Monday, October 4th 2021 (17 days ago)
According to Investopedia, about 90% of startup companies fail, nearly 30% within the first two years alone.
If you are a founder, this information likely comes as no surprise. Between identifying the correct target market, finding the right investors, and building your actual product, the initial startup years are fraught with relentless ambiguity and pivotal decisions around every corner.
However, according to nearly every research study on the internet, the number one reason that startups fail is running out of cash.
As a founder, the best way to bulldoze your business is to cash plan inaccurately.
Even if you’re using a great tool like Forecastr to project your cash runway, founders need to understand the importance of accurate financial inputs to achieve long-term success. Running out of cash does not necessarily mean your business is not making enough money. In fact, most businesses do not even come close to turning a profit until at least three years after launch (Fleximize) – nor do they need to do this early in the game.
The team at Forecastr has witnessed cash planning failure hundreds of times across a multitude of startups. These failures are not limited to first-time entrepreneurs – in fact, many seasoned founders have made critical decisions based on faulty cash plans that ultimately devastated their startup.
We have narrowed down the three biggest mistakes that founders make during cash planning so you don’t have to make them.
Founders often have to be optimistic people to push through the constant challenges of getting a business off the ground. However, when you’re planning for cash, you need to be as realistic as possible to understand the length of your runway.
Share your aggressive revenue forecasts with potential investors – they need to see your optimistic plan for growth to realize the potential return opportunity. Conversely, in your internal cash plan, revenue forecasts should be more conservative. When unexpected hurdles arise (and they will), a conservative revenue forecast will provide a buffer and allow you to allocate resources toward your priorities in advance.
Forecasting too much revenue will lead to over-forecasting cash, which ultimately sets up your company to fall short.
Also, founders need to account for collection time on cash: revenue does not equal cash collections. For example, if it takes 30 days for any cash payment to hit your company account, you need to include that timeline in Accounts Receivable and dampen your cash forecast.
Founders often fail to project the amount of time they have left to remain solvent, without raising additional funds. Founders should always input a four-to-six-month buffer in planning the runway for fundraising.
As we already mentioned, the early startup years are particularly fraught with ambiguity. Often, founders begin planning and fundraising before the actual product even exists, largely basing revenue projections on customer validation data and market research. With so many unknowns amidst the strenuous process of finding investors and raising money, founders need a runway buffer to prevent potential financial ruin.
Fundraising is a full-time job. Even for the experienced entrepreneur, fundraising usually takes months to execute successfully. Your cash plan needs to account for enough cash to hit your goal metrics plus an extra 4-6 months of fundraising. For example, if my goal is to hit $100k MRR before my series A fundraise, and I plan to hit this metric over the next 18 months, my cash plan should account for 22-24 months of operations to allow me a fundraising buffer.
Often, founders obsess over financial forecasts while preparing for a fundraise, but once the fundraise is complete, they neglect financial planning to focus on business operation.
However, what was an excellent financial forecast three months ago may be a completely inaccurate picture of your business today. Running a business without tracking actual data on a monthly basis is like driving with your eyes closed. Founders must track actual data against their financial forecast.
Each month, compare the forecasted cash to the actual cash and dive deep into the variances. If cash is significantly lower than what I expected, I need to know where that cash is going and what I need to do to course-correct. Is revenue significantly lower than planned? A significant gap may exist in sales, marketing, or customer experience. The earlier you catch variances, the more likely you are to pivot and achieve success.