Proper financial modeling is critical, but not for the faint of heart.
Work with enough early stage companies, and you’ll inevitably hear reference to a financial model. Depending on the company in question, the model will be either a mysterious topic discussed only in hushed tones, or something casually mentioned on a Friday afternoon as a box to check in the start-up’s sure-to-be rapid ascent to riches. Neither is correct; in my experience, entrepreneurs at early-stage companies almost always approach financial modeling from the wrong angle (if at all), resulting in incorrect expectations and potentially costly decisions down the road.
Here’s a quick list of the five most common misconceptions and mistakes that early-stage management teams make when it comes to modeling.
Proper financial modeling is not for the faint of heart, and it’s one of the areas in which Burkland’s on-demand CFOs excel. It requires an interesting mix of accounting knowledge and good, old-fashioned operating experience to do well, which means modeling is often the very last thing an entrepreneur wants to tackle. But it’s critical to not only understanding and managing the inner workings of your company at a granular level, but also to raising outside capital, and most importantly, to understand all the moving parts that affect your own business. Take the time to do the modeling right; your company, your investors and you will be thankful you did.
Photo courtesy of Christopher Michel.
To grow faster, follow their footsteps and learn from their mistakes.
For this article, I found a quote from Steven Dunn that says that “You can never make the same mistake twice because the second time you make it, it’s not a mistake, it’s a choice.” Quite fitting regarding how we can learn strategic finance lessons from second-time CEOs and avoid some of the mistakes they made in their startups the first time around. At Burkland Associates, we give strategic finance cover to many CEOs that have been there before, here are some of the lessons we’ve learned from them:
A few years ago, RedRocketVC came up with a checklist for startup success. One of the items on their list is “Flexibility to fine-tune model and navigate challenges.” We see it and hear it from our CEOs time and again: modeling is one of the very few “must haves” for any startup. For a startup, business modeling and finance modeling is exactly the same thing. It may seem like a theoretically painful process, especially early on, but it is definitely one that will yield many benefits. A sound financial model that you can iterate over time, provides clarity on the current business and also illuminates the strategic choices available. Furthermore, this model will focus product, sales, business development and management on the same strategic plan and the levers available to make it viable.
Another reason to invest time in modeling is that a sound financial model will help you see the holes in your go-to-market approach that an experienced investor will detect at first sight, enabling you to bulletproof your investor pitches. Also, strong financial modeling will help a founder show investors the tangible steps to transform their idea first into a successful revenue model (generates revenue but burns cash) and eventually into a successful business (generates both revenue AND cash!).
Although good accounting is a basic skill every startup needs, its role needs to be understood. It is natural for a good accountant to become a “right-hand” guy for a CEO early on. After all, the accounting person usually knows more about the overall business than other management team members. Thus the CEO will often use them as a sounding board for discussing future plans for the business.
This is where things can go wrong. Good accountants are trained to look in the rearview mirror to make sure you do not leave out anything from the financial scorecard that provides an honest assessment of historical company performance. What they are not trained to do, however, is look out the front windshield and see what’s coming and/or which strategic turn the company should take.
That is the role of a strategic finance professional, who can use both the rearview mirror as well as look out the front windshield to help a company navigate around the obstacles and find the opportunities in the road ahead. Accounting and strategic financial professional are very complimentary and should be brought in as early as possible in a startup’s life — and remember, they are more affordable than ever since you can rent both in the new sharing economy!
The third lesson in finance we can learn from second-time CEOs concerns financial discipline. Financial discipline implies running your business based on both your financial model (which is forward-looking) and your accounting (which is backward-looking). Take these two extremes. First, most first-time CEOs have a good innate sense of their monthly burn (they usually are signing the checks!) and yet they are often surprised when the money runs out.
Why? Often founders do not want to really think about what is happening to their dwindling cash and without a true cash flow statement it is easier to not think about what is coming. Real financial statements with a solid cash flow statement provides founders with an unambiguous picture of what is happening to their cash including how important payment terms and collections are to making your payroll in the coming months before that next fund-raising round. This becomes especially important with the big-name clients that often will only accept 60-day payment terms when most of your own expenses need to be paid in less than 30 days.
Strategic finance as an early partner to grow with confidence
Like second-time CEOs, most successful first-time entrepreneurs eventually come to realize the finance function is more than just parental supervision required by their institutional investors. The only question is how much time (and opportunity cost) passes before they recognize that strategic finance is a vital ongoing partner in company success…just like development, sales, marketing, and customer success.
Photo courtesy of Christopher Michel.