What are the key elements of a good business plan or investment appraisal?
Being able to put together a good investment appraisal or business plan is a critical skill for senior managers. However, many business plans are poorly formulated and end up being re-written several times. High-level management time is wasted and the implementation of good investments is delayed. In the worst case, inappropriate decisions are taken.
Added on 23 June 2015 by David Smith
One common problem is that the plan does not include all the required elements – so what are the key topics that need to be covered?
1. Relationship of the plan to the business strategy
Only investments that are fully in line with and support current business strategy should be undertaken. Investments to promote diversification are rarely successful as the necessary management knowledge and experience is invariably absent. All projects should strengthen or derive from positions of competitive advantage and should only be made in attractive markets - that is where high returns on capital employed can be achieved. Business plans for a new business venture should similarly demonstrate a combination of market attractiveness and competitive advantage.
Anyone approving a significant expenditure proposal needs to know that all alternatives have been explored, why those alternatives have been rejected and that the project under consideration is the best option. This can be difficult, especially when the sponsor has already made and is promoting a decision. However, if a mistake is made, it is most likely made in coming up with a sub-optimal solution. The more creative or innovative the alternatives, the more confident the sponsor will be that all options have been explored and the more likely the approving authority will gain comfort from this work.
This is probably the least-well addressed section in the majority of investment proposals. The critical point is to identify all the risks inherent in the investment as well as the risks of doing nothing. As far as possible, risks should be assessed in relation to their size and probability. Any failure to identify risk can rebound in the culpability of the project sponsor when such an unidentified risk manifests itself as a loss at some point in the future.
4. Financial justification
All projects should meet the appropriate corporate criteria for payback period, accounting rate of return, internal rate of return and net present value. However, these forecasts themselves do not communicate sufficient information about the robustness of the investment to enable the approver to make an informed decision. In order to understand the context of these measures, the basic assumptions on volumes, cost and revenue growth, working and other capital requirements, tax, inflation and so on, should also be clearly stated along with any other important project-specific variables. There should always be a sensitivity analysis or a scenario plan to illustrate different future outcomes from the base case financials. Only when the basic assumptions are understood and the possible variability in future expected outcomes appreciated, can the authorising body be in a position to approve the investment.
Often seen as peripheral to a project, intangible benefits can yield important, if unquantifiable, returns on investment. There are even instances where intangible benefits outweigh the quantifiable financial benefits. This is particularly so when projects can improve the brand or image of a company, where an office-move is proposed or, for example, where business is being defended against a competitor. It is also especially true in an era when corporate social responsibility, green credentials and a light environmental footprint can be the determinants of acceptability by employees and in wider society. In these instances, care should be taken to make realistic and positive evaluations of the intangible benefits, which, particularly when positioned at the end of the investment case, can sway the approver to approve the investment.
Ashridge runs Open programmes in strategy and finance, which can be taken as combined packages to help equip executives with the skills they need to progress their careers.