I believe that knowledge of finance to include: an ability to understand and communicate your financial model; cost structure; revenue streams and route to markets; is a fundamental requirement for every small business promoter. This is a two part blogpost on Finance for Startups. The first post will detail 12 things I have learned about finance as it relates to startups and small business while my next post will look at financing your startup and the options available.
What promoters need to know about finance when planning their business?
- Be realistic on what business setup costs.
- Expect limited financial reward for startups in first year or two.
- Service based models gain revenue immediately.
- You have to spend money to make money.
- Management development is critical. Take time to upskill on finance.
- Set and track budgets.
- Find out if grants are available for your business
- Leverage startup goodwill to get good deals
- Utilise online resources
- Don’t neglect getting paid on time
- Partnes need to be built into your Financial Model
- Spend time on financial projections
Starting Point : I am not an Accountant
I have a strong working knowledge of Accountancy having studied it for two years as part of my Bachelor of Commerce in University of Galway with Marketing as my major. But I am not an accountant and do not offer accountancy service. I have used my finance skills in every role since and I now help startups and SMEs to compile financial projections for business plans, tenders and grant applications.
Most serious conversations with startups embrace Finance starting with the fundamentals as outlined in the figure below.
The more involved finance related questions for startups include:
1- How do I set pricing levels?
2- How should the business manage our cost base (and what cost base can we expect)?
3- What margins do we need to secure to ensure that the business is viable and sustainable?
4- What level of turnover is required to justify either a bank loan or attract equity investment?
These are all elements in defining your financial model which is at the core of your business model. The fundamental importance of Finance is reflected in the Business Model Lean Canvas – with Revenue Streams and Cost Structure being two of the key key business blocks of the business model canvas as per figure below.
Twelve finance issues promoters need to manage when starting and running their business?
Apart from defining and validating the business model, here is my list of 12 finance and business planning issues for business owners to manage as they start and grow their business.
#.1 Be realistic on what it costs to set up a business
My experience of engaging with lots of startups is that this old project management chestnut is indeed true:
Setup costs will vary by business. If looking for a loan or investment it will be important to know how the money is going to be spent – a good plan will be required. I would also add that it important to design the business to future proof for ‘sustainability and environmental’ concerns. My personal opinion is that it will be easier to do from the outset – start as you mean to go on!
It is important to have a plan for how the business will be financed. My advice to pre-startups is to start saving money for your startup before you finish your current employment (the earlier the better). Part II of this blogpost will address accessing finance – grants, loans and external capital – but a lot of businesses will have to bootstrap which is generating funds from revenue.
#.2 Limited reward for startup promoters in early days
My experience is that business startup promoters work very long hours often with limited (financial) reward in the first year or two particularly for Technology based startups.
Prior to startup you will need to discuss the financial implications of starting a business with your immediate family (if applicable). At the recent SCCUL Enterprise Awards in Galway, Bobby Kerr, the former Dragon said something to the effect that he personally would not mind if a business failed from a financial perspective, but he did feel pressure that he would be denying his family a good life if the business did not succeed and that this probably influenced his perception of risk.
In any event, you will need to plan your own personal budget based on the projected salary that can be paid by your business. It is ok to forego salary from a startup for a short while, but long term this is not sustainable. If your business can not pay you a competitive salary then this reflects on the viability of the business over the longer term. In this regard, I often suggest to people that they set up as a Sole Trader as this can offer flexibility over the short to medium term. I know of several people who followed their dreams and set up their business as a Sole Trader and then easily moved back into the mainstream employment market after a few years when the reality of running their own business and the opportunity cost involved became evident (one got an offer that he could not refuse!).
#.3 Service based models gain Revenue immediately
I remember learning in school that businesses lose money in year one. This is not necessarily true. Service businesses should gain revenue immediately and should reach breakeven and indeed profit in a matter of months. The nature of services also means that growing and expanding service businesses can be more difficult.
I often remind startup promoters that establishing a business with regular service based revenue streams is a valid route to help pay for product to include software development, particularly if you are gaining industry and domain knowledge. Equally, I know of businesses that set up to distribute or retail a product range in order to gain market traction which they utilised to launch their own range of products.
#.4 You have to spend money to make money
Starting a business will cost money. Staff salaries, product development, and marketing all cost money. Understanding the financial model and creating a robust bottom up cash flow projection is critical to ensuring that a return is achieved. By the same token you need to be careful with the money available – no need for plush expensive offices in the middle of the city if that is not a factor for your customers.
The best way to not have to worry unduly about the cost base is to attract profitable customers.
#.5 Management Development – Upskill on Finance
You should have someone on your team who is responsible for bookkeeping and accountancy. But everyone on the senior management needs to appreciate and understand the business and financial model – upskilling on finance is an investment.
I attach three images (click to enlarge) that I use as part of my training ….
The first one lists the key Financial Statements;
the second explains that these statements can be used to record the past or project into the future;
while the third is a little more complicated – it graphically portrays the double entry nature of accountancy. This helps to explain why a business needs all 3 financial statements: cash flow, Profit & Loss, and Balance Sheet.
Every small business owner (and startup) must have within their team someone who is good on Finance. There is training and one to one coaching available so that strategic decisions can be taken with the full backing of the numbers!
For instance, in my training I ask participants to debate how the following cash flow and net profit scenarios could happen:
– A business is making a profit but there is no cash in the bank .. and how do we solve this?
– There is money in the bank but the Accounts show that a loss is being made … and again if this can be addressed?
If you have 15 minutes, I suggest that you read my blogpost which features a quick explaination of Cash flow. It includes a short video which addresses another particular scenario.
#.6 Set and track budgets
Starting a business is indeed an investment in the long term. Once your business is up and running, diligent financial management is essential. My advice to startups is to set budgets and accurately track your costs both in terms of Profit & Loss and Cashflow. Work with your accountant to implement accounting and financial tracking systems to stay informed about your business’s financial health.
I also advise startups to engage with a business advisor or mentor who can take a strategic view of your finances [this can be an experienced business person that you know, your accountant or indeed a mentor provided by an enterprise agency]. This management skill is generally referred to as ‘financial control’ and is critical for every business. Regular reviews of Pricing is also recommended.
#.7 Find out if Grants are available to your startup
There are grants available depending on your business. As a business owner, you need to understand the criteria that apply and the level of matched funding required. For more see my article What ‘grants’ and other supports apply to my startup business in 2023?
Sometimes promoters feel that they don’t need a grant as they are going to start anyways. They also feel that it takes too much of their time. My view is that they should apply, if they are likely to meet the criteria. Time taken to complete the forms is certainly a factor, but the application is time spent on business planning. Most promoters benefit from the process even if they might not like it at the time. It is also worth proceeding because the additional funding will bolster the business in terms of budget and resources and accelerate the timeline for success.
#.8 Leverage Startup Goodwill to get good deals
Small Business Owners need to decide what business functions they will look after internally and which ones to outsource. This will include professional services provided by Accountants, Web Designers, and Branding and PR Agencies to name a few. You will need to evaluate the benefit in terms of cost savings, learning and control of DIY options versus the professional outputs available when experts are used.
I generally advise startups to leverage startup goodwill to get the best deal possible (without affecting level of effort expended and service received) as most businesses remember what it was like to be starting out and are happy to help you at the startup stage – it is very much about establishing a relationship that works.
Small business to include startups need to embrace procurement best practice. All I mean here is that you need to get quotes for every major expenditure. I was mentoring an established small business several years ago. I suggested that the owner review all supplier contracts as the business was under pressure to maintain margins given a reduction in acceptable prices in the local market and increased competition. After a review exercise, he was shocked that some of his long standing suppliers which were established based on personal relationships were not offering the best deals (and he felt he was being taken for granted).
#.9 Utilise online resources
It is generally accepted that one advantage of starting a business is the flexibility to start with a clean sheet and to reinvent how things are done. Startups have significant advantages given the availability of online resources. Many SaaS services offer free price plans which are ideal for startups – they make their money when you increase number of users. Scale Ireland members can benefit from perks and discounts – well worth checking out the list which includes: AWS, Google, Microsoft, Intercom and Frankli.
#.10 Create a proccess for Getting Paid on Time
You might get very lucky and never have a problem getting paid on time. Or you can make your own luck by having good processes to ensure that you do. This starts by getting a solid agreement on the pricing model with customers. You also need to comply with their purchasing procedures, most particularly getting Purchase Orders (POs). This is particularly important in the public sector. Then you need to submit invoices in a timely fashion. Personally, I invoice as soon as the work is done, as opposed to waiting until the end of each month. A delay of a few weeks in raising an invoice is an avoidable delay in payment particularly if you miss the customer’s payment run.
The key aspect of getting paid is having good customers in the first place. For example, will they agree to pay a retainer and a percentage upfront payment as part of the Terms & Conditions?
#.11 Partners need to be built into Financial Model
Most startups operate a Direct model initally. As such their product or service is bought directly from them and delivered to the customer by them (in person or via the post). That includes eCommerce model. The challenge with this model is scale. Or looking at it another way, growth comes from working with partners with either a large customer base or greater geographic reach. As such your business model may need to evolve over time as your business enters new markets to include international expansion. So your business planning needs to account for how external partners will be remunerated.
The classic example is a retail product. This can be sold directly to individual retailers, to central purchasing in a retail group or via a distributor. The table below shows an example breakdown of the pricing model for a ficticious product sold to consumers for €25.
|Product||Cost of Goods||Distributor Fee||Total CoG||Cost to Retailer||Retailer Margin||Retail Mark Up||Retail ex VAT||RRP|
|XYZ||€5||3 (negotiated 30%)||€8||€10 (negotiated)||€10 (calculates as 51%)||103%||€20.32||€25 @ 23%|
The margin or profit per unit for the business is €2. This compares to €3 for the distributor and €10.32 for the retailer. In this case, one might think that selling directly online would be a better approach. It might be – the margin before expenses is €15.32 (306%) – but beware of the cost of customer acquisition as per the example of Hello Bello referenced in my LinkedIn post below. You will also have increased handling (fulfillment) costs and will have to decide how much to charge for postage.
Over recent years businesses with eCommerce models are selling via the major Online Marketplaces (OMPs) like Amazon and Etsy and indeed niche product category websites. In all cases you need a financial model that factors in all players. This will determine the viability of your business model.
#.12 Spend time on Financial Projections
Planning is the process through which entrepreneurs shape the future of their business. Planning develops tentative initial forecasts into clear plans of action to achieve specified goals. It is not about hit-and-miss attempts to predict the future but is a pragmatic management activity to control it. Planning involves quantifying ultimate and intermediate goals in terms of profit and cash flow and thoroughly exploring the actions that might influence them.Page 279 of TENBIZPLAN Dynamic Business Planning for Start-ups, 2nd Edition,
by Ron Immink & Brian O’Kane, Oak Tree Press
A business plan with robust financial projections forces the promoter/team to examine every element of the business, to really figure out if the goals are right and to develop a plan to achieve them. For me robust means:
- Profit & Loss, Balance Sheet and Cash flow statements – figures have to balance, be correctly presented and be consistent with the business plan document or pitch deck.
- Demonstrate how the proposed financial package will change the future events of the company.
- Accompanied by underlying assumptions and notes on how figures are calculated.
The figures will support the story of the business in terms of the value proposition, target customer and business model. They should copper fasten the credibility of the action plan presented by the team to 3rd parties such as investors, banks, and grant agencies. There has to be an ‘Ask’ and the business plan and projections should secure a ‘yes’ response.
I have published two online programmes addressing financial projections. Both use a scenario based approach whereby I explain how you can use an Excel template to create projections for your business by using the template to create projections for a specific scenario. The scenarios are for a local business, a dog groomer and secondly a more involved template but equally manageable for a SaaS business – it factors in SaaS business issues such as customer retention/churn.
Financial planning and control is a key management skill for startups and small business owners. By creating a sound financial plan, exploring funding options, and incorporating sustainability practices, you’ll be better equipped to navigate the startup journey and challenges of running a business. Do you agree that financial knowledge and prudent planning are key to the success of your business?
As always I hope you enjoyed this blogpost … comments welcome and appreciated. Part II of this blogpost series On Finance for Startups will address funding options for startups and small business in Ireland – 12 broad sources will be discussed.