The Silent Curse for Startups
Number talk and you absolutely have to know your profit and loss information inside out if your business is to become a success because if the cash dries up, the business fails, plain and simple. People often talk about ‘margin’, which is the gross profit. The issue is, too many people think they have a margin of 85% (for example), and they don’t focus on what makes that margin up.
The margin doesn’t burn cash your cost of sales does that for you. If you focus on sales increases, and your cost of sales is wrong, you may find it’s not long before your FD is telling you that you can’t pay the suppliers or the wages that month and then the game is up – too late, you are against the clock, unless you have a pot of cash available then you could have a lucky escape.
If you are anything like me, the idea of looking at complex spreadsheets and numbers although important, is both scary, boring. I like to see the growth, the creativity and the graft that is being put into the startup. The belief and confidence that the team builds as the hard work starts to show. However, the problem is usually that P&L (Profit & Loss) sheets tend to come into existence after the event (or period end), so these are historical documents, and in a fast moving environment they become just that - history. The reality is, these are guarding your future. The P&L we speak about as startups before we start trading is really the business model and the forecast – and those are vital to maintain as you get underway, so you can get ahead of any issues with both your cost of sales and your fixed overheads. Not forgetting achieving your sales forecast.
Don’t end up in sinking in the river
The P&L report is only effective if it can report on what has happened, but also needs to show you the risks that you might have with your cash flow. This normally comes from the challenges you may be having with both generating income and controlling fixed and variable costs. Make your P&L report show your team where your margin/cost of sales targets and your overhead costs and budgets are, for the next three months and then talk about how you can achieve it.
Why forecast and talk about it? Have you ever tried to drive a car down the middle of a forest track at midnight with no headlights to help guide you? Probably not; but that is what you would be doing if you don’t forecast your numbers first. Good luck with the trees you hit along the way, the river you end up in or the chasm you fall down - head first(!)
What could go wrong?
The best course of action is to go through the many ‘what if?’ scenarios across your business; play out the very worst case, best case and everything in-between before going live. An effective ‘what if?’ scenario should be designed around what the entrepreneur believes could happen, so they need to be able to ‘flex’ any part of the P&L to make the numbers work whether trading (income/margin) and overheads (fixed and variable costs, interest or depreciation). Startups will also need to consider their funding needs, to ensure the right amount of cash is available at all times.
What if the payments are late, reduced or worse still, don’t arrive? When you can change all of these parameters and get an immediate review of your business model and forecast, then you have a really good chance of assessing all of the risks associated with your new business idea in a transparent, logical way. From there, you have your targets planned in case that scenario presents itself – no panic, follow the steps that have been discussed and agreed across the team.
The hidden curse
There is never any confusion about what margin is, it’s the gross profit. But whenever I ask people about their ‘cost of sales’, I nearly always get a slight delay while they try to recall their basic accounts studies. That is why cost of sales is the silent assassin for startups because it isn’t recognised as being important enough when we learn about the dynamics of business. ‘Income and margin’ I hear people say - got to get growth and hit the margin.
We all know our margin percentage if we have market experience of our sectors before we start our own business. For instance, ‘it’s 85% and always has been’. Hopefully now, you will be forensically checking the forecast first to see if that can be achieved, and then going back to the history to see if you have ever actually achieved it.
Many people make mistakes with their numbers in the beginning, me included. I have always surrounded myself with good financial people (because I am accounts/admin averse) but the only problem I ever faced was depreciation some years ago when I had appointed a young financial director who didn’t advise me properly and didn’t do the numbers. That slowly crippled the business, but we fought hard to keep our heads above water, with the help of our bankers, and we ended up selling it on. Lesson learned; move on.
Blinded by detail
As entrepreneurs, we are inherently creative and spontaneous individuals, we are risk-takers, innovators and our drive and determination to launch a new venture means we are sometimes blinded by the detail that really matters early on in our journey. Entrepreneurs today, need something that is sophisticated, yet pretty simple to use, and that helps them to get that bit right at the very start before any money is spent and the business finds itself in trouble. This is why I believe that more needs to be done to support entrepreneurs with their business modeling.
We don’t need another set of spreadsheets, but instead a complex, multi-dimensional, modelling and forecasting tool that provides an easy end-user data entry workflow to allow you to achieve the model and forecasts that identify the risks and challenges we have discussed previously. It has to be fully secure and backed up for the entrepreneur to continue to check and adjust as they go through their start-up years; oh, and it has to be free of charge because most startups don’t have extra cash to burn.
Startups are the lifeblood of this country
That was the real reason behind why I launched a registered charity this year for budding entrepreneurs and why I have developed such a tool. Entrepreneurs and startup businesses are the backbone of the UK economy, and with Brexit still ahead of us, support for startups has never been more important. More new businesses would succeed if P&L, cash flow and risk were addressed much earlier on. So anything we can do to help that process to run more smoothly, can only be a good thing.
By Jerry Brand, Founder of entrepreneurs charity, The Brand Foundation.