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This article is based on a piece written by David Ehrenberg, CEO of Early Growth Financial Services, It highlights some important financial and accounting considerations for founders.
As David points out, when you’re starting and growing your startup, you naturally want to devote all of your time and attention to building your team and product. However, much like getting your legal house in order at the outset (see our article Why You Can’t Afford To Be Disorganized), planning your financials and keeping them organized is important not only to the operations of your business, but also as a positive signal to investors when it comes time to pitch and go through the due diligence process.
By: David Ehrenberg, CEO of Early Growth Financial Services
When you’re an entrepreneur, you’re busy working every day to find your way, build your product/services, grow your company, and achieve your goals. Unless you’re a financial whiz, it’s not always easy to also work out your financial plan and pin down precise numbers—and sometimes important financial details can fall by the wayside. Even if you are a financial whiz, creating a financial plan and managing your finances can be challenging. But it is essential that you understand the importance of accurate financials—both for your own stability and ability to plan, as well as to convince and assure potential investors of the validity of your business.
There are so many financial mistakes that you can make as a startup. However, once you know the potential missteps, you can take simple steps to avoid them. Here are the top 5 financial mistakes startups make—and how to steer clear:
1. Miscalculating (or not calculating) your cash burn.
Your burn rate is the amount of capital you go through every month to keep your business running. If you don’t have a good understanding of your burn rate, you are seriously hindering your ability to achieve your milestones before your money runs out. According to some recent surveys of new business owners, approximately one third admitted to underestimating monthly expenses. Along the same lines, almost 20% of new business owners realized that they didn’t have enough financing. It’s all too easy to miscalculate your operational costs, so initial financial assumptions are often off. Keeping track of all of your startup expenses will minimize these miscalculations.
The first step in managing for cash flow is to create a bottom-up projection, using real-world variables. Top-down forecasting can lead entrepreneurs to be overly optimistic about the sales they’ll close and the revenue they’ll earn. Bottom-up forecasting will give you a more realistic (albeit a less inspirational) gauge of how much money you’ll need to get going—and keep going.
Reforecasting is also key. You need to account for both fixed and variable costs and continually make projections that accurately reflect the real state of your business.
2. Not completely understanding your market place.
If you don’t properly understand your market, you may be guilty of mis-pricing your products/services. Don’t merely add your costs and calculate in the margin you’d like to make. Consider your market position and the value of your offering; start with price and work backwards. In your calculations, keep coming back to the marketplace: who is your customer, what need does your product/service fulfill, what do you have to offer, who is your competition, and what trends may affect your market—and how.
3. Hiring and expanding too quickly.
One of the greatest expenses of any company is its people. To keep your costs low, you need to consider ways to save money on staffing. A big mistake many startups make is to hire too quickly. Too many employees is a huge drain on your funds.
In addition to the recruitment and salary costs, there are additional physical costs such as a necessarily larger office space, equipment, and supplies. There’s also the psychological cost: what will happen to these people if your company doesn’t grow and you need to lay them off? And don’t forget the all-important reputation cost as well: how will it look to investors and others if you have to disassemble your team? Instead, hire slow as you grow.
4. Making bad hires.
Another key to saving on staffing costs is to hire for potential, as opposed to experience. Don’t waste money hiring experience just for the sake of experience. And, whenever possible, outsource non-core competencies. For example, outsourcing your financial support frees up your time to focus on other aspects of your business. The company you hire will be responsible for making sure that you stay on track and take care of your financial obligations.
5. Doing your own finances (when you have no training).
If you’ve closed a seed round of funding, have a lot of expenses, and/or are earning real revenue, you need a CFO to help you manage your finances on a strategic level. If you don’t yet have a lot of financial activity, you may not yet be in need of CFO services, but, at the very least, you still need some financial support with your day-to-day accounting and bookkeeping. Honestly, it will cost you more in the long-run to do your own finances, rather than hiring a professional to help you manage your finances from the get-go.
Note that there is no need to bring a full-time accountant and CFO on staff. If your company is still small, it makes more sense to outsource these functions, getting support on an as-needed basis while simultaneously reducing your cost structure. Just don’t do it yourself!