Establishing Your 2024 Company Vision Part 1: The Thinking Model
Here's a simple yet powerful approach for modeling next year's financial performance for your small business.
One of the most challenging tasks for small businesses is communicating annual goals effectively to their team. It's a delicate balance between providing sufficient information and avoiding overwhelming your team.
In 2024, we're taking a different approach—one that's simpler yet more impactful.
Our aim? To ensure every team member comprehends our 2024 company goals and has an exciting personal incentive tied to these objectives.
It's about aligning individual rewards with collective success.
So, what's our strategy?
In 2024, we'll be using two tools.
The first is a "Thinking Model," based on Greg Crabtree's Simple Numbers 2.0. This model considers three performance "levels" for 2024: Minimum, Target, and Stretch.
The second is what I call "The Playbook." This is a 2-3 page document describing the "who, what, and how" of the financial models. (Here’s a link to my post on The Playbook.)
Today, I'd like to explain the Thinking Model, and in next week's newsletter, I'll discuss The Playbook.
But first, you don't want to miss next week's newsletter, so take a moment and subscribe here.
OK, now that you've done that, let's dive into the Thinking Model.
The Thinking Model
The Thinking Model looks like this:
It's a straightforward profit and loss statement (income statement) with three columns: Minimum, Target, and Stretch. Here's what each of those columns means.
Minimum: The existing baseline performance, adjusted to account for "known effects." For example, your Minimum model may account for a reduced revenue over last year because a client is terminating their agreement starting January 1. Otherwise, Minimum is "business as usual" based on the previous 6-12 months of performance.
Target: Realistic financial model with a 50-75% chance of coming true. In essence, if we execute well and our growth initiatives pay off a bit, we have a great shot at hitting the Target.
Stretch Goal: Attainable if circumstances align favorably, a challenging yet feasible objective. Essentially, if we execute exceptionally and get a little help (luck) along the way, we have a 25-50% chance of hitting the Stretch.
How To Set Up Your Thinking Model
You wouldn't think I'd just show you the Thinking Model without providing a download, right? (Excel | Google Sheet)
The Thinking Model may look intimidating, but all you need to do is fill in the light blue cells, and the rest populate automatically.
I'd recommend working across and then down instead of isolating each column. This allows you to think through the three scenarios (Minimum, Target, and Stretch) for each light blue row before you move on to the next row.
Here's a guide for each of these rows you need to fill in:
Revenue (Line 3)
Minimum: Plug in the last 12 months of revenue and adjust up or down for any guaranteed effects.
Target: Increase revenue over the Minimum column in a reasonable, achievable amount.
Stretch: Increase again, but this time, make it a number that is both achievable and uncomfortable for you!
Gross Profit As a % of Sales (Line 6)
Minimum: Divide your rolling 12 gross profit by your rolling 12 revenue (sales). Plug this in.
Target: Increase your percentage over the Minimum column in a reasonable, achievable amount.
Stretch: Increase again, but this time, make it a number that is both achievable and uncomfortable for you!
dLER (Direct Labor Efficiency Rate) (Line 9)
Minimum: Divide your rolling 12 gross profit by your rolling 12 direct labor. Plug this in. (Direct labor is any labor for a person that interacts with a customer more than 50% of their time. All other labor is "Management Labor.”)
Target: Increase your dLER Minimum column in a reasonable, achievable amount.
Stretch: Increase again, but this time, make it a number that is both achievable and uncomfortable for you!
Operating Expenses (Lines 13-17)
Management Labor: This is simple: plug in your existing management labor in the Minimum column, then increase it for the other two columns for what’s needed to "manage" the additional revenue. (If you're "over-staffed" right now, you may not need to increase left to right…)
Marketing: Figure out your rolling 12 marketing expenses as a percentage of revenue and use that to determine your marketing expense across all three columns.
Facilities: This number will likely stay the same for all three columns unless you relocate.
Payroll Taxes & Benefits: Calculate your rolling 12 payroll taxes & benefits by dividing your total payroll taxes & benefits by your total direct and management labor for the last 12 months. Then, use this percentage across the three columns.
Other OPEX: You get the pattern here, right? Figure out your rolling 12 OPEX as a percentage of contribution margin (line 10), and then set that up as a formula across.
Other Income & Expenses: This varies widely across different businesses, so just make your best guess on these items. In this model, it's much more important to analyze your Net Operating Income in line 21.
Now, Analyze the Results
Now that your Thinking Model is populated, set it aside for a day. Then, come back to it and look at each column independently. Ask yourself a few questions.
If we keep doing what we're doing, is the Minimum column very likely to happen? Have I accounted for the known, surefire, guaranteed things that will impact my numbers, either up or down?
Do I think, with reasonable effort, we have a 50-70% chance of achieving our Target numbers?
Does the Stretch column make me uncomfortable? Do I look at it, take a deep breath, and say, "Well, I think we can make this happen with some luck and great effort?"
If your answer to these questions is "yes," your Thinking Model is complete!
If not, go back and play with the numbers until you feel this way.
Now, it's time to move on to The Playbook.
I’d love it if a few more folks read this newsletter. Might you consider forwarding it to someone you think might benefit from it?
Books of Note: I enjoyed listening to Sam Walton: Made in America a few years back. My favorite part was the narrator. It’s like Wilford Brimley is walking you through this magnificent story of how a guy with a few fives & dimes built the largest company in the world.
I’d love a follow over on X (Twitter) and Linkedin, as I post things there that are either too brief for the newsletter or are just entertaining things I come up with over a responsibly-sized serving of Blanton’s.