This blog post is co-written by Yngve Dahle and Mark Robinson.
Traditional board meetings often consist of comparing a company’s financial results with the budget made at the start of the year. Some even compare them with the results from the previous year. While this probably makes sense for a stable company that has been run the same way for years, it adds little value to the type of innovative companies categorized as “startups”. These companies are characterized by constant uncertainty and change. They are living in an experiment of continuous trial and error. So, our recommendation is to abolish the budget, and stop comparing with the previous year.
We suggest you make a “best estimate” for your plan period instead. This estimate combines the results that you achieved for the months behind you with your best guess for the months ahead of you. This will ensure that you always have a forecast of the most probable result for the plan period. If you know that a big contract is going to slide from May to July, move the revenue from the contract ahead by two months.
Our three recommendations for managing your objectives are:
- Use a relatively short plan period: Don’t make objectives for more than a few months at a time. Setting goals far into the future is difficult and demanding, while it yields little value.
- Use a rolling forecast: At the end of each month, add a new month at the end of the plan period. This way you will always have targets for the next three to six months.
- Use the principle of “best estimate”: Enter the achieved results as early as possible, and edit the estimate for the coming months as soon as you have new information suggesting the current one is improbable. Remember not to be too optimistic when making the estimates. It is often easier to deal with a positive than a negative surprise.
Most companies unfortunately limit themselves to setting financial objectives. The problem with this strategy is that the financial results usually only indicate how good a job you did with your recruitment, training, product development, marketing and sales.
The DuPont model in the figure below (Zane, Kane and Marcus 2004) illustrates this well. This model has 13 examples of objectives. It is only possible to directly influence the first five. They can be considered the most important objectives for both the Board of Directors and the management. Skilled employees and good organization leads to both a good product and a professional sales force. A combination of the two generates satisfied customers. This in turn results in increased turnover, returns and profits. This has a starting point in the individual employee.
The objectives are divided into four groups:
- Begin by setting objectives for competence and organization.
- Create product objectives based on the competence you believe you need.
- On the basis of the first two groups, create sales and market objectives.
- Create financial objectives based on sales revenues and costs.
Within the four groups in the example, there are 13 objectives that all must be specific, quantified, realistic, achievable and measurable.
Objectives you can control:
If you are (1) an attractive employer, you can hire and retain great employees. If your employees’ collective competence and experience correlates with the company's needs, you will have (2) the right competence. If responsibility, roles, processes and information are each handled well, then you have a (3) professional organization that leads to (4) professional processes. These processes create the company's products by way of a (5) high-quality product, i.e. supplies on a par with (or exceeding) customers’ expectations.
So far we have identified five parameters (1-5) that we can both control and measure. The other eight parameters (6-13) can only be measured. This means most of managements attention should focus on the first five parameters.
Objectives that can only be measured
Let us say our product exceeds the customer's expectations for value and price. In this case we have (6) satisfied customers. At the same time if the company gains more customers it may even become (7) a preferred supplier. Now things are going well - and we gain (8) even more customers and (9) increased revenue. Good management ensures (10) cost effectiveness and (11) improved profitability. From this we get (12) effective use of capital, which in turn leads to (13) greater profit.
Take a moment to think about your company’s management and board meetings. How often do you discuss things that can be both controlled and measured, i.e. points 1-5? How much time is spent following up points 6-13, perhaps especially the purely financial key figures 11, 12, and 13? While these are important, they are only consequences of the previous points.
In this part of the planning process you will work with the full spectrum of objectives for your company. Between 6 and 12 objectives are manageable. If you include more, you risk losing focus. If you include fewer, you risk missing important target areas. The order in which you review objectives is also important.
As you would begin with the foundations when you build a house, you must start by defining the paramount objectives. We suggest you follow the order in the model above. As with the rest of the planning process, the entire organization must contribute to formulating the objectives. In this way you will create motivation and ownership. You are more motivated to achieve objectives when you have helped create them. Set your objectives within the chosen time period, and mark objectives you achieved. If you see that the objective is unrealistically high, you must take the consequences and reduce it. On the other hand, if you see that you will reach the objective easily, you should set a new and more ambitious goal.
We hope that this blog post may inspire you, and perhaps start a discussion. If some of the entrepreneurship terminology used is new to you, you can find more details about it in the Objectives chapter of our Lean Business Planning book.