Startup Annual Planning 2: Budgets

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Hi, I’m Kwin, co-founder of and two previous startups. This post is part of my series about startups and tech. I’m always happy to be helpful to startup founders, and to people trying to break into tech, if I can be. Feel free to schedule a video call with me, here.

It’s January, so if you’re a startup founder you probably are working with your team on finalizing your plan for this year.

This week I’m posting on annual planning at early-stage startups. Part 1 was about setting a top-level company goal. This is part 2: the annual budget. And part 3 is about performance reviews and individual goals.

So what’s this “budget” thing, anyway?

The most important job of an early-stage startup CEO is to make sure the company doesn’t run out of money.

That means that you need a simple, granular, cash-based view of your business. Early on, it’s unlikely that you have a full time CFO or controller on your team. So if you’re the CEO/founder, you need to make the budget yourself, and pay attention every month to whether the budget still maps to what’s happening operationally.

You should not rely on a consultant, part-time bookkeeper, or accounting service to create or monitor your budget. There are many, many examples of startups going out of business suddenly because they had a higher burn than the CEO thought, or greater liabilities, or less money in the bank. Don’t let that happen to your company.

If you have finance training and are very comfortable using accounting tools (like Quickbooks), do your budgeting in whatever tools make sense for you For the rest of us, there’s that old standby, the spreadsheet.

Cash, cash, cash

By the way, you definitely should have real accountants do monthly, quarterly, and annual financials for you. But those financial statements will be accrual-based, not cash-based. Both the IRS and professional investors need to see an accrual-based picture of your company’s finances. But if you’re running an early-stage startup, you need to also think in terms of cash in the bank, and how many months of runway that cash buys you.

Translating between accrual-based and cash-based views of a company’s finances is one of those things that seems like it should be trivial, but isn’t. My answer to this is to maintain a cash-based budget myself, and work with our accountants to make sure the accrual-based financials they produce separately are accurate.

You can’t spend money you don’t have in the bank. So as a startup CEO you need to always, always know how much money you have in the bank, and how much you expect to have in the future.

A budget template

If you’re a seed-stage startup — fewer than a dozen people, less than about $1M in annual revenues — the structure of your annual budget should be simple enough that you can whip up a draft document in an hour or so. That doesn’t mean you’re done with budget planning that quickly, of course! The devil is in the details, and working on the budget really does help you plan for the coming year.

Here’s a template for an annual budget. I’ve filled it in with round numbers so that it’s easy to look at it and see how it works.

A quick tour

Like most budgets, this one is organized into three sections: spending, revenue, and burn/cash on hand.

Tracking spending in a cash-based view of the world is pretty straightforward. Every month, dollars go out the door. The spreadsheet should — at a high level — predict all of them. Some categories of spending are relatively fixed (salaries, rent). Some are variable (usage-based cloud services costs). But either way, it should be possible to project clearly what you expect to spend.

Tracking revenue is harder and more complicated. Revenue that comes in the door is a result of a lot of other moving pieces of your business model working together. Ultimately, you need to build your projections bottom up. For example, in a SaaS business you need to model revenue from existing customers, churn, acquisition funnel for new customers, conversion, and when customers actually pay you (annual vs monthly). Here’s a classic post from Brad Feld with advice on revenue projections. This is so company- and stage-dependent that in this template I just sketched out a very simple revenue section for a hypothetical SaaS company with two levels of subscription pricing. (I’ve ignored the underlying business model drivers. But you shouldn’t.)

Finally, the single most important line in the budget is the one at the very bottom: “Cash On Hand At Month End,”

Gross burn, net burn, and cash on hand

When people say “burn rate” they might mean either of two things.

Gross burn is how much cash you are spending each month. (Exactly the same as the Total Outgoing Cash number in our template.)

Net Burn is Total Outgoing Cash subtracted from Total Incoming Cash. In other words, the change in your bank balance every month.

This ambiguity about what “burn” means can be problematic. If you’re having a conversation with someone about burn rate, make sure you’re both talking about the same thing.

A typical monthly gross burn for a seed stage startup in the San Francisco is $15k times the number of employees on the team. (This is a rule of thumb that an investor might use, for example, to eyeball your budget and see if there’s something out of whack about it.)

Net burn, together with how much cash you have in the bank, determines how much runway your company has. If you’re “burning” $100k/month and have $1M in the bank, you can just divide $1M/$100k and see that you have 10 months of runway. This simple, static, calculation of runway is always important to keep in the front of your mind.

Your budget factors in how you expect revenue and spending to change each month. So it provides a more complex, informative, dynamic view of how much runway you have than simply dividing cash on hand by last month’s net burn.

Conditional equations for conditional decisions

At the very top of the template is an example of how to represent conditional spending or revenue changes in Google Sheets.

In this case, I’ve put two hires into the budget plan that (independently) might or might not happen. I find it useful to do this for things like hiring, and for large, discrete revenue items like big services contracts. You can look at the equations in the cells to see how I did it. (And if you have a better way of doing this, please share! I’m definitely not a Google Sheets jedi.)

Be aggressive in your goals and conservative about your projected burn

I put round numbers into the budget template that are more or less in the ballpark for what an early-stage startup might spend and earn midway between raising a seed round and being ready to raise a Series A.

You can see how much the numbers are projected to change over the course of the year. In this simplified model, revenue grows 10% each month. Net burn starts above $50k/month and declines to almost $0. And the company goes from having $500k in the bank to having less than $20k on hand!

Clearly, these projections indicate that either the startup will need to raise another round of funding fairly soon, or more aggressively control costs, or generate revenue faster.

The basic idea, though, is that things will change over the course of the year. As a startup founder, you hope you’ve anticipated the way things will change, but that’s never completely true. (Here’s another great post from Brad about that.)

Here’s my advice. First, be aggressive in your goals for revenue. Aiming high is a good — really, a necessary — thing for a startup. But at the same time be conservative about how you project your burn rate. It’s important not to have money leave your bank account faster than you anticipate.

You should always have a backup plan for managing cash on hand if revenue arrives more slowly than you project. That means knowing where you can cut spending if you have to. It also means making sure variable spending doesn’t increase too much, too fast, in advance of revenue. Hire more slowly than you’d like to. Be quick to cut down on ad spending that isn’t producing results. Monitor all of this monthly, and adjust the budget to account for changes on that all-important “cash on hand” number.

I hope that if you’re working on your 2018 plan, the above has been helpful. Please feel free to read the part 1 and part 3, if you’re so inclined. And let me know in the comments what I missed or got wrong!