Estimations are important for businesses – allowing you to gain a sense of the opportunity size and possible revenues. Some calculations will be detailed – using spreadsheets and in-depth analysis to more precisely calculate the desired estimates. Other calculations are a lot less in-depth – the back of the envelope calculations, that embody assumptions and approximations to quickly get a sense of what is going on. This article explores back-of-the-envelope calculations – and their role in business planning.
What are back-of-the-envelope calculations?
Back of the envelope calculations are the simple, quick calculations that you can undertake to gain an approximate understanding of a particular situation. When making financial projections or estimating the market size, for example, you may be able to make some quick calculations – extrapolating from a different setting or based on some approximate assumptions – that can help you gain an understanding.
Why are back-of-the-envelope calculations so important?
It is easy to think of back-of-the-envelope calculations as in some ways inferior to more detailed analysis. While there may be some truth to this – often times back-of-the-envelope calculations do not have the full support, detail, or justification as more in-depth analysis, there are many benefits that come from being able to quickly gain insight into a particular problem.
Quick: Calculations in a few minutes
Possibly the primary benefit of back-of-the-envelope calculations is that they are quick. While it may take weeks to perform detailed analysis, it is often possible to get a sense of what is going on very quickly – within a few minutes.
Useful insight - can directly impact decisions
The fact that calculations can be made quickly can be very powerful – it allows you to explore questions in real-time. Not all decisions can wait, or justify the time required for more elaborate analysis. By performing simple calculations, you are able to explore questions that you may not otherwise be able to examine. In many ways, this increases the scope of questions that you can analyze – simple calculations can often more directly influence decisions than complicated analysis that requires much more time to perform.
Easy to understand
Another benefit of back-of-the-envelope calculations is that they are often a lot easier to understand and discuss than more detailed analysis. Rather than having complicated spreadsheets, with thousands of decisions that are hard to easily comprehend and discuss, back-of-the-envelope calculations are often a lot simpler.
This can result in much more buy-in than is the case with more complicated analysis, as well as the possibility for the assumptions embodied to be more actively discussed. Indeed, gaining some initial understanding through simple calculations may result in more confidence in any subsequent analysis.
Provide the basis for more accurate estimates
A final benefit of back-of-the-envelope calculations is that they provide a basis for more in-depth analysis – using triangulation to for example examine the problem from a different direction.
Often times there may be certain components of the calculation that you are relatively sure on – potentially the size of your existing customer base. There may be other parts that you are a lot less sure on – for example, the extent that your existing customer base is likely to want to also buy a particular product or service. Having an initial understanding of the situation allows you to prioritize your subsequent analysis on areas where you are less confident. Looking to verify assumptions to gain a more complete understanding. In some ways, gaining an initial understanding of the market allows you to focus more in-depth analysis on the areas that you are less confident about – verifying your assumptions, and gradually improving your estimate.