Understanding Top Down vs. Bottom Up Calculations for Business Planning

Today I want to talk about the difference between top down and bottom up calculations in business planning.

When I meet with clients, much of our time is spent around crafting a business plan that sets the business owner up for success – whether they’re going after outside funding or the plan will remain an internal strategy document – and one of the things that nearly every entrepreneur I’ve ever worked with misses is bottom up calculations.

Many of you are probably shaking your heads in confusion so let me explain. Top down calculations for a company figuring out potential annual revenues look something like this: “The total U.S. market for widgets is $20 billion so if we get just one half of one percent of the market we’ll be a $100 million revenue company.” They’re called top down because you’re starting at the top, the high level, the whole market, and working your way down to your overall business.

The trouble with this is that it has no strategy attached to it whatsoever. Cool, you can do math to figure out that one half of one percent of $20 billion is still a lot of money, but it doesn’t mean anything for your business. I could say if I just managed to get one half of one percent of Ben and Jerry’s sellers to give me a free pint of ice cream I would eat Ben and Jerry’s for a year at no cost, but I’m probably not going to be buying extra freezers to house all of my Ben and Jerry’s because I have no plan for making that happen. In a business plan, it’s the HOW that we need to focus on to produce the what, not the what itself. If you have no how, you just have a top down calculation and you’re giving yourself away as being naive about how challenging it is to acquire a customer and making yourself look unsophisticated.

So that brings us to bottom up calculation, which will give you a more accurate prediction of the future of your business, if you do them right. Now, in contrast to top down, which started at the high level and moved to down to the business, bottom up starts at the individual sale and moves up to the overall business. So, for example, if you’re going to use Adwords as one of your marketing paths, you might say, “Okay, I will run ads with abc keyword, which has an average cost per click of x, an average click through rate of y, and average conversion rate of z, for an average sale of $lmnop and build up from the cost to acquire one customer to the total projected revenue for the business. You can see that the bottom up calculation is inseparable from the plan for how you will achieve that final revenue number, so it’s a more useful method of estimating. If you notice that you have revenues in your pro forma income statement that are not directly accounted for with a marketing expense, you’re probably not using bottom up and likely want to take another look and see what you’re basing your revenue predictions on.

If you’re an aspiring entrepreneur, the best thing you can do for yourself is to just get started. Pick up my business planning ebook here to be guided through the whole business planning process for less than $5. More of a video person than a text person? Click here to try my ecourses instead.