Great products, and anchor customer wins are the things that hog the limelight with startups. But in my opinion, sound financial planning is the unsung hero of the early stage of a company’s life.
Sound financial planning can mean the difference between survival and an early demise. More commonly, an absence of financial planning means you have to raise a round of funding before you expect to do so—and that is never optimal for a young company.
Your primary tool is your budget. The most important purpose of a budget is to forecast cash flows. It is easy to become lax about forecasts, especially beyond the next quarter, since there is so much uncertainty in the early stages of your business. You might be asking yourself: “How do I forecast revenue when I haven’t sold anything yet!?’ But the absence of revenue is not a good enough reason to leave a revenue line out of your budget.
Creating a budget with assumptions and forecasts in it allows you to do a ‘build’ of the whole company’s financials. Whenever you change an assumption (such as your sales forecast), you adjust your model. Now you can build scenarios and explore alternatives for your company’s performance. This will become an important part of your decision-making process.
Creating a budget also forces commitments out of your functional heads. Adhering to financial commitments in the budget is a discipline that you need to instill in your team early on. This doesn’t mean you have to stick to the budget all the time. It just means that if you make an exception, such as an unplanned hire, you weigh the benefits of hiring that person _now_, against the additional cash outflow and adjust your other assumptions in the model accordingly.
Startups are about dealing with uncertainty. Where hiring decisions are within your control, revenue is not. When you are doing your financial modeling, build worst case scenarios. What if that “revenue hockey stick” does not happen when you want it to? Keep your worst case scenario as the baseline and work from there.
Lastly, good financial planning means maintaining a certain attitude to costs. What is the right way to make cost-based decisions for your company? How do you prioritize costs? The answers to these questions may seem obvious, but if you don’t stop and delineate a method for how to make these decisions now, you’ll make some decisions that you will greatly regret down the road.
How you prioritize costs will vary from business to business, but it always helps to have an open discussion about how to address these decisions with your leadership team. And although coherence is important, having people on your team who have different attitudes to spending is good, too. If you, as CEO, are very product and market oriented and want the best outcomes there, then hopefully you also have a conservative, frugal co-founder who will ask the tough questions on spending.
As you go along, make sure you keep revisiting your budget and fine-tuning it. Budget, measure and assess. At the end of each month, we compare our forecasts against our actual performance to ferret out all the assumptions that didn’t hold true. You need to constantly iterate between reality and your budget for them to be in sync. Get into the habit of forecasting now, so that seeing and responding to changing trends in your company’s performance becomes second nature. Startups are about taking risk. But the risks can be, and should be, more fully understood with sound financial planning.