Good cash flow control is important for any business. For a growing business, it's crucial - cash constraints can be the biggest factor limiting growth and overtrading can be fatal.
Making the best use of your finances should be a key element in business planning and assessing new opportunities. With limited resources, you may need to pass up promising opportunities if pursuing them would mean starving your core business of essential funding.
Planning ahead helps you anticipate your financing needs and arrange suitable funding. For many growing businesses, a key decision is whether to bring in outside investors to provide the equity needed to underpin further expansion.
An early stage company with a compelling business model and poor financial management can die or fade away quickly
Investors and other stakeholders take startups planning to raise fund more seriously when they can perceive some level of organization in terms of financial management — ‘the numbers’ as generally called. A level of credibility and confidence is then transmitted when they can established that the financial management is top-notch. Therefore, startups that pay attention to financial management at the early stage are data driven, scale operations better, and make informed strategic decisions that add value to their businesses.
Why you should you care about finance
You need to understand your numbers — to understand your business better, make better decisions, make fewer mistakes, and hopefully turn a little cash in to a lot of cash.
You need to understand the underlying financial flows of your business. That's key to your understanding of how to manage your business. Sometimes finance is not about money.
For example, how long will it take to get a customer to buy your product? How much cash do you need to get to this milestone? How much do we spend on marketing in order to generate the revenues we're looking for? How long will it take to convert a prospect into a paying customer?
These are some of the questions that investors are going to ask you that you should be asking of yourself that finance can help you answer.
Tips on Building a Financial Model
When building a financial model and before breaking the business into discrete pieces and asking yourself which direction each will go, first look at the business as a whole and understand both what you as an organization are trying to accomplish as well as what the intended use of the model and financial projections you are building will be.
What do we need to accomplish over the next x months…
…in order to put ourselves into a position to successfully raise a Series B round?
…for this partnership with Big Co. to make an impact on our bottom line?
…so that we can hit profitability and maintain optionality over how we finance our future growth (customers vs. investment)?
…for this product or distribution decision (which puts a significant amount of capital at risk) to pay off?
The Goal of a Financial Model
The goal of a financial model is not to be exactly right with every projection.
The more important focus is to show that you, as a founding or executive team, have a handle on the things that will directly impact the success or failure of your business and a compelling plan for executing it successfully.
Mark Suster of Upfront Ventures puts it similarly:
See, I don’t care if your projections prove wrong over time. I care about your assumptions going in. I care about the thought that you’ve given to the customer problem. I care about how much you’ve thought about market share, competitors, adoption rates, etc.
A good financial model consists to two things:
Well thought-out projections about the future of the business
A properly structured, understandable, and dynamic spreadsheet
Common Financial Projection Mistakes
Assuming that revenue will come with scale. While this has long been a criticism of social networks and consumer apps hoping to monetize a critical mass of eyeballs through advertising, many companies who have revenue models built into their businesses from the start (think SaaS or Marketplaces models) still falsely assume that revenue, to the extent they need to be sustainable, will happen once they reach X number of users or “decide to turn on the spigot”.
Focusing too much on point estimates and not range estimates – Instead of agonizing over whether your conversion rate will be 2% or 5%, focus on the possible range or conversion rates and evaluate the results based upon the range of estimates, not the point estimate of 2% or 5%.
Underestimating Customer Acquisition Costs (CAC) – The the second biggest cause of startup failure, behind the failure to get product/market fit right, is that the cost of acquiring customers turns out to be higher than expected, and exceeds the ability to monetize those customers.For an in-depth analysis of this issue, read this blog post from David Skok.
Not doing your homework – There is a tremendous amount of information available, for free, that can help you gauge your performance and benchmark your growth. Great resources include AngelList, Mattermark, and the blogs of companies embracing the Radical Transparency movement. Do some startup post mortems or check out Quora.
Common Spreadsheet Mistakes
Spending too much time on non-material data points – While it might seem like spending time optimizing everything in your model will yield the best results, the reality is that going deep on 5 – 15 core assumptions will yield a much more effective result.
Failure to design your model for usability – To make your model most effective, you need to pay close attention to how usable the output is for viewers. That means clear explanations, a simple structure, and making sure to follow convention so there are no surprises.
Neglecting to include a sensitivity analysis – This goes back to the idea of understanding what your model outputs look like for a range of estimates. You should also keep in mind that your model should be treated as a flexible, living document. That means that your assumptions shouldn’t be hard-coded. Instead create your assumptions so that you can easily change an assumption in one place and all formulas and outputs will recalculate automatically.
Displaying only financial statements and neglecting key metrics – Financial statements go a long way in showcasing the overall health of a business. Unfortunately, many models stop at the financial statements. What investors want to see is a synthesized look at those financials that make it easier to evaluate your business. As an example, a good model won’t just showcase projected revenue growth, it will look at how things like customer growth (and churn) and contract size work together to contribute to that top line number.
For help with the Challenges of Growing Your Business, contact me at email@example.com.
Feel free to also visit our website to learn more about the services we offer to help you Position Your Potential: https://www.therevenuegroup.net/.
I also invite you to download the white paper and learn the 5 step process on How to Quickly Increase Your Valuation: a Proven 5 Step Process.