According to the Small Business Administration, the federal organ that provides support to entrepreneurs and small businesses, about 20 percent of new businesses survive their first year while around half of them shut down after hitting the five-year mark with only one-third making it to their 10th anniversary.
These are alarming statistics that can instill fear into every budding entrepreneur. And yet, they only tell a small part of the story as there are several reasons why some startups fail while others soar. They include not having a product or service that fills a specific need in the marketplace or not leveraging marketing that lets your community and target audience know about your business.
Another key reason for startup failure is not having a well-thought-out and clear financial plan or model in place prior to the launch. This might sound like a banal tenet pulled from every business 101 class but it bears repeating: Financial planning for startups, particularly when they're in gestation mode, should never be ignored or downplayed. Without having a financial plan as a foundation, startup entrepreneurs will not only encounter difficulties when it comes to keeping their business afloat that critical do or die first year; they might also struggle with attracting the necessary financing, which includes bank loans or venture capital that can help grow their business to its next level.
Financial Planning for Startups
A business plan is a clear outline of goals and how to reach them. It is an essential tool that should be in the entrepreneur's arsenal. It's what separates a business that has yet to formally launch from a mere idea. One of the most important elements of the plan is the financial section, which contains key elements such as sales forecasts and revenue projections. This information is the piece de resistance of the plan as it can play a significant role in swaying potential investors or financial institutions into backing the startup.
Ivan Ivankovich, co-managing director of California-based Full Stack Finance, a provider of accounting and financial services for startups, agrees, insisting that this section is especially compelling as it provides startup owners with an opportunity to translate their ideas from the abstract into concrete numbers.
“Investors want to see that you understand the numbers and have thought through your execution strategy,” he said. “They want to see the founders’ financial sophistication level--not just the product/marketing expertise.”
More than that, Ivankovich adds that the forecasts “gives confidence to prospective investors that you understand the key financial drivers, costs and the capital it takes to build your business."
Key Elements of Financial Planning for Startups
Forecasting sales and revenue projections
Startup entrepreneurs need to make informed revenue projections based on inventory, market, geography, and demand. What is the pricing of your products or services? What are your overall vendor costs? What is your target demographic and how do you intend marketing-wise (i.e. word of mouth, local press, etc.) to reach this customer base to let them know about your business? Further, how much do you expect to generate in sales during the first year? What about five years? These estimates should be grounded in solid financial reporting and not simply pie-in-the-sky conjectures.
When making these projections, don’t forget the assets and liabilities that aren’t in the profits and loss statement. The latter pertains to loans and inventory that are assets until you pay for them. To figure out assets and liabilities, look at your assets and then gauge what you will have each month for cash, accounts receivable, inventory, equipment, and property. Then you can figure out debts or liabilities.
Bear in mind that these aforementioned numbers are not only to show bankers or potential investors the possible growth trajectory of the startup but for your own benefit as well. Use it as a guide to run your startup. However, at the same time, be realistic. Don’t act like your business will be the next Facebook or Google. And, if you foresee retail slowdowns due to the vagaries of the sales cycle and holidays, be honest about it. The bankers and investors you approach are not gullible and will be able to see through the disingenuousness. You’re not the only business owner who has approached them for funding. Even if they do turn you down initially, it’s important you leave a positive impression otherwise your chances of securing financing from them in the future may be nil.
Writing a cash-flow statement
The longevity of a startup very often hinges on cash flow, which is dollars moving in out and out of the business. Many young businesses have faltered as a result of not having sufficient cash flow. For startups that haven’t launched, forecasting cash-flow can be a dicey proposition. In this vein, you will need to make a cash-flow projection for the long-term. How many of your invoices do you expect realistically will be paid in cash during a given period? Again, be truthful with yourself: If you realize you may have instances where your cash flow will be running poor, then you will need to adjust expenses accordingly to prevent this.
Do a breakeven analysis.
This is when your business expenses are commensurate to your sales volume. A three or five-year income projection will help you make this analysis. If your startup is viable, then it stands to reason that your revenue may eventually surpass your expenses. Potential investors will want to know this as it could entice them to back your company.
Don’t forget to update the initial forecast -- things change!
A big mistake that some entrepreneurs make after creating the forecast is forgetting to review it later on. It behooves every business owner to review his/her initial financial plan regularly and compare the earlier projections with the actual sales figures. If there are disparities in the figures and most likely there will be, then the information should be used to revise the forecast.
Whether it’s attempting to secure financing from banks or private investors or simply to keep your business alive its first year, financial planning for startups is essential. The best way for an entrepreneur to accomplish this is by writing a comprehensively detailed analysis and projection in the financial section of your business plan. Ultimately, it’s not about predicting the future but presenting intelligent projections that could be instrumental in determining the success of your business.
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