3 Biggest Mistakes In Financial Planning For Your Startup
Over the years, I’ve seen a number of start up companies’ business plans. It is interesting to see how they can be so different. Most of the time people go over the same areas: business model, marketing and sales, competition, etc. But there is a really wide range in the quality in terms of the financial plan. Some people create really fancy spreadsheets with many linked tabs and beautifully formatted charts. Some create a simple, straight forward one-sheet plan. While others create a document that is hard to follow and doesn’t take into account the basic drivers of revenues and expenses nor accounting rules. These issues come from the fact that most entrepreneurs are not trained in accounting and finance. This isn’t bad or good. It’s just a fact. Once you learn some basic concepts and how they work for your business, you are really set. You will need to hire an accountant anyway, so no need to learn all of the details yourself.
If you are creating the plan for yourself (not for investors) it only needs to make sense to you. But with that being said, you do need to take some things into consideration in order to make the plan useful. Let’s assume that you know some basic finance and accounting and that you need to create a plan that shows revenue, expenses and the cash in and out over time.
In this exercise of planning revenue, expenses and cash in and out I have some of the same mistakes over and over. When creating your plan try to avoid the following. It will help you to create a plan that actually helps your business to grow and you to make smarter decisions.
1) Not taking into consideration payment time
I put this one first because I think it is the most important. You need to know when you are going to collect cash in the bank. This means knowing how much time it will take to get cash in the bank after you close a sale. It does not matter if you closed a million dollars in sales if you do have have enough money to pay your suppliers, employees and other expenses.
If you run an ecommerce business for example, check the time delay in credit card processing to bank transfers. I have seen between two and five business days, but it may depend on your business, industry and relationship with the bank. Also, find out the credit card policies on refunds and chargebacks, you may be liable to give refunds to customers in the future because of the agreement with the credit card processor.
If you have a subscription business, when do you collect the cash from sales? Before the subscription starts? 30 days after the customer signs up? Monthly?
If you have a consulting business, how is your contract structured? When will you invoice clients? How long will it take for your clients to pay you?
Make sure that you understand how much time it will take to get cash in the bank. The rule of thumb is usually the larger the amount, the long it will take.
2) Not taking into account seasonality
I have seen people say I am going to sell X units next year. Then they divide X by twelve and evenly distribute the sales across the months.
Not only is that very unlikely, it is dangerous from a cash perspective. If you did your research about the seasonality of your products, then you will likely find that your sales will not happen evenly throughout the year.
Let’s say for example, most of your sales happen in the second half of the year. If you don’t plan to for minimal revenue in the first half of the year, your business could shut it doors because you ran out of money before you even got going.
Every business will have a time of the year when they are selling more or selling less. Getting a handle on the seasonality of your business is key to your company’s success. It enables you to plan for lean times. Often times certain industries are seasonal or you may even sell seasonal products. This makes a big difference in your sales.
3) Mixing the cash flow statement and income statement
Just a reminder that the income statement shows your revenue and expenses when they happen and the cash flow shows cash in and out when you receive it or pay bills.
The income statement is a little trickier, but bear with me. It is very important in service businesses, like SaaS, Consulting firms, Accounting firms, etc. This is because in these industries you may collect cash upfront and deliver the service later. On the income statement you must put your revenue in the month that the service is delivered. Make sense?
For businesses that sell physical goods, you need to account for the cash out to pay for inventory when you buy them. So if you get 1,000 pieces from a supplier and you have to pay that supplier upon receipt, you need to take that into account on the cash flow statement. It doesn’t matter when or if you ever sell the inventory. Without enough cash on hand you will find yourself in a terrible loop: unable to pay for inventory because you do not have cash and you cannot get cash because you do not have inventory to sell.
The problem with mixing up the accruals from an income statement with the cash in and out from the cash flow statement are that you could easily run out of money.
Business planning is an iterative process. You need to plan, review, compare, analyze and then plan again. In the beginning it may seem cumbersome, especially because you have no idea what to expect, but it will become easier over time. Planning for your business needs is the best way to set yourself up for success.