First Steps to Proper Financial Management in Start-Ups
As an entrepreneur, you may have raised money for your start-up during these uncertain times. Congratulations! But now what? You need to control the money raised in a good manner and always be available to answer several questions:
How to understand that something has already gone wrong with financials?
How much may I spend?
Are you short on money or still have a buffer?
When to raise the next round?
Your company is probably in an early stage, so your time is scarce, and you cannot hire a great CFO yet. At first glance, you can delegate answers to all of these questions to an accountant, but financial management and accounting are slightly different. The first one tries to predict and react, while the second one only reflects on the current situation.
So how will you understand that everything is going right or wrong for your business? Financial management is an important part of any business. In the very beginning, it is even more important to understand it in order to develop your business further.
This article is part of a series of articles in which we will share our advice to help you simplify financial management in your company and set a good foundation for the future.
Develop a "Proper” Financial Model
A common mistake within start-ups is not having a proper financial model that suits all your needs without oversimplification or vice versa. The current situation is changing day over day, and it is impossible to plan the future - Yes, that is true! But you need a financial model not only to anticipate the future but also to understand the drivers of your business better.
Thanks to financial modelling, you can answer the following questions:
How much does my business earn per week/month/year?
Which factors affect revenue: conversion, traffic, average check, etc.
What is my business break-even point: how much do I need to sell or where do I need to save to reach a balance of profit and costs?
What are my costs, and how fast do I burn money?
How is my cash flow, and where is the cash flowing to?
Do I need more money to raise for further development?
Basic financial models give insights on:
Sales
Revenue
Variable costs
Fixed costs
Other expenses to calculate net income (depreciation, interest on loans, taxes)
Cash flow
You can use a template to create your first financial model. Examples are:
It’s important to mention that a financial model is not a budget; it is an approximate forecast. Don’t focus on forecast accuracy at the very beginning. The goal is to build relationships between business factors correctly and come up with realistic approximations. The main indicator of a high-quality financial model is that you can draw conclusions from it, which can then help you manage your business.
Analyzing Factors of Your Business
In this article, we cover the revenue part. Revenue management is very important because your start-up will only take off like a rocket if it has great potential to grow sales and related revenue.
Revenue = volume of products sold * price of products.
Check the article - Corporate Finance Institute - where you can find different examples of business drivers which can be determined as “volume of products sold”. Let’s use “number of customers” as an example.
Step 1
To calculate the number of customers, we need to understand whether we have any data and what approach to use:
Historical data: can be used if we had sales before or pilots of product sales;
Market/competitor data: market volume, growth forecast, competitor sales data, growth projections;
Assumptions - if we don’t have historical data nor market/competitor data, assumptions may be applied to calculate revenue for your start-up. This method is the most uncertain because we often tend to be too optimistic in our forecasts.
Step 2
We chose our approach, and checked data availability. Now we can calculate the number of customers for our financial model:
For example, the whole market volume is 100 clients, market growth by the end of the year will be 10%, and we believe we can achieve a market share of 15% by the end of the year. That means that by the end of the year, we expect to have 17 customers = (100 clients*(1+10%)*15%);
If the product has a subscription model, the following factors should be taken into account: the number of new users each month and retention rate (how many users renew their subscription for the next month; the opposite of retention is called churn, which is another common term in the start-up world).
Using this data, you can calculate the number of customers you’ll have for each month until the end of the year.
Step 3
Now you have to calculate the average price you’ll charge for your product. If you don’t know your pricing yet, the easiest is to use a competitor's benchmark. Determine your pricing strategy:
Is my product cheaper, equal, or more expensive than the competitor’s product?
Is there a free trial period?
Are there any discounts for my product?
The answers to all these questions need to be included in the financial model. That will allow you to simulate/forecast for future periods and see the impact of your pricing strategy on your revenue.
Expand a Culture of Financial Responsibility
The culture in start-ups is openness, quick decision-making, trust in the team, and moving fast. Start-ups create huge opportunities. The whole team works hard, passionately, and is focused on results. Each of its members makes a significant contribution to business development. The results of these contributions can be seen in the financial statements that the whole team can analyse at the end of the month.
The whole team should participate in the financial process so that they immediately learn what the key drivers are and understand how their actions or decisions affect the financial performance of the company.
Sometimes companies don’t openly discuss their finances with employees. Is that right? Partly yes. Not all employees should be immersed in all the details, but every employee should understand exactly which financial goals the company is facing and which of these indicators he/she can affect.
Financial processes are not only the result of the work of the finance department and the CEO; it is the result of proper interactions within the team and requires involvement of every employee. Involvement of the team and representatives of different departments will improve the quality of your forecasts and simplify the collection of actual data.
Small things make big changes. Great companies and good products were once start-ups. Some were lucky or had the timing right, but most used the right processes early on, had the right understanding and management of their business drivers and financial results.
Quick recap
Develop a proper financial model to understand your business better and answer important questions such as revenue, break-even point, costs, cash flow, and funding needs.
Revenue management is crucial for start-ups to grow sales and related revenue, and it involves analyzing factors such as the number of customers, market volume, growth forecast, competitor sales data, and pricing strategy.
Expand a culture of financial responsibility by involving the whole team in the financial process, setting financial goals, and understanding how their actions or decisions affect the financial performance of the company.
In the next article we will focus on the cost part of a financial model.
At Lipefi, we build financial products for startups to help manage their finances better and optimize cash flows. Our first product is a credit card for startups, in combination with insights, control, and planning tools.
Do you want to be one of the first startups using our product? Sign up to our Waitlist.
The first 100 customers will get something special!*
*Conditions apply
Written by Julia Rozenfeld, Georgy Taranov, Christophe Sion