As a modern-day entrepreneur, do you face challenges in managing your startup finances?
The health of your startup’s financial structure is certainly the key to success. It is quite common to encounter issues while dealing with the complexities of record-keeping, accounting, regulatory requirements, and taxes at the initial stages of your business. The truth is that managing finances is a simple task.
If you are establishing a startup then you are on an exciting roller coaster journey–each day presents a new set of challenges to be overcome. In this turbulent journey of a founder, getting your finances right can really remove glitches from the path to success. Streamlining finances from an early stage can help remove financial blockages that erode startup growth. Here is the HOW:
1) Know your business
For you to make money, you need to make optimum use of available resources. Having a clear picture of what you are doing and where your business is moving in your mind is not enough- it is imperative for you to keep record and plan. This will serve as the foundation of your business and will make it easier for you to define your short term and long-term goals, while staying focused on your startup idea. If you have a business plan, you are at an advantage, since you can identify the shortcomings of your business, seek direction from experts and finetune your document to include all necessary details investors are interested in. Your business plan presents a picture of your financial projections, which allows investors to understand how well you have worked on your numbers and what potential there is for the idea to scale. Once you have a business plan, the next step is to set the financial structure as per the industry and vertical. For this, you need to identify revenue streams, possible direct & in-direct costs, and balance sheet items. List down the possible heads of accounts and give it the shape of the ‘chart of accounts‘. It will help you in setting up the direction for the startup to classify income and expenses.
Once the structure is set, you can start listing project income and expenses to get a clear picture of profitability and your financial needs.
2) Separate your business expenses from personal
As an early-stage startup, you need to keep your business and personal spending separate before you are in the red. Many startups pay from their pocket / personal bank accounts for startup expenses and likewise receive income in their personal bank accounts without keeping a separate record, which creates complexities in the longer run. As an example, many e–commerce businesses in Pakistan use PayPal accounts of their close family members/friends to receive revenue from foreign sales.
Hiring a full-time employee with financial expertise might not be budget-friendly for many early-stage startups but if you know the ropes, then a simple excel sheet can do the job. Start recording all expenses and income in an excel sheet and reconcile on a weekly or monthly basis by tracing startup income and expenses from your personal accounts.
3) Make a legal structure
When establishing a new business, formulating a legal structure for your startup is the key to your endurance. You will require not only the knowledge of your business but also understand laws at a local and federal level. t is the responsibility of the business owner to identify and seek expert advice as to which registration suits his case (Association of Person / Sole proprietorship/ Private Limited Company / Partnership LLP).
Deciding the registration format can be tricky but do not worry it can always be changed/re–structured. At the ideation stage, you may think of setting up a partnership or sole proprietorship till the time you validate your idea. The legal structure a founder decides to go with is dependent on several factors including the nature of the business, and the knowledge a founder has on shareholding structures, tax implications and investor expectations.
4) Open a business bank account
Once you have identified your legal framework and registered your startup with a regulator, the next key step is to open a business bank account. If the ins and outs of the company are not streamlined at an early stage, it can create major complexities in the future especially with the FBR and for proven record for investors.
It is recommended to only use your business account to pay expenses and receive business income. Inject money in your startup account as share capital or loan; likewise, if you need funds for personal use, pay yourself through payroll or owners‘ drawings, and do not use your business account for your personal expenses.
5) Cloud Accounting – Go digital!
Once you have registered your business and set up your business bank account, you need to keep records of all financial transactions– an accounting software would really make your life easy. We recommend you use a cloud-based accounting software to monitor and track business transactions. A few top-rated accounting software are Xero, Quickbooks, Freshbooks, and Wave Accounting. Cloud accounting is valuable for your business as it allows multi-user access to collaborate, automate tasks, and 24/7 access without the anguish of bearing administration, up-gradation, and maintenance costs.
Further to that, cloud platforms can be integrated with banks, payment gateways, and different point of sale systems to automate your bookkeeping. All you need to do is simply register, check the charts of accounts, adjust if necessary, and start entering data. Categorization of transactions and data is essential for entry into the platform-e.g., salaries for employees can be categorized as a ‘Salary Expense,’ and each individual employee salary can be entered within this category.
6) Do a monthly reconciliation
A month after opening your account, go back and check how well your business is doing. Thanks to digital accounting tools, you can easily generate reports, understand if there are overdue payments, or just reconcile your bank with cash in hand.
Startups can easily lose financial control if they do not regularly track and monitor their finances which is why monthly tracking can give you a clear picture of your current financial position. It is also recommended to prepare bank reconciliation statements manually if your accounting system does not generate them automatically. You should also draw comparison between your performance and projections to understand whether you are deviating from your forecast and understand the possible reasons for this.
7) Create Financial Projections
Now that you have structured your business and its finances, it is time to keep an eye on funds and cash flows. Most businesses fail because they run out of cash. So, it is important to set a financial budget and growth in the form of financial projections for at least three years. The long-term revenue and expense forecast can help in setting up your business direction. Moreover, your projections will allow your potential investor(s) to analyze how your startup will operate in the next few years– how profitable you will be and what will be the return on investment. To create these financial projections, you need to get back to the initial financial projection sheet you made with the business plan. Now use historical data, research, and competitor analysis to set assumptions for every estimate you make for customers, pricing, expenses, and market–spread. Write it down in the assumption sheet for further clarity, record, and ready reference for later use. Run numbers as per your assumptions, classifying them as per your chart of accounts, and calculate your startup valuation. These projections and estimates should be backed by research and realistic assumptions rather than simply putting pie-in-the-sky measures. Any variations in the sales cycle should religiously be updated in the projections-many founders do not do this with a fear of recording how reality is deviating from prediction, however honest projections are really the key to your startup success.
Notice that these prefatory numbers are not only for potential investors but also for your internal working as a company. You can use them as reference point to run your startup and to validate your customers, market and product as your business evolves. However, it is crucial to be prudent. Do not expect your startup to become the next Amazon overnight.
Valuations are never carved in stone. They diverge based on several factors and the nature of your startup. However, valuation is important as it provides the basis for raising capital–what percentage equity can be offered at what capital needs. It allows you to gain a fair idea of your company’s worth before others determine its value.
At early stages, valuation does not exhibit the real value of your startup but rather the value potential investors will gain from investing in your startup. With no or little revenue, drafting your startup valuation can be tricky for which we will propose different methods and strategies in future blogs that will help you value your startup and facilitate you in fundraising in the future.
In summary, finance is fuel for your startup. You can avoid burnout and generate results by getting your finances right. The processes listed in this blog can serve as a checklist you can refer to, to know if you are on the right track. Stay tuned for more blogs on valuation, projections, and forecasting budgets. As a modern-day entrepreneur, do you face challenges in managing your startup finances?