This article was originally published by The Finance Navigator – a startup company which simplifies financial planning and cash flow management for other startups.
Why should you, as an entrepreneur, care about financial planning? I hear you think: ‘Easy question! To find out how rich I am going to become when my business succeeds, KA-CHING!’
Well, if you’re lucky that’s indeed the fun part of financial planning, but forecasting can also give you the insight that you are not going to be rich, or maybe not even profitable at all! Or it tells you that you first need to raise a couple of millions before you actually start making money. Therefore, below I present 4 reasons why YOU as an entrepreneur should care about financial planning.
A good idea is not necessarily a good business! Let’s say you have just started a new business and you have validated to the extent that you’re quite convinced there is demand for your game-changing, industry-disruptive idea that will turn your startup into a new unicorn (yes, we like to just throw in a few random startup buzzwords here and there). In that situation it is extremely helpful to create a high-level forecast using market size data, your revenue streams, your main cost drivers and your capital investments. No need for huge spreadsheets yet, keep it simple and use for instance the process we describe in our earlier blog where basically all you need is a business model canvas. You might find out that even though your idea might be great, your business model might suck.. or that your costs might be so high the idea is not commercially viable, meaning you have to re-consider your business model or cut costs.
One of the things you might figure out by doing exercise 1 is that your idea CAN be turned into a business, but that you need to raise investment to do so. You can raise funding using family, friends & fools, via crowdfunding, angel investors, a VC or maybe even from the bank. But the further you go from left to right in this list, the more risk averse the investor is and the more detailed your financial plan needs to be. When engaging the investor, do not share your full financial plan upfront, but start with some highlights. You have to be able to back up your claims with more detailed info though. The challenge with building a financial plan to convince an investor is finding that thin line between being realistic yet ambitious. You want to give the investor the feeling that you are not selling baloney, while you also want to convince him/her of your company’s potential.
You want to give the investor the feeling that you are not selling baloney, while you also want to convince them of your company’s potential.
How do you know how you’re doing if you don’t have any targets or steering information? Or how are you going to update your investors about how you’re spending their money and whether you are performing as promised without any financial plan to benchmark against? You will need a forecast to do so. Specifically, a simple cash flow statement comes in handy for this one. Create a forecast of cash inflows, define the major costs that drive your cash outflows and present your actual cash in-and outflows against these targets. Explain large deviations from the targets. Create a monthly/quarterly overview for 12 months ahead and a yearly one for the years thereafter (e.g. 3 or 5 years ahead). If you include a P&L and balance sheet, the major milestones, the cash you have left, the burn rate/runway and maybe some sector specific KPIs, you have built yourself an investor-proof shareholder report. If you want to learn more about shareholder reporting, here you can find a nice article explaining more on this specific topic.
Entrepreneurs tend to be optimistic, which is a good characteristic to have as an entrepreneur to keep up the energy. Unfortunately, in many cases life of an entrepreneur tends to be a bit more disappointing than it is on paper (at least from a financial perspective, don’t get too depressed now). Therefore, concerning financial planning it is good that next to your default financial plan (called the ‘base case’) you also prepare a scenario which is a bit less optimistic (your ‘worst case’). What if you launch 6 months later? What if sales do not ramp up as expected? Answering such questions helps you anticipate how your cash flow, profitability and funding need might be impacted in a less optimistic scenario.
Oh, and by the way, also don’t forget to create a ‘best case’ scenario. Why? You can give potential investors a sneak preview in the upside potential of your company and most importantly: it’s fun! KA-CHING!
Wout Bobbink is the co-founder and Chief Marketing Officer of the Finance Navigator – an in-corporate venture of EY. Wout and his team are both our colleagues and alumni – they went through the HighTechXL accelerator program, next to guiding our startups into the development of their financial models.