basics of startup financial planning
DESCRIPTION
What goes into a useful set of financial projections for a startup? How do you go about building a set of projections that meet your needs and best position you for success? Tom Schryver, Visiting Lecturer of Management at Cornell University, provides an overview of financial modeling and planning principles for startups. This session includes: • How different reviewers of these projections look at them, and what they look for • A high level overview of how to construct a set of projections • How to break down the components of financial projections into actionable blocksTRANSCRIPT
FINANCIAL PLANNING FOR STARTUPS
Tom Schryver, CFA Visi3ng Lecturer, Johnson Graduate School of Management
Execu3ve Director, Center for Regional Economic Advancement Cornell University
Why Create a Financial Plan?
• Know when you’re running out of money • Know how much money you need • Enable you to describe your vision
– To partners – To employees – To funders
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Why Pitch a Startup?
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Why Pitch a Startup?
à Generate interest in the next conversa3on
• Very very very rarely will anyone write a check based solely on a pitch
• Uninformed investors are dangerous • Tom’s rule of investors: they all add value, the ques3on is the +/-‐
sign
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Financials In A Pitch – Audience View
• Does the company have a good understanding of its poten3al market?
• Does the company have a sense of how much of that market is obtainable? Are poten3al unit sales reasonable?
• Are sales prices reasonable? Is there any evidence to back them up?
• Are projected costs complete and reasonable? • How much money will be required to start the business? • How much money will be required to get the company to self-‐
sustainability? • How profitable could the company be at maturity?
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Financials In A Pitch – Ideas of What To Include
You choose what you think investors should be most interested in / know about / have as main takeaways about the opportunity: • Details on target market: size, basis of es3ma3on, es3mate
on how much is obtainable by you • Es3mate of startup costs with details on major items • Projec3on of 3me to ramp up to cash flow breakeven and
total startup + losses to breakeven • Projec3on of profitability at scale
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Showing Returns To Investors
• If you are pursuing a loan, demonstra3ng ability to service payments with a safety margin is cri3cal
• If you are pursuing an equity investment, demonstra3ng ability to exceed required cost of capital is cri3cal
My opinion: • Defining a poten3al exit is very difficult; only volunteer it if an exit is the
only way an investor can get their money returned (no possibility of dividends)
• Calcula3ng an IRR or NPV on investment is not your job – it’s the investor’s: give them the informa3on they need around profit poten3al and allow them to do their assessment themselves
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Financials In A Pitch – What To Avoid
• $Trillion markets • Magical thinking:
– Unreasonably high net income margins (sofware and pharma rarely exceed 30%)
– Revenue growing while other costs remain flat-‐line – Revenue growth without marke3ng expense – Free labor, free space, no insurance costs, etc. – Ignoring 3ming impacts of acquiring inventory or capital items before revenue
• Showing loan proceeds without interest expense or repayment • Providing excessive detail that demonstrates lack of focus on key
performance indicators
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Key Building Blocks
• Revenue Model • Key Resources • Cost Model
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Revenue Model -‐ Es3ma3on
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Month 0 Month N
Units Zero Reasonable share of
TM (total? per loca3on / store?)
Price / Unit N/A Validated Price
Revenue Zero Units * Price = Revenue
Revenue Model -‐ Details
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• Experiment with reasonable growth rates • Es3mate number of months to get to “N” • Compartmentalize by product line, loca3on, store, etc. as
much as possible • Must stack up to a reasonable share of reasonable market
Key Resources
• What do our value proposi3ons require to happen? • How do we support our channels? • Do we need resources to have the customer rela3onships we
want? • How about suppor3ng our revenue streams?
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Key Resources are all the things required to open your business
Key Resources -‐ Types
• Physical – buildings, cash registers, phones, trucks, etc. • Intellectual – patents, databases, process knowledge • Human – salespeople, customer service reps, store managers,
produc3on staff, R&D • Financial – funds to pre-‐buy inventory, vendor financing
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Key Resources -‐ Examples
• Physical – Dean & Deluca store; FedEx trucks • Intellectual – drug patent; process knowledge on how to
make beer • Human – people to fill and cap toothpaste tubes; picking
orders and packaging goods for shipment; people to answer the phone
• Financial – money to buy the product that will be sold in the store, or to buy raw materials to be made into finished goods; funds to cover gap between sending an invoice and receiving payment; vendor lease
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Key Resources -‐ Es3ma3on
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Month -‐N Month 0
Building
Equipment
Patents
Beginning Inventory
Etc.
Key Resources
• What key resources will be required? • What are a few hidden things that might otherwise get
forgoren? • How much will it cost to get these in place?
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Cost Model
• What will your costs be when you are up and running? • How will those costs change as you grow? • What risks are inherent in your cost assump3ons?
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Cost Types
• Fixed costs – remain the same (mostly) regardless of volume • Variable costs – vary propor3onally based on how many you
make
Consider: • Economies of scale – savings as you grow in volume • Economies of scope – savings as you grow in breadth
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Fixed Costs
• Management and overhead compensa3on • Buildings • Machinery • Permits and licenses
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Variable Costs
• Direct labor • Raw materials • Shipping • U3li3es
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Economies of Scale
• Buying in bulk • Shipping in larger volumes • More efficient use of machinery • More efficient use of labor (ie: specializa3on)
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Economies of Scope
• One store selling many products • Mul3ple value proposi3ons for a single customer • Mul3ple revenue streams from the same transac3on (product
+ extended warranty)
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Categorizing Expenses by Type: COGS
• Cost of Goods Sold (COGS) are the direct costs associated with providing the product or service. Examples: – Direct labor – Raw materials – Warehousing – Produc3on equipment
• Revenue – COGS = Gross Profit
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Categorizing Expenses by Type: SG&A
• Selling, General and Administra3ve expenses (SG&A) are the indirect costs associated with opera3ng a business. Examples: – Adver3sing – Sales salaries and commissions – Management salaries – Fringe benefits – Office rents – Insurance
• Revenue – COGS = Gross Profit • Gross Profit – SG&A = Opera3ng Profit
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Categorizing Expenses by Type: Non-‐Opera3ng
• Non-‐Opera3ng Expenses are business costs that do not impact regular opera3ons. Examples: – Interest – Income taxes – One-‐3me revenues and expenses (ie asset sales) – Foreign exchange gain / loss
• Revenue – COGS = Gross Profit • Gross Profit – SG&A = Opera3ng Profit • Opera3ng Profit – Non-‐Opera3ng Expenses = Net Income
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Expense Checklist
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q Rent q Furnishings q Computers
q Sofware! q U3li3es
q Electric q Internet
q Payroll q Payroll taxes q Workman’s comp q Unemployment
insurance q Gen. liab. Insurance q Key man Insurance q Banking and Credit Card
fees q Patent fees
q Professional services q Cleaning services q Lawn care q Lawyers q Accountant q Bookkeeper q Recrui3ng q Other freelance
q Marke3ng expenses q Web development q Print q Conferences q Memberships q Ads q trademarks q Other
q Travel q Discounts
q Sales taxes q Shipping
q Customs q Supplies
q Toner! q Misc
q Repairs and Maintenance q Facili3es q Equipment
q Licenses q Royal3es
Use this as a guide and apply the level of detail that matches your business
Cost Model -‐ Es3ma3on
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Month 1 Month N
Raw Material / Unit Costs at Low Volume Costs at Full Volume
Labor Divide total by units / mo Divide total by units / mo
Produc3on Equipment Divide total by units / mo Divide total by units / mo
Total COGS / Unit
Adver3sing Startup Run-‐Rate
Other SG&A Startup Run-‐Rate
Non-‐Opera3ng Expenses
Cost Model -‐ Es3ma3on
• Start to link revenue growth with costs • Keep in mind 3ming of costs compared to revenues! • Use unit growth to drive breakpoints in cost decreases as you get to scale
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Building Your Cash Basis Financial Model
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Startup Costs: Acquire Key Resources
Revenue: Units * Price
Cost of Goods Sold: Units * COGS / Unit
Selling, General, Administra3ve
Non-‐Opera3ng Expenses (Including Costs of Financing!)
Net Income (Cash Basis)
Pre-‐Revenue Startup Growth Profitable Maturity
Source of Cash: Investments
PLUG N’
CHUG
“I have no idea what the poten3al financial performance of my business is”
>
“I don’t know what these numbers signify, there’s lirle thinking behind them – I just have
them because I was told I have to” “I don’t know what this model does – I just filled
out someone else’s form”
Cash vs. Accrual Method: When To Go Accrual
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• Do you have significant 3ming risks? • Inventory • Holding other peoples’ money • Other people holding your money • High upfront capex
Hypothesis Tes3ng
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Fundamental principles: • The financial plan you just created is made up of a large number of
hypotheses • It is cri3cal to maintain your plan as a living document to reflect new
knowledge • Your financial plan should help you iden3fy key areas of risk – which is
made up of: 1. Areas of high magnitude: large profit drivers, big capital expenses 2. Areas of high uncertainty: shaky es3mates, factors with a large number of
con3ngencies
What Do You Do About It?
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• If an item is substan3al and you are es3ma3ng, dig to ensure no cheap / free informa3on is available that could help you refine
• Treat revenue model, key resources, and cost model as areas of testable hypotheses
• Iden3fy key data, test, and measure
What to Present
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• How much will it cost to get started – and how long • How long will it take you to become self-‐sustaining • What does the sunny, happy future look like (how profitable)
• Choose metrics and graphs based on industry norms
Q&A
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