Prof. G Shabarinathan is an Associate Professor teaching Finance & Accounting at the Indian institute of Management, Bangalore (IIMB). His interests are in the areas of SME finance in India, private equity, venture capital, and the regulation of the securities market in India.
This post contains a summary of his lecture at a Demo Day Pitch event organized by Startups Club, held recently at Taj Vivanta.
In the lecture, Prof. Shabarinathan outlined startup planning and accounting best practices that you need to follow in order to attract investors and keep them satisfied about the direction the business is heading in.
Financial planning for startups, managing equity and valuation
Financial sustainability is necessary for startups. You need to be happy with the returns. As a startup, sharing profits enables you to give metrics on performance and serves as the means of attracting people. “Do not run out of cash in a business,” is what he says. “1-minute finance lesson is – Don’t run out of cash.”
He mentioned 4 important buzz words. If you want to measure performance in a company, you need these tools / statements – A profit and loss account, a balance sheet, a cash flow statement, and a cash budget. These are 4 very essential statements that help you track performance in a company.”
For startups, the P&L is not worth looking. It is equivalent to the monthly household expense statement. The P&L is equivalent to sales – costs in a company. In a company with no sales, P&L is useless. It varies from month to month.
The balance sheet is a static statement of your financial worth, or where the company is at one point of time. It is not of much practical use.
The cash budget is the only one which is relevant to a startup and should be looked into. It tracks every rupee coming in and going out. It is statement of income and expenses in general terms. He explained the cash budget for a startup is just like the household finance planning for the month, and needs no major expertise.
He also explained the “Sales plan -Unit Cost- Cash Budget and Investment / Funding Plan” in detail. The formula to work with is:
Capital + liability = Assets
This completes the Balance sheet ideally.
These are steps for you to go through to think systematically. To start with, we need a Sales Plan. Sales being source of cash, and Unit cost being the use of cash, you need to build cash budget for the startup. It is your enterprise and you need to think of your role in it. Equity brings with it the right to make decisions in the company.
While we identify how to raise funds, look into valuation implications too. The valuation suggests how much of the company you will own if you raise this amount of money. Valuation is where startups differ from large company financing.
Why make a cash budget and financial statement?
Entrepreneurs hesitate to make a financial statement and cash budget. But you have to know how to use the cash budget for your startup. Do monthly cash budget for 2 reasons:
1) Seasonality is inherent in most businesses in India. So check for cash burn monthly.
2) In India, people want to use services and pay later. So a company providing credit has to keep track of it, and keep the cash budget updated. Only then you can know the amount of funding you require.
If you look at a year as a whole, it will not give you the complete picture. Cash budget will help you in knowing and identifying the cash deficits. Prof. Shabarinathan explained the importance of monthly cash budgets to be able to manage funding and balance your statements to be in between the peak amount and never run out of cash.
Investor practices and startup spending
Two components of what startups need cash for are to meet cash deficits and the investments you need to make. More cash burn means that you’re spending more on production and other expenses than the sales revenue generated.
Sensible investors do have a common practice. They would want you to talk about the problem statement even before you present a cash budget. They would want you to talk about the solution and why and how your solution is addressing the pain point and benefiting the customer.
Investors want to see whether you have thought about all these funding KPIs, like a checklist. Your cash budget is the best means to show investors that you have thought about not just how much funding you need, but also whether you are able to keep track of it. You must know how much you are spending, and how much more you will spend (and need) in the next quarter, six months, a year, 3 years or 5 years.
Your business plan, accounting and book-keeping allows you and your investors to sit together and look at scenarios – what is the peak funding to expect, and what are your minimal funding requirements. If you are an entrepreneur looking to raise startup funding, you must take time to create the financial statements mentioned above.