In every source of words of wisdom, entrepreneurs are taught to write a business plan before they embark on starting their new business venture. This is good advice provided it is done correctly and based on realistic expectations.

The academic approach to writing a business plan typically includes conducting market research to determine the size of the potential market, characteristics of the competition and nature of the customer base. The entrepreneur usually gets in trouble when it comes to using this information to determine a revenue and profitability forecast. Taking a large potential market size and calculating the penetration needed to become profitable can lead to an unrealistic conclusion. It may seem very possible, for instance, to assume gaining 1% market share of a $100 million regional market in the first year. A first-year forecast of $1 million even looks like it would be a very conservative projection. The key question is “how?”

A much more realistic approach is to work with the things the entrepreneur knows best about his venture. Determine the answers to the basic operating questions: how much advertising money does he have to spend; how many sales people he can afford to hire; how well known is the product or service; how easy will it be to convince a customer to buy; and how often will the customer re-purchase in a year. Then do a “bottom-up” forecast of the expected revenue and expenses for the first couple of years.

• Advertising will reach the eyes of how many customers?

• Each sales person can contract how many customers each week?

• How many customers would have to be contacted before a sale is made?

• After an initial sales call, how long should it take before the customer actually places an order and pays the invoice?

• What is the average sales revenue per customer?

As an example, the start up company can only afford to hire five sales people. Each sales person can be expected to get through to 50 prospects per week for 50 weeks in the year. Of those prospects, 5% will be become customers within six months. The average customer can be expected to order $500 each year. Therefore, a bottom-up approach would calculate the first-year forecast as follows: 5 x 50 x 50 x 5% x $500 = $312,500

The main point is that a bottom-up approach will produce a much more realistic forecast than the most conservative estimate about the market share of an estimated market size. The entrepreneur and his team can argue about the advertising budget, sales calls per week, new customers added each month, increasing the order size, and so on. The bottom-up approach also forces everyone to carefully think about the strategies and the tactics that must be implemented to achieve the planning goals. Certainly these statistics should be monitored and the planning model revised accordingly as more actual results are known. More importantly, positive or negative results compared to the original assumptions will dictate the actions needed and the urgency required by the team.

Unless the company is blessed with an unlimited amount of start up capital, the entrepreneur must base his business planning on cash flow for the initial years. Uncollected receivables, sales growth, market share and “paper” profits are not going to ensure the survival of the new business. Each year 7 out of 10 new businesses fail and one of the primarily reasons is poor management of cash flow. This means that the start up may have to pass up some possible sales if those sales would take a long time to collect, and it may also have an influence marketing strategy for the product or service. Ideally the product or service has a short sales cycle (less than a month), practically sells itself (low selling costs), payment is received on delivery (account receivables less than 30 days sales), advertising is word-of-mouth and customers re-order often. If any of these are not ideal, then the cash flow requirements will likely be higher than expected. Managing for cash flow, not sales growth and profitability, is not for the long term, but it is essential until the company has accumulated a cash reserve or can attract financial backing.

Business planning provides the initial roadmap to the future for the new start up company, but it must be modified and revised periodically if it is to be of any real value as a management tool. Day-to-day, the entrepreneur will have to make decisions rapidly based on his knowledge, gut-feel or intuition. There usually is not enough time to conduct research and investigate alternatives thoroughly. As Mas Kodani, a Buddhist in Los Angeles, points out, "One does not stand still looking for a path. One walks; and as one walks, a path comes into being." The business plan is there to be used as a reference check so that those incremental decisions do not cause the business to stray too far from the original plan expectations and the bottom line results become disappointing over time.