October 12, 2012 | 5-minute read (968 words)
When you’re an entrepreneur, you’re busy working every day to find your way, build and optimize your product/services, grow your company, and achieve your goals. With your hands so full, it's not easy to also stay on top of all of the day-to-day accounting (AP/AR, payroll, 1099s, etc.) and bigger picture finances—and sometimes important financial details can fall by the wayside. Even if you're a financial whiz, creating a financial plan and managing your finances can be challenging. But it is essential that you understand the importance of accurate financials—both for your own stability and ability to plan, as well as to convince and assure potential investors of the validity of your business and actual investors that you're not wasting their capital.
Unfortunately there are many financial mistakes that startups make. However, once you know the potential missteps, you can take simple steps to avoid them. Here are the top 5 financial mistakes startups make—and how to steer clear:
1. Miscalculating (or not calculating) your cash burn. Your burn rate is the amount of capital you go through every month to keep your business running. If you don’t have a good understanding of your burn rate, you are seriously hindering your ability to achieve your milestones before your money runs out. According to some recent surveys of new business owners, approximately one third admitted to underestimating monthly expenses. Along the same lines, almost 20% of new business owners realized that they didn’t have enough financing. It’s all too easy to miscalculate your operational costs, which leads to your initial financial assumptions being off. Keeping good track of all of your startup expenses can help.
The first step in managing for cash flow is to create a bottom-up projection, using real-world variables. (see my previous article on Bottom-Up vs Top-Down Forecasting). Top-down forecasting can lead entrepreneurs to be overly optimistic about the sales they’ll close and the revenue they’ll earn. Bottom-up forecasting will give you a more realistic (albeit a less inspirational) gauge of how much money you’ll need to get going—and keep going.
Reforecasting is also key. You need to account for both fixed and variable costs and continually make projections that accurately reflect the real state of your business. (For more information about managing your burn rate, see my previous article on How to Reduce Your Startup Business Burn Rate.)
Contact Early Growth Financial Services for help calculating your burn rate.
2. Not completely understanding your marketplace. If you don’t properly understand your market, you may be guilty of mis-pricing your products/services. Don’t merely add your costs and calculate in the margin you’d like to make. Consider your market position and the value of your offering; start with price and work backwards. In your calculations, keep coming back to the marketplace: who is your customer, what need does your product/service fulfill, what do you have to offer, who is your competition, what differentiates your offering, and what trends may affect your market—and how.
3. Hiring and expanding too quickly. One of the greatest expenses of any company is its people. To keep your costs low, you need to consider ways to save money on staffing. A big mistake many startups make is to hire too quickly. Too many employees is a huge drain on your funds.
In addition to the recruitment and salary costs, there are additional physical costs such as a necessarily larger office space, equipment, and supplies. There’s also the psychological cost: what will happen to these people if your company doesn’t grow and you need to lay them off? And don’t forget the all-important reputation cost as well: how will it look to investors and others if you have to disassemble your team? Instead, hire slow as you go.
4. Making bad hires. Another key to saving on staffing costs is to hire for potential, as opposed to experience. Don’t waste money hiring experience, just for the sake of experience. And, whenever possible, outsource non-core competencies, from development to marketing to accounting.
(For more startup staffing tips see my previous post on Bootstrapping Your Startup: 3 Staffing Tips.)
5. Doing your own finances. If you’ve closed a seed round of funding, have a lot of expenses, and/or are earning real revenue, you need a CFO to help you manage your finances on a strategic level. If you don’t yet have a lot of financial activity, you may not yet be in need of CFO services, but, at the very least, you still need some financial support with your day-to-day accounting and bookkeeping. Even if you have the accounting skills to manage the block-and-tackle accounting, it's not a good use of your time. Better to hire a professional to help you with these administrative tasks so you can focus on your core business.
Note that there is no need to bring a full-time accountant and CFO on staff. If your company is still small, it makes more sense to outsource these functions, getting support on an as-needed basis while simultaneously reducing your cost structure.
What financial mistakes has your startup made and what have you learned from these mistakes? Let us know in comments below or contact Early Growth Financial Services for help avoiding financial mistakes.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, a financial services firm providing a complete suite of financial and accounting services to companies at every stage of the development process. He's a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.