Last week’s Entrepreneurship 101 lecture was on financial planning for startups and Andrew Graham, CEO and co-founder of Borrowell, broke it down perfectly for all us non-accountants who still need to know this stuff. As Andrew put it, “I am going to teach you just enough to be dangerous.”
Why does financial planning matter?
As we all know, financial planning can be complicated. In his lecture, Andrew broke down the key reasons why financial planning really matters to help get you through the sometimes boring parts.
Top 3 reasons financial planning matters:
- Ensures you have enough to pay bills, employees and suppliers. This can kill an otherwise good business before it even gets a chance to get off the ground.
- Increases and attracts confidence of investors. Investors want to see you have a solid financial plan and planning skills, and are often scared away if you don’t.
- Helps you make profit—the desirable outcome of any business.
Financial planning tools
Next, Andrew outlined the main tools for financial planning. As a startup owner myself, I found it really useful to get a good overview of these tools that can sometimes be quite confusing. Here’s a brief overview of what Andrew covered in his lecture.
- The income statement answers the question: “Is the business profitable?” It looks at a business over a certain period of time (usually quarterly or annually) and shows how much income the business has brought in (revenue) vs. expenses over that period.
- Andrew gave a great example of why examining a company’s income statement is valuable. The income statement from mega-giant Amazon.com shows it actually lost money last year, despite a revenue of $88 billion!
- There’s a problem with income statements—they don’t show the true value of the company in terms of assets and they also don’t show anything about cash. Knowing about cash is important because a company needs to make sure it has enough to pay suppliers and employees. Andrew gave a fantastic example of a company with a great business model that went bankrupt in three months due to a lack of cash to pay suppliers.
- The balance sheet shows the overall health of a business in a single snapshot.
- Highly important, according to Andrew, as it shows how much cash the business has at one time.
- When accounting is done properly, there is a symmetry between income statement and the balance sheet. That is, they complement each other.
- Pronounced as it looks (Eh-bit-dah), this acronym stands for Earnings Before Interest, Taxes, Deprecation and Amortization.
- Andrew didn’t go into much detail about this tool, but said that instead of the income statement, investors sometimes often want to see this form as it may give a more accurate assessment of the company’s health.
Final notes and top takeaways:
- For a startup, it’s all about cash, not just your income statement. You can’t use an income statement to pay suppliers and employees.
- When planning for future income, aim to forecast from the ‘bottom–up’. Instead of trying to guess the market size and what percentage you can take (top-down forecasting), speak to real customers about what they can pay and what they would pay for your service or product. The best thing you can show investors is interest from real customers.
- Be prepared. Ask “How sensitive is my business to change?” Understand the key components that drive your business (e.g., fuel for an airline company) and create multiple scenarios to plan strategies for major change (e.g., when fuel prices go up).
- There’s no substitute for a professional. Get a professional accountant when you need to create or understand detailed reports such as audits.
Q&A with Andrew Graham of Borrowell
I got a chance to speak to Andrew before the event to get some answers to questions about how financial planning applies to the lean startup mentality.
Adam: A lot of advice floating out there in the Lean Startup world is that business plans and financial projections aren’t so important anymore, as companies need to take action early, stay flexible and be ready for change.
Andrew: Even if you are staying flexible and are taking quick and early action, it’s still necessary to have a handle of financial skills in order to make sure you have enough cash to pay for employees, iteration, etc.
Adam: On a similar note, a lot of companies these days, especially social media networking and mobile apps offer free services and don’t have a solid financial model at first. What should they do in place of financial projections?
Andrew: While it is sometimes good to focus on free products and services to gain early traction with customers, you still need a plan to show how long your cash is going to last and to project by when you plan on flipping to a profitable business model.
Adam: In your opinion, what is the No. 1 thing investors are looking for in a company?
Andrew: In my experience, investors are primarily looking for a business with a good core team that understands how the business will operate and how it can make a profit. Essentially they need to see that the business has a viable business model.
Thanks for reading—and tune in to the next Entrepreneurship 101 lecture on recruiting and building a startup team. I will be blogging on April 22 for the lecture on raising capital so check that out if you like what you read here.