One of the biggest problems startups face is a lack of money. This can come about due to a vast number of reasons, such as having extremely limited initial resources, poor decisions in spending, or failing to keep track of how and why money is spent. With most startups facing the challenge of having a limited amount of resources, managing their expenditure is paramount to avoid the death of the company.
Boon Teck Lee, a Partner at Deloitte and adjunct professor at Singapore Management University, talks about the differences between using cash flow and profit and loss models to quantify the movement of funds in a startup. He gives insight on how to prioritise and when to change the company’s method of viewing their finances, whilst constantly reiterating the importance of being flexible, and planning early. He further explains and stresses the importance of reviewing and re-assessing a company’s budget plan in order to avoid any waste in resources.
What do these have to do with startups
The first question one may have is: What is cash flow? What is profit and loss? And how do they relate to startups? Well, fret not, Boon Teck has already answered these questions.
The main thing to note is that both of these are really just different perspectives for measuring how money moves in and out of a company’s hands. Cash flow is simply taking note of how money moves as each transaction occurs. For example, when a boss buys ten laptops for his employees to use, from a cash flow perspective, this money is charged immediately from the company’s reserves. Simple as that.
Profit and loss, on the other hand, does not represent the exact transactions, and hence is quite different from cash flow. Profit and loss is a measure of business performance over a period of time. So going back to the earlier example, the ten laptops will not be charged all at once, but will be charged over the period of time they are expected to be in use. As such, profit and loss is important to measure business performance over a period of time, but is not reliable for checking the exact resources gained and lost by the company.
So which should be used for startups? According to Boon Teck, the painful truth is that in the early years of a startup, profits are not expected. As such, he advises that measuring cash flow is more important than measuring profit and loss.
Forecasting and Budgeting
Lee strongly reiterates the need for startups to have a good plan for their budget. Initially, all a startup may have in terms of resources is their angel investment, and maybe a little bit more from the pockets of the founders. Startups must use their funds wisely to prevent going bankrupt, which is one of the top 5 reasons startups collapse.
Once a company plans a budget, they can then benchmark their cash flow against it to see how the company is doing. This involves checking how money is being spent to better the business, for example hiring talents according to the current needs of the company and checking if that investment pays off. However, this cannot be done just once. Lee stresses on the need for re-forecasting and re-budgeting again and again. This is due to the dynamic nature of startups and the volatile market. By monitoring cash flow, it may become obvious that there is a pressing need to change the budgeting plan, and revising the budget would be of the utmost priority.
Boon Teck explains that having a flexible mindset and constantly revising budgets can help startups avoid the 5 most common factors for the death of startups.
Running out of finances
A lack of demand for their products and services
A poorly skilled workforce
Inappropriate pricing or strategies
Which of the three is the most important?
With three strategies having to be balanced and worked on simultaneously, one may wish to prioritise themselves in order to be as efficient as possible.
In the early stages of a startup, profit and loss is not relevant, and is the lowest on the list of priorities. Cash flow would be used instead to measure the movement of resources. Budgeting and early planning cannot be more important in determining the success of the business. As such, in the initial years of a startup’s existence, the priorities are Forecasting and Budgeting > Cash Flow > Profit and Loss.
As some time passes, the startup will begin to grow, with more resources to manage, a larger staff, and hopefully, managing a profit. The priorities should still stay the same, but with an increasing amount of attention paid to profit and loss.
A little later, shareholders will start to expect payouts and returns from the startup, especially after profit begins to grow. A need to monitor the revenue generated by the business emerges. Now, forecasting and budgeting are still at the top, but both cash flow and profit and loss now come in second on the list of priorities.
Throughout the journey, the importance of planning has stayed the same all through the entirety of the startup’s maturing process, and even after the company has attained success, it should stay that way.
Watch the full Arcadier Inspire Summit by Boon Teck Lee here