The Most Common Financial Mistakes by Startups
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Abstract Finance is about more than just money and numbers. This article explains importance of five key elements of startup finance i.e accuracy in financial projection, recognizing the key drivers of profitability, to compete the market on value, underlying financial flows of the business and also analyzing right way of financial numbers on which every startup can build the company. These are key elements for success of any startups. The author has found the common financial mistakes that startups often make. Here in this article author has explained these financial mistakes that a startup should refrain from and avoiding which will likely funnel the common mistakes that usually kills a startup at an early stage. |
A successful start-up cannot start a business just with passion and an idea. When anyone begins to contemplate starting a business, they assume it will be successful, but many entrepreneurs find out after launching the company that success can be elusive. A high level of leadership skills, Analyzing the market’s needs, formulating business strategy, maturity to see things in right perspective along with the ability to take calculated risks are required on the part of the entrepreneurship. Lack of awareness, lack of mentoring, Not adapting quick enough, Startup lacking Vision, lack of successful innovation, forecasting errors, Business Plan Mistakes, common HR mistakes, Lack of Uniqueness and lack of reforms are some of the common Mistakes. Did you know that nearly 80-90% of Indian startups fail within the first 5 years of their inception?
From 2016 to 2018, the highest numbers of startup failures have been in the e-commerce, fintech, consumer services and food tech sectors. This calls for a profound contemplation on the possible reasons for such a trend. It is important to analyze the common mistakes made by the Start-Up founders and their Investors.
Here is the only list of Financial Mistakes that a startup should refrain from and avoiding which will likely funnel the common mistakes that usually kills a startup at an early stage.
# 1 Financial Projection Mistakes
No matter what approach you use to build your startup’s financial model, it is crucial you are able of substantiating your numbers with assumptions. As a startup, historic data is often not available, so you need to be able to present the ‘proof’ behind your numbers.
This will also help you when you start discussing with investors, as they are typically interested in knowing the reasoning behind your numbers. They are considering putting money in your company, so you do not want to give them the feeling you are selling baloney!
In order to produce a financial forecast for your startup that you can rely on, you need to find a balance and be realistic. Underpin all your projections with facts and data but don’t get too wrapped up in the details of your research.
It might be worth considering forecasting different scenarios – best case and worst case and discuss them with your mentor or business advisor. This way, you could unpick the data behind each forecast, and will you will probably end up with a happy medium.
Assumptions can be anything that validate your numbers: market research, web search volume, contracts with suppliers, pricing validation, historic sales, conversion rates, bills of materials, website traffic, etc. It could be useful to create a “data room” (e.g. a Drive folder) in which you collect these kinds of evidence. By doing so, you are slowly building a library that underpins all the numbers you have put in your model and you are well prepared in case an investor might request a due diligence process.
You can find ten common errors below:
- A mismatch between the financial model and the business plan: a financial model should resonate with the overall business strategy
- Overoptimistic or very pessimistic revenue projections: check out section ‘Revenues’ on how to forecast sales
- A funding need that is not adequately explained: make sure you include a breakdown of costs
- Underlying assumptions that are not clearly defined: you should be able to provide clarification or proof to the numbers
- Not enough employees as part of the personnel forecast: do not underestimate the number (and costs) of employees you need to build a fast-growing company
- Revenue projections which are not aligned with the market size: revenues cannot be larger than the size of the market
- Operational expenses that are being left out: make sure expenses are aligned to your strategy
- Operational expenses which are misaligned with the forecasted revenues: make sure expenses resonate with revenues
- No realistic view of the gross, EBITDA and net margins: when speaking with investors, always be prepared to answer questions on your current and expected margins
- Disregarding the importance of working capital: do not underestimate the effect of payment terms on your funding need
# 2 Competing on price, Not Value
Making a business successful might be a complicated venture, with two routes for profit standing out above all the rest — price and value. As an entrepreneur, ask yourself, “What makes my product or service worth what I’m asking my customers to pay?” You can compete on price or quality, but it’s hard to compete on both.
The big players, already established, have greater leverage on pricing. They undercut, lower prices, offer discounts, offer freebies. They can afford it. Startups can’t. That doesn’t mean they can’t compete. Startup have to add value to what’s already available to customers. If your service or product offering adds value to what is already available in the marketplace or if the value is added by offering something that’s not found anywhere, you don’t need to be a low-price leader. The lowest price is the last place you want to be in to compete because it’s too vulnerable to too many variables. If you’re focused on the greatest value, your main concern isn’t managing the external variables that could affect price, but are focused on adding what matters to your customers to your offering. One of the arguments in pricing strategies is that if you don’t have the lowest price, people won’t buy. It’s false. If you don’t have the lowest price some people won’t buy. But in the end, who are those customers? Customers who shop solely based on the lowest price can never be loyal to brand customers, because they’re loyal to price first. In the end, there’s always someone out there willing to make some crazy deal, even if it’s just temporary, and when there’s that possibility, those price-only focused customers will always leave for the lower price.
Value-based customers are your prime group for creating long-term loyal customers because value customers realize the potential in your offering.
# 3 Not recognizing Key Drivers of Profitability
There are four major profit drivers: 1) price, 2) variable costs (i.e. those costs that vary in direct proportion to revenue, typically represented by cost of sales), 3) fixed costs (or overhead), and 4) sales volume. In other words, these are the underlying issues that directly determine your company's financial performance. If you want to increase profitability, then you must work on these areas.
Which leads to an interesting question: do all these drivers have the same impact on profit? Without getting into too much detail, the simple answer is: no. In fact, price will always have an impact that is two or three times greater than any of the other drivers. The reason for this is quite straightforward: an increase in price has the greatest impact because every additional dollar goes straight to profit. By comparison, an increase in sales volume will be accompanied by an increase in variable costs, so the gain will be smaller. A decrease in variable costs will increase the margin but will not increase overall revenue. Finally, a reduction in fixed costs (i.e. overhead) has no impact on revenue and therefore will always have the smallest impact of all.
The strategic implications of this analysis are very important. Many business people are preoccupied with getting more revenue, often from new customers. However, they often pay little regard to the customers they already have and usually adopt the view that price is something over which they have very little control because of competitive pressure (classic mistake #1). They also believe that reducing costs is the most effective way to building a profitable business (classic mistake #2)
This is absolutely the wrong way to run a business. Even though it makes intuitive sense that cutting costs leads to improved profitability, there is a big qualifier to this. If a cost is necessary for you to do business (for example, customer service costs), then reducing it may reduce your capacity to do business. Furthermore, the costs that can be reduced most easily are usually those of a "discretionary" nature, and these tend to be the ones geared toward building the future of your business (marketing, team training, R&D, etc.).
Calculating the breakeven prices of its goods and services allows a business to check that it is charging appropriate prices to its customers and, more importantly, making an enough margin on sales. Many small business owners calculate the cost of supplies but do not accurately assess the cost of factors such as their own labor or marketing. The break-even price for a business is the amount at which it would sell its good or service to cover the costs of production. Anything above the break-even price is profit.
# 4 Profit and Cash Flow: they’re not the same thing
There is a common misconception among many business owners that profits and cash flow are the same thing. They are not. For a business to thrive, it must generate profits while also operating with positive cash flow. The two terms represent different financial parameters, but in order to thrive, every entrepreneur must have a solid system to keep track of both. A good way to learn respect for the concept of cash flow is to compare it to the idea of profit. As a business owner, you understand and strive to make a profit. If a retail business can buy a retail item for Rs 1,000 and sell it for Rs 2,000, then it has made a Rs 1,000 profit. But what if the buyer of the retail item is slow to pay his or her bill, and six months pass before the bill is paid? Using accrual accounting, the retail business still shows a profit, but what about the bills it must pay during the six months that pass? It will not have the cash to pay them, despite the profit earned on the sale. While this is a basic premise of accounting, many entrepreneurs don’t fully grasp the accrual accounting concept. Also, many business owners plan for increasing profits but don’t spend the time needed on improving cashflow.
# 5 Lack of processes to manage and maximize cash flow
Being profitable on paper is one thing but having the money in your pocket is quite another. Letting receivables gather dust is a common cause of small business failure; healthy numbers alone can’t pay for premises or keep the lights on. For this reason, it’s important to have standard timeframes for sending invoices and collecting payments. In the event a customer is late on a payment, having a follow-up system is essential if you don’t want them to make it a habit.
Some Startups tend to send their invoices significantly after the services were performed. When companies send out invoices on a late schedule, the customer may not only forget about the services that were provided, but also has been conveyed a message that they can take their time in paying the invoice. The general rule is that you should try to get an invoice to your customer within one week. It is also recommended that you make it as easy as possible for your customers to pay you (e.g. accepting credit and debit cards, direct deposit, and so forth). If you prefer your customers pay you via a cheque, that’s fine, but be sure to deposit the cheques on the day you receive them and not have them sit in a deposit book for days on end. In today's world, e-transfers are quite common in many small businesses.
Many Startups do not take the time to create and implement a credit policy that dictates the required payment terms that need to be conveyed to your customer and the call to action if accounts become past due. A comprehensive credit policy is a company’s road map that will greatly supports its ability to increase its cash flow and minimize the risk of selling on credit.
Poor inventory management practices can suck up a lot of cash and leave a company with more inventory than it needs. However, on the opposite side of the equation, too little inventory can leave a company unable to fulfill orders. The key is to accurately forecast sales, which can be used to predict needed inventory levels. Companies can also implement inventory management practices such as just-in-time (JIT) inventory management principles, which encompass procuring inventory just in time to make the sale.
Too often business owners do a cash ?ow forecast in their head. Putting the cash ?ow forecast on paper, however, will give you the following: ? A format for planning the most effective use of your cash (cash management). ? A schedule of anticipated cash receipts – follow through to see that you achieve it! ? A schedule of priorities for the payment of accounts – stick to it! ? A measure of the significance of unexpected changes in circumstances; e.g., reduction of sales, strikes, tight money situations, etc. ? A list, on paper, of all the bill paying details which have been running around in your head, keeping you awake nights. ? An estimate of the amount of money you need to borrow in order to finance your day-to-day operations. This is perhaps the most important aspect of a completed cash flow forecast. ? An outline to show you and the lender that you have enough cash to make your loan payments on time.
Managing Finance is di?cult for most Startups. If these above common financial mistakes are avoided, the chances of surviving of Startups will increase. Financial accuracies are critical to the success of each startups. Without meaningful and actionable insights, you can hardly evaluate the current state of affairs or plan the future business moves. Partnering with a Management accountant who has the skill and expertise to guide business can greatly contribute to the success of Startups.
Linkedin - https://www.linkedin.com/in/dramarendrakumar
REFRENCES:
http://www.feedmeideas.com/startup-forecast-mistakes/
https://smallbusiness.chron.com/important-entrepreneurs-develop-financial-plans-companies-73993.html
https://bizcapcommercialfinance.com/common-cash-flow-mistakes-to-avoid-for-new-entrepreneurs/