We are currently going through a series of blogs on the types of statements which are more relevant to planning than the traditional financial statements (income statement, balance sheet, cash flow). In this blog, we will look at the fourth and final one of the documents to use in their place—the Investment Statement.
The purpose of the Investment Statement is to provide a strategic framework for understanding corporate overhead. “Investment” consists of spending for items which provide benefits for multiple years Yes, the balance sheet and cash flow statements also have lines describing various costs related to investments. However, the income statement doesn’t tell you why these numbers were chosen, how they relate to strategies, or what benefits are expected from these benefits. That’s why I designed the Investment Statement.
Since there are so many different types of business models out there, the Investment Statement would need to be tweaked a bit to fit each type of industry. But a rough example can be seen in the figure below.
1) The Baseline
The first part of the Investment Statement is used to carry forward the investments already made. This should be fairly easy to do, because these investments are already recorded in a company’s financials.
2) Strategic Investments
The next step is to outline all of the investments needed to complete each of the strategic initiatives. This would include the upfront costs, depreciation/amortization impact, and return on investment (typically based on a discounted cash flow analysis or other, similar type of measure).
3) Net Results
The third and final section looks at the net impact of the first two sections on investments, including the total level of investment and the total impact to depreciation/amortization.
The benefits from using an Overhead Statement are as follows:
- It proactively links all of your strategies to specific investments.
- It separates all of the components of strategy, so that you can critique each one for reasonableness.
Now that we have looked as all the documents separately, we can put it all together into a single process. It is illustrated in the figure below. The process has four parts:
- Baseline Assumptions: First we do internal and external research to determine two things:
- Where the market is going; and
- How we will play in that space if we do not change our status quo.
The result of this work will be our baseline assumptions.
- Strategy Development: Next, we devise strategies and strategic initiatives/tactics to optimize our performance and position in the future. This is your basic core work of strategic planning.
- Quantification/Validation of Strategies: This third step is where we get specific on the expected costs and benefits associated with the strategies and tactics. To do this, we use the statements mentioned in this and the prior four blogs—the Revenue Statement, Operations Statement, Overhead Statement and Investment Statement. There is a sort of circular process between steps two and three. As we start quantifying the strategies, we may see a need to modify our strategies a bit to improve their impact. Also, as we look at the four statements (revenue, operations, overhead, investment), we may see some gaps that weren’t covered by our original list of strategies. This may require adding additional strategic initiatives. We keep up this circular approach until there is agreement on the final list of strategies and their quantifications.
- Translating to Standard Statements: Once the strategies and their quantifications are approved, one takes the data and translates it into the standard financial statements (income statement, balance sheet, cash flow). Now, you have the documents you share with the rest of your stakeholders.
Future projections in income statements, balance sheets and cash flow statements are only as good as the assumptions behind the numbers within them. To make sure the assumptions are solid, a lot of prior work needs to be done to properly quantify not only the tasks associated with those figures, but also the specific financials attached to each task. To help quantify the tasks and financials associated with them, I have devised the Revenue Statement, the Operations Statement, the Overhead Statement and the Investment Statement. When used properly, they can provide the missing link between what needs to be done and what outcomes are expected.
These forms were left a little bit vague, because each industry has its own nuances which will impact how the forms should look. But that doesn’t mean you should leave them vague. Your role is to customize them to your industry.