Most founders don’t start off with a fully-fledged 3-year financial plan, with built-in scenarios and key drivers. Instead, they start off with an idea. They perceive a gap in the market, either an unnecessary friction point or an entire service gap. However, a robust and adjustable financial plan is a must when it comes to assessing your business idea or presenting it to potential investors with the hopes of attracting funding. A financial plan shows you’ve done the footwork. That you have a clear idea of the path your business is going to take, and how you will achieve your goals. Ultimately, it’s essential to building credibility around you, your idea, and the opportunity you’re laying out.
However, the process of drafting up a financial plan can seem intimidating, and even futile. Most preliminary business forecasts trace a similar pattern: for the first year the business invests in product development. Then in subsequent years there comes ever-accelerating profitability. However, when approaching investors, it’s crucial to have at least a basic business plan to show them, so you can prove your startup idea is cohesive and well thought out. Are you prepared to commit a large portion of your life for the next few years to your idea? Have you thought through various different outcomes and prepared for adverse situations? A plan will act as proof that, yes, you have.
If you’re new to creating business plans, read on for some basic tips on how to structure yours and what to include.
Understand Your Unit Metrics and Build Them Into Your Financial Plan
Investors want to know the unit metrics beneath your numbers. Unit metrics are how you measure the success of your startup, so you have an objective way of comparing yourself to external businesses as well as tracking your growth internally. Make sure you assess the validity of these metrics for each major milestone in your scaling journey.
Revenue
Investors will want to see you’ve thought out a solid process and mechanisms for bringing in revenues. This means you need to show them
- You’ve planned out how much to charge for your product or service
- How you will bill for it
- What upsell and downsell options there are in your pricing structure
Gross Margin
You can calculate your Gross Margin by subtracting your Cost of Goods Sold (COGS) from your Revenue. Then, divide that result by Revenue. For a company that sells a physical product or service, COGS would be the cost of each unit of sale. For SaaS services, this can just be your hosting costs. However, most SaaS companies also include the customer-success team as a unit cost of sale.
Development
What percentage of your revenues per unit sold will you invest back into product development? For the early years of your startup, this will likely be a fixed cost as you get your reach minimum viable product. However, as your revenues grow, so too should your quota of revenues to be re-invested in research & development. Your business plan should reflect this, to show investors that you are looking ahead to your startup scaling successfully.
Cost of Acquisition
Set aside a percentage of your product sales price as a projected cost for marketing and acquiring sales. It’s possible that this percentage will be greater than 100% at first. Investors will expect a period in the early stages of your business where marketing and sales costs may well exceed revenue. However, as revenue grows, it will outstrip your acquisition costs. And your percentage amount of revenues to be allocated towards marketing and sales will become more moderate.
Cash Conversion
Your Cash Conversion Rate is how long it takes for your business to turn its revenues into cash, and then use that cash to discharge costs. This metric effectively shows the relationship between your company’s revenues and cash flow. It shines a light on how quickly your business can turn an investment into returns. This will demonstrate whether your business model is likely to ultimately grow organically, or if it will always need injections of third-party capital.
Get the Mechanics of Your Financial Plan Right
Financial planning involves putting together a number of key financial statements for the future. Namely, these should include the following:
- Profit and Loss Account: This shows all revenue billed set off against all costs incurred over a given time period.
- Balance Sheet: This shows the amount of money the business owns, and the amount it owes at any particular point in time.
- Cash Flow Statement: This shows all the revenue collected and all the costs paid by your business over a given period of time.
These three statements work in combination with each other, and each should be assessed using the others as context. However, a common mistake made by founders is to start with a cashflow statement. Then down the road they struggle when they try to convert this running total into a profit and loss account and balance sheet. The best approach to get the mechanic correct is as follows:
- Step 1: Populate your profit and loss account from the unit metric and volume assumptions
- Step 2: Prepare a balance sheet based on how much credit you expect to give your customers. Offset this against how much credit you expect to be given from your creditors.
- Step 3: Formulate your balance sheet to solve for cash. Let cash in bank be the balancing figure always. That way, no matter what assumptions you make, your cash balance formulae will ensure that your forecast is always balanced.
For example, say you forecast the following for Year 1:
Revenue of €1.2 million
Costs of €2.4 million
Revenue to be collected 1 month after billing
Costs to be paid 1 month after incurred
Your investors have given you €2 million
Use this input to prepare your financial forecast, according to the 3 mechanics listed above…
Profit and Loss
Revenue of €1.2 million
Costs of €2.4 million
Loss of €1.2 million
Balance Sheet
Receivable €100,000
Bank Balance (formula) €900,000
Payables (€200,000)
Net Assets €800,000
Losses (€1.2 million)
Share Capital €2 million
Net Equity €800,000
The bank balance is a formula, and must solve to €900,000 in order for the financials to balance. Once you have the Balance Sheet working, you can then easily prepare a Cash Flow Statement from the Profit and Loss Account and the Balance Sheet.
Cash Flow Statement
Money In (Revenue less Receivables) €1.2 million less €100,000 = €1.1 million
Money Out (Costs less Payables) €2.4 million less €200,000 = €2.2 million
Cash Burn (€1.1 million)
Starting Cash €2 million
Ending Cash €900,000
Make Sure You Can Summarize Your Numbers in a Few Bullet Points
There is nothing more disheartening than preparing financial forecasts, poring over the construction and mechanics of your plan, only for executives and investors to tear it apart – sometimes only spending a few minutes reviewing the numbers. Unfortunately, a common pitfall when constructing business plans is to put the majority of your focus on the mechanics of the numbers, rather than assessing the merit of those numbers and what they say about the business. Can you describe your plan using a few key numbers? Are your words in sync with your numbers?
Always have a clear mental expectation of what the numbers will say if you tweak variables. Put yourself in the investors’ shoes, and try to predict the questions they will ask. How will you answer? Try to predict your responses solely from your understanding of your business. Then, check them against the model. Repeat the exercise. If possible, get a friend to help you prepare by playing the role of the investor.
It’s also important to understand the likely criteria of your investors, and what they typically invest in. Research the metrics common in the industry they invest in and be able to explain why your numbers are different.
Make sure your forecasts can demonstrate the return an investor might realistically get back. Remember, investors are not interested in investing in lifestyle businesses. They can deploy their cash into liquid growth companies on the stock exchange, so your return on investment must outstrip this. It’s by presenting them with a comprehensive and formulaically sound financial plan for your business that you can inspire confidence and persuade them that you’re a safe bet for investing.
If you’re a startup founder looking to scale your business, ProfitPal can take on the functions of an outsourced finance department to manage your payroll, R&D tax returns, and more. Contact a member of our team to learn how we can best help you and your startup.
