enterprise forum, which assists emerging growth companies.
- DG Mr. Gumpert is an associate editor of HBR, where he specializes in small business and marketing. He has written several HBR articles, the most recent of which was “The Heart of Entrepreneurship,” coauthored by Howard. H. Stevenson (March–April 1985). This article is adapted from Business Plans That Win $$$ : Lessons from the MIT Enterprise Forum, by Messrs. Rich and Gumpert (Harper & Row, 1985). The authors are also founders of Venture Resource Associates of Grantham, New Hampshire, which provides planning and strategic services to growing enterprises.