Financial Model for Founders
Running out of money is one of most common reasons for startup failures. You can reduce this risk by making a few simple estimates and updating your plan to make it both realistic and economically attractive.
Opportunity search. Many people find an opportunity first, then start looking for resources for make it happen. Do the opposite. Estimate your resources first, then look for opportunities that match this budget.
Decision to start. How profitable can this business be? Do you have enough money to survive until the project breaks even?
Measurement system. What are the key numbers of your business? Do you have written projections to keep the company on track?
Action steps
- Plan your budget and burn rate.
- Identify key business drivers and make revenue projections.
- Estimate a concrete calendar date for breakeven moment.
Project budget
The budget is the total amount of money you can put in the project. Be ready to loose them all. The budget comes in two parts:
- Initial capital the team has on day one.
- Money that can be raised in critical situation: family, personal loans/credit cards, selling assets (your car, garage sale, electronics), part-time work on other jobs.
Initial budget does not include money sources like investors or business loans. These fundraising opportunities are typically open only after your first business success.
Your budget is a hard number. Know it.
Example: We can put $125000 in our restaurant.
Expenses
There are two types of expenses:
- Fixed expenses that you have to pay regardless of customer transactions. This category includes incorporation, salaries, rent and equipment.
- Variable expenses that are based on number of products sold or amount of services delivered. Typical examples: costs of materials, support costs, delivery, sales tax, reseller cut, and author royalties.
Many new projects have a large one-time setup cost plus slowly growing monthly expense (called burn rate). Variable expenses come later, after the first paying customer comes in.
Be creative and think about ways to minimize both the setup costs and monthly burn rate. Shift expenses from fixed to variable. Compensate employees and vendors by small fixed payment and a share in company revenue. Cut or postpone all non-critical expenses. Ask others how you expenses can be reduced.
Revenue projections
Monthly revenue typically comes as some simple formula from a few parameters call key business drivers.
Examples: number of visitors multiplied by average check. Sum of revenue from three types of services. Your unit price multiplied by number of customers multiplied by average amount of service usage.
Now you need to estimate these key business drivers. The best way is to use analogy. What are competitor prices? How much customers do they have? How much money do customers spend on similar products.
As a secondary estimate use “bottom up” approach. What can be initial numbers (price, customers) at the very first month of your business. What kind of growth is realistic from this initial base?
Using “top down” estimates (total size of market multiplied by your market share) is almost always unrealistic. Do not use them as your primary planning tool.
Breakeven moment
Breakeven is a moment when your monthly revenue exceeds monthly expenses. Fixed expenses are relatively easy to control, so it comes to reaching a certain revenue target.
Example. You fixed expenses are $12 000 per month and variable expenses are 40% from sales. Then, you get to breakeven at $20 000 monthly revenue ($8 000 in variable expenses + $12 000 fixed expenses).
Have a hard calendar date for your expected breakeven moment. Check with other similar businesses, what was their time-to-breakeven?
Financial model review
Do you have enough resources for setup costs and covering monthly deficit? Compare you burn rate and your budget. How long can you survive without any revenue? With revenue twice below your projections? What will happen if breakeven will take 50 percent more time than what you expected? Two times longer?
Take into account payment delays. Customers pay late all the time. Especially in the case of big corporate orders. Have some overdraft credit solution on hand.
Show your estimates to other people. What numbers seem most unrealistic to them?
Keep control
Get your key estimates in written: budget, setup cost, burn rate for fixed costs, ratio of variable costs to sales, key business drivers, time-to-breakeven. These are estimates, not truths.
Update your model every month or so. Do you have enough remaining cash to get to the new date of breakeven?
This article is a part of Earlydays, an open guide for first-time entrepreneurs.
Written by Yury Lifshits — yury@yury.name — @yurylifshits
