When launching a new business, you may (rightfully) be concerned about your likelihood of survival.
According to LendingTree’s research, 23.2% of private sector businesses in the U.S. fail within just the first year. By five years in, that number rises to 48%. After 10 years, 65.3% of private sector businesses close. Research shows that one of the biggest reasons for a failing business is a lack of financial planning.
A study from Wilbur Labs asked 150 startup founders about their biggest struggles and what ultimately led to failure. The most common reason was that the company ran out of money.
Interestingly enough, many of the other reasons cited all circled back to the same overarching issue: money trouble.
Safe to say, when you’re launching a startup, one of the most crucial parts of your business model is developing a sound financial management plan.
A financial management plan allows you to keep an eye on cash flow, prepare for risks and unexpected costs, and solidify your financial future.
What makes up a financial plan? Here’s a look at its core elements and how you can build an effective one for your startup.
Critical Pieces of a Startup Financial Plan
Your startup financial plan should vary based on your industry, offering, and where you are in your growth, but there are some core pieces that make up most strong financial management strategies. Such pieces include:
- Profit and loss (P&L) statement: Your P&L is also called your income statement and relies upon your revenue, cost of goods sold, and overall expenses. Once you subtract your cost of goods sold and your overall expenses from your revenue, you’ll gain an understanding of how much income you’re bringing in. A P&L helps you track your cash flow.
- Balance sheets: Balance sheets reflect your overall financial standing and include three parts. Your assets are your available cash, goods, and other owned resources, while your liabilities are what you owe, including to your vendors, landlord, and employees. Shareholder equity is the third component, and it’s essentially your net worth, measured by subtracting your assets from your liabilities. Your equity informs the value of your company to shareholders, including your employees, who may be holding restricted stock units (RSUs) as a part of their equity compensation.
- An informed budget: Building a budget enables you to stay ahead of upcoming costs. Your budget establishes spending guidelines based on your expenses and expected revenue. With a proper budget, you can prepare even for unexpected costs, as a solid budget will have wiggle room for you to pivot when the necessity arises (more on that soon).
- Tracked financial data: As a startup, you might not yet have a lot of data to utilize to build your P&L, balance sheets, and budget. However, as you grow, it’s essential to have historical financial information available to stay on top of your cash flow and overall costs. This allows you to adjust your financial management plan as changes to your company, industry, and the greater economy occur.
How to Create Your Startup Financial Plan
Start tracking financial data from day one
As a startup, you likely don’t have much historical data to influence your financial plan just yet, which is why it’s vital to start tracking such information as soon as you can.
Automate your financial tracking to make this process easier and more streamlined, as you should build your financial plan with the expectation of growth.
Ideally, you want your financial plan to one day transition beyond the startup phase and having automated data tracking allows you to integrate your information into all of your financial management tools, such as an ERP or CRM.
You may be able to manually track your data right now when you have few employees, vendors, and other expenses, but as you grow your costs, revenue, and income will, too. Your financial plan should always be scalable.
Create financial projections through realistic goal setting
Your goals should inform your financial plan. Utilizing your tracked data, establish financial forecasts based on what you hope to achieve and what you believe is reasonable to reach.
If you set financial projections based on simply what you hope to reach in a year or less, you may set yourself on a path of disappointment and spend your valuable time in the wrong places.
Instead, set reachable milestones that you can strive for throughout the year. Once you achieve a milestone, look at what your next goal is and use your recent data to rework your milestones based on your sales and trajectory.
Build a budget that expects the unexpected
According to Wilbur Labs’s research, the fourth-most common reason startups failed in recent years was due to the COVID-19 pandemic. In other words, unexpected costs can sink a company fast if they don’t have any room in their budget to pivot.
Your budget should take into account your goals, revenue, expenses, and income to create boundaries for your spending, but you also need to ensure that you have ample room in your budget for flexibility.
Even if you’re tracking your financial data, your industry’s data, and the overall economic fluctuations, you still need to have space in your budget to prepare for changes you couldn’t have anticipated.
Establish transparency with stakeholders
The second-most common reason for failing as a startup is a lack of financing and investor interest.
Startups tend to go through four main funding rounds: seed, series A, series B, and series C.
Even if you receive seed funding, in most cases, you need to generate enough interest in your company to procure more funding with subsequent rounds to stay afloat. Establishing clear and honest communication with your investors and stakeholders is core to a functional financial plan. It will help you develop trust, which, in turn, can result in further funding.
Your Startup Financial Plan = Future Growth
While cash flow is one of the most crucial parts of establishing an effective startup financial plan, your money management plan should go deeper than simply tracking cash in and cash out. Through financial data tracking and necessary documentation like your P&L statement, you can keep an eye on your financial standing and prepare for your next stage of growth.
Think of your startup financial plan as a living document.
As you gain more insight into your finances through data tracking, you’ll find it necessary to rework and retool your plan, especially in regard to your budget. The best startup financial strategy recognizes that startups need to pivot often, both due to internal reasons and uncontrollable external forces. Your future growth will be bright when you have a financial plan that expects the unexpected, setting you up for success even where many others have failed.
