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CATEGORY - BUSINESS PLANS

FORMULATING ASSUMPTIONS

All Business Plans will include estimates and assumptions relating to future income and expenditure. They are necessary in order to prepare cash flow and profit forecasts in support of loan finance, capital investment, government grants or simply as a means of calculating whether the business will be viable or not. Common assumptions will include specific variables such as units sold, net rates, selling prices, the number of employees required, the amount of space required for business premises, the cost of overheads at different levels of activity, the lead time necessary to produce or acquire stock and the timing of cash flows. They will also include general economic data such as interest rates, tax rates and exchange rates.

Often these assumptions will take the form of targets. Sales revenue is an obvious example. Costs can also be targeted as part a budget which plans expenditure for the year ahead. However, the most important thing to remember about assumptions and estimates is that they must be based on known facts or supported by careful research, as opposed to hopeful guessing. It is no use simply working out what your breakeven point will be and then blithely assuming that sales will be sufficient to reach it. You need to show that your sales revenue figures stack up and are supported by reasoned arguments. For example, if you are opening a new branch, you need to show that projected sales revenue is comparable with similar areas taking into account local competition, transport links and population profiles.

Formulating assumptions is clearly an inexact science, so it is often a good idea to consider a range of possible outcomes and try to assess the most likely result in a given situation. It may help to assign a probability to each outcome and then stand back and review the whole picture. For example, suppose that XYZ Limited launches a new product and estimates sales revenue, both with and without an advertising campaign, as follows:

Sales Revenue No adverts Internet ads Newspaper ads
£50,000 50% 35% 10%
£75,000 25% 35% 25%
£100,000 10% 20% 30%
£125,000 5% 5% 15%
£150,000 2% 3% 8%
£175,000 1% 2% 5%
£200,000 - - 2%

These scores would not be plucked out of the air but based on market research or on previous advertising campaigns for similar products. It is possible with this approach to produce best/worst case scenarios and perform sensitivity analysis or financial modelling. These are dealt with in more detail in our other Information Sheets.

It will often be the case that some variables impact on others. For example, rapid sales growth may require more staff or bigger premises. A low exchange rate may impact on net rates and therefore reduce your margin. Increased competition may necessitate a reduction in your selling prices. And as in the example above, increased advertising may affect sales volumes. In this situation it is important to link your variables for assumptions so that changes in one are reflected in others all the way through the financial model.

Finally, assumptions and estimates should always be fully detailed in an appendix to your Business Plan rather than simply shown as footnotes in the Financial Analysis sections. They should also be cross-referenced to other parts of the Business Plan in which these assumptions are discussed and validated.


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For information of users: Although every care has been taken in compiling this material, it only provides an overview and does not take the place of an individual consultation. We strongly advise all users to consult the detailed legislation or seek professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or this firm.

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