Accounting isn’t the sexiest part of running a startup. But without clear visibility into your financials you’re putting yourself and your company at risk. Paul Graham generally has excellent advice for startups, an example of which is to “not die”. As soon as the cash starts flowing (customers start paying or you start providing paychecks), you’ll have a hard time not dying if you don’t keep your eye on a few metrics.
I’ll leave more advanced matters for future posts but let’s get started with a couple of things you can’t afford not to track.
Cash flow forecast
Cash flow is probably at the top of the list of failures for startups. It represents the total amount of cash that enters and exits your company. Having a clear idea of where you’ll land in the next few months helps you make better decisions across the startup, from recruitment, to contract negotiation, to when to buy the newest MacBook Airs.
I keep the following in mind when preparing a cash forecast:
Round up your costs. If your payroll is averaging $6,510.00, bump it up to $6,600.
Don’t overestimate your income and expect slow payments. I usually consider everything we receive will be Net 45 (payment is to be received under 45 days upon receipt of the invoice).
Cash will run out faster than you expect. If you think you’ll have a slow month, and it will impact you at the end of your quarter, start acting on it now. Expect the unexpected. Events that accelerate the reduction of your cash reserves will happen.
The Profit & Loss statement provides an overview of revenue, costs, and expenses over a specified period of time. It is commonly used to know how profitable a business is and its ability to cut down costs.
There are many KPIs you could be looking at, depending on what you do and what you’re aiming for. That being said, there are a few important questions you should always try to answer:
“How long would I be able to run the business with only what I have in the bank right now?”.
Your runway should tell you how long you can go by without any sales. It’s a critical aspect of planning as time can be tough and cash flow is not linear over time.
“How much does it cost me to run my business?”.
Your overhead includes all the costs that are not related to direct labor (salaries, taxes, etc.) but need to be paid to make sure the business is running (rent, utilities, etc.). This is a key component to define the pricing of a company as those costs are difficult to compress.
“For each dollar that hits my bank account, how much do I keep?”.
The Net profit margin is the profit after tax divided by the revenue. It is a great metric to figure out the evolution of the profitability of your operation over time. You’ll have a hard time comparing it between businesses as different types of activities have widely different profit margins, but you should be able to ballpark where competitors stand.
Small businesses tend to overlook financial metrics, preferring to focus on activities that have the potential for generating profit. In the case of startups, it usually means working directly on the product. With that being said, a proper understanding of your cash flow and P&L is key to managing your growth and gives you key insights as to what your options are at any time.