Why is it essential for startups to have their financials in order?
This was the topic of a recent webinar that featured a lively conversation between Lighter Capital’s Chief Investment Officer Allen Johnson and Sirk Roh, consulting CFO of Early Growth Financial Services, a company that provides financial services to privately-funded, venture-backed startups.
The webinar focused on how startups can get their financials in shape to approach investors, but all the advice applies to any young company that wants to make sure its house is in good working order.
Fortunately, the essential advice on this topic is more straightforward than many assume.
“The key to all of it is understanding your business,” were some of Johnson’s first words in the session. If you understand your business well, it becomes much easier to articulate your company’s value to an investor, whether you’re looking for VC funding or debt financing (including revenue-based financing or RBF).
“The better prepared you are in understanding key metrics of your business, the higher the chances of securing one or another form of growth capital,” said Johnson.
That general principle is a good place to start, but course there are a lot of specifics to learn, too. Here are some of the most salient takeaways from the webinar:
The first step to financial clarity, said Roh, is getting a quality accounting system in place so you can collect your data, run your numbers, and create the right documents and reports to discuss with potential investors.
The reports investors most need to see are a profit and loss statement, a balance sheet, and a cash flow statement; these three together provide an excellent snapshot of the health and growth potential of your business.
More important than running your numbers is understanding what’s going on with them. How is revenue being generated? Where’s it coming from? What does the expense structure look like? Always look at your budget in terms of your actuals.
Many young companies start out with cash accounting in which you only put income and expenses on the books when they enter or leave the account. Roh highly recommends switching to an accrual-based accounting system founded on the generally accepted accounting principles (called GAAP). This is especially important for SaaS companies, as clients may pay up front for subscriptions that persist for months.
Other metrics you should understand and be ready to discuss with investors are MMR, burn rate, churn rate, customer lifetime value, gross margin, and run rate. Investors will want to see that you’ve considered where you can cut, what you can tweak, and how much leeway you have for course correction in a downside scenario.
When you put all this together, you’ll have a deep and responsive understanding of your business. You’ll be able to convey the competence and knowledge they’re looking for in those they fund. Plus, you’ll have a solid idea of which decisions will make your business stronger.
Watch the full webinar on YouTube.