Know Your Numbers – Finance & Controlling in Early-Stage Startups
by Jana Ludwig-Martyushev and Florian Huber
The focus in early-stage startups is always on “building” and “selling”. If you don’t have a product that you are able to sell to your customers you basically don’t have a business. You might think that finance & controlling are rather unimportant at this early stage. On the other hand, cash for a company is like oxygen: when it is there, nobody notices it, but as soon as the oxygen is gone, death occurs in a short time.
Nine out of ten start-ups fail. Most of them in the first years and due to financial issues. And financial problems don't just mean running out of money, but the lack of financial knowledge. This includes:
1. No Control about the Runway
What most start-ups lack is not good ideas, but money. It is therefore crucial to know exactly when your last euro will be spent. Long-term cash planning will save your butt. And raising a new financing round isn’t done within a week. You need to know at least six months in advance where the journey is going or how long your cash will be sufficient to cover all fixed costs. In contrast, if you just received funding don´t spend your money like a drunken sailor for the sake of showing your investors that you are "doing something" with their money. If you don't have product-market fit yet, keep on doing small experiments to find your sweet spot in the market. Don't start trying to scale before you aren't ready. Even if this means that your investors' money has to sit in your checking account for a couple of more months before you launch all your shiny sales and marketing campaigns.
2. No Accounting Hygiene
Correct accounting is the base for everything: Investor reporting, taking decisions for your leadership team, liquidity management, communication with the tax advisors and as well as to authorities. Without clean accounting, you can neither make good calculations nor produce trustworthy reports. Only if you have correct numbers, you are able to identify pain points in your company.
3. No Financial Planning
Financial planning isn’t sexy and creating a comprehensive financial plan isn’t much fun. But it’s super important in order to understand the mechanics of your business model. Many pre-seed founders think that they can do this at a later stage and don’t want to “waste” time. A financial plan is your compass – it helps you steer the ship, know where to adjust all leverages and parameters early enough while comparing it with your actual numbers. Your financial planning should also include a staff plan and a detailed marketing plan as personnel and marketing are usually the largest cost items in a tech company.
4. Emotional Pricing
Richard Branson admitted that his first start-up failed due to emotional pricing and a lack of control of the runway. This was 40 years ago, and founders are still making the same mistakes. Often, pricing is made based on gut instinct, not on facts or numbers. And here the dog bites its own tail, because there is no financial plan or no correct accounting numbers available. It is also important to understand what the perceived or estimated value of a product to the customer is (value based pricing).
5. No control of your Margins
Do you know what your customer acquisition costs (CAC) and your customer lifetime (CLV) is and how this impacts your gross and net margin of selling one unit of your product? If you don’t know what it costs you to sell your products, you could run into the issue that you are burning money with every piece you sell. Of course it could be a go-to-market strategy to initially sell below cost, but then it’s a plan and part of a strategy you are aware of backed up with numbers.
6. Problems with Tax Authorities
Unexpected tax payments often lead a company into problems. In some countries, such as Germany, you must pay payroll tax monthly and VAT no later than one month after sales. This can lead to cash issues if it’s not included in your liquidity planning. As well as bad accounting and wrong tax declarations can lead to big problems that require time to solve afterwards. Clean accounting and a good tax advisor can help avoid running into these issues.
Why are many people afraid of Numbers?
Many people are getting nervous when talking about numbers. Things we don't understand scare us. Concepts we are not familiar with such as P&L statements, balance sheet, liquidity, taxes, etc. tend to scare us off. Many see all the receipts and slips of paper and push the topic to the back of the list until the chaos is perfect. Letters from the tax office make you break out in a cold sweat. Old-school tax advisors and technical jargon do not make the accounting issue any better and turn it into a nightmare.
Numbers give you Superpowers!
If things are structured and clear and you understand how the process is working and why numbers are as they are, you will feel more comfortable. Your confidence towards investors will be so much higher when you know your chart of accounts, when you know exactly what the numbers in the reporting are about and what precisely is the reason for making losses. You will be able to explain your pricing strategy and what your margins are. You will know everything about your liquidity and remaining runway. Once a structure and an automatism are established, you will spend much less time with numbers, so you can focus on the hard nuts without an uncomfortable feeling in your stomach.
How to get there?
First, it is fine to ask for help if you don’t know what a balance sheet or a profit and loss statement (P&L) are. Talk to your tax advisor or book a short training with a coach. Second, clean and fully-digital processes enable you to be much faster in coordinating your daily accounting. Automate as much as possible. You don't have to spend a fortune, as there are numerous free or low-cost financial software tools available (see our recommendations below).
1. How to start Finance?
Start with the right initial set-up, like hiring a good tax advisor who can work with you digitally. They are asking you for paper receipts or have never worked with an early-stage tech startup before? Not the right one! Think about the first finance hire, helping you with your numbers, ideally a “finance generalist” who can support you with the initial setup and all your daily financial to-dos. At the pre-seed/seed stage you usually don’t need a full-time CFO.
2. Accounting Hygiene
Accounting is the basis for everything. Without accurate accounting, you can neither make correct tax statements nor good price calculations, meaningful forecasts or trustworthy reports. You will only be able to identify pain points in your company if the numbers are correct. This contains implementing a crisp and short account plan, easy (non-corporate) accounting guidelines so that every new accountant and your tax consultant knows where to book expenses. It is important to use the right accounts to make financial plans and budgets comparable.
3. Incoming Invoices and Approvals
Let’s be honest, how often have you asked yourself: Why am I sitting here searching and scanning invoices? Missing or incomplete processes, non-scalable workarounds, document chaos, time-consuming invoice allocation and approvals, chaotic structures, and hours of document searching – sounds familiar to you? Be assured, this is a problem many start-ups are struggling with. If you don’t have a tool to handle incoming invoices, it makes sense to start with an invoice-log (e.g. in Excel, Google Sheets) and get the overview you need in terms of payments and approvals. A shared invoice email inbox is helpful as well. Here you can put structure with different folders like for instance: approval sent, approved, done, and tbd. At the end of the week, make sure that the inbox is empty.
4. Cash and Liquidity Planning
Cash is king, and you need to know well in advance when your last euro or dollar will be spent. Learn how to manage your working capital in which you keep track of your accounts receivables (AR) and accounts payables (AP). To improve your cash situation, increase your income and make sure that it is coming in faster than you are paying your suppliers. Make sure to decrease and control your expenses. Create a regular cash forecast without much manual effort by exporting data directly from the online bank statement into your liquidity plan. Involve your sales team into the cash planning and make sure they know how important it is that they reach their monthly sales quotas.
5. Travel Expenses
Surely you have already asked yourself: How do I get a grip on the receipt chaos of my colleagues? How do I ensure that the travel expenses are coming in on time? For travel expenses use a software tool from day one. They are affordable and helpful. Team members can upload all their receipts via an app, their supervisor can approve and with an interface to the accounting software it goes directly into your accounting system or to the tax consultant. A travel expense guideline for all employees helps understand which expenses the company covers and how they book and record their travels.
6. Month-end Closing
As a founder, you need regular reports and evaluations to manage your business and make the right decisions. Investors are asking for monthly reportings as well. To do so, a monthly statement is indispensable. It provides you with the necessary data basis and helps you understand how much money you burn each month. A month-end closing checklist can be helpful. You will be able to compare your budget monthly and you won’t have a lot of issues with the year-end closing. You don’t have to make a science out of it, but the basics should always be checked. Did we book all invoices? Are the bank accounts reconciled? Credit card statements balanced? It also makes it easier for you to close the year and you don't have to go looking for receipts just before the deadline of the annual statement.
7. Budget and Forecasting
The budget and the financial plan are something you need to have, for new investors, for banks and for you and your team to make sure you are still on track. This one is the start for all calculations. It should include the liquidity check: how much is the burn rate and the runway and when do I need to start fundraising again? Keep in mind that the budget also helps you keep an eye on your strategy focus. A well thought through budget includes different plans like the staff planning, the marketing plan, and all the different cost centers like the tech team, hosting fees, etc. Work on the budget together with your team to make all budget owners feel responsible for their numbers. With your month-end closing you can check every month if you are in line with your budget or if you need to adjust the plan or the strategy and whether a new forecast is needed.
8. Reporting and KPIs
Reporting can be time consuming. When creating a report, start with the question of who the target audience of the report is. Usually there will be internal recipients (your co-founders, your team) and external recipients (current and future investors, banks). Think of the selection of insightful KPIs for your target audience. For investors relevant KPIs to include in your monthly (or quarterly) reporting usually are revenue, revenue growth, CPA, CLV, churn, burn rate and your remaining runway. Regular and concise reporting helps create trust in the founder’s team and makes sure that everyone is on the same page. Don’t worry too much about design and layout. Often a plain email with highlights, lowlights and KPIs/key financial numbers works better than a fancy PowerPoint presentation.
9. Cost Transparency and Controlling
Controlling is about nothing less than securing the long-term existence of the company. It should reflect the flexibility of the startup and at the same time be very accurate. Controlling is essential for managing the company. Accounting is the base to get the numbers right, the controlling means using this base and getting numbers for analyses and decision making. It is about having full transparency about your margins, your expenses, and all your other numbers including the overall financial health of your company.
There are tools and there are the little helpers. No matter whether it is accounting, liquidity planning, reporting or payroll, you should always be clear about the actual necessity and added value for your company. The problem gets bigger the more specific a software needs to be adapted. How much data do I want to have in which concentration in which tool (“data silo”) and how necessary is this? Before implementing a tool, take some time and talk to all people in your team and organization. What do they struggle with? What are the main questions they receive from management?
You have chosen one? Ok, then let’s implement it. Take your time, don’t forget to get everybody on board. If nobody will use it because the team is not happy with your choice, it is a waste of time and money. Calculate a high-level business case upfront and make sure the new tool does fit your needs. Too many tools can do the contrary to your daily routines by adding unnecessary complexity.
How to start?
All of the steps above are not complicated to implement and will help you navigate your startup journey. They will support you in understanding the big picture and you will even start having fun when dealing with numbers. Finance is not rocket science and the right tool will give you the power to build a growing and sustainable business.
Start Finance Now
To kick-start your financial journey and get you on the right path from day one check-out the Start Finance Now toolbox from Jana. This all-in-one toolbox for early-stage start-ups addresses all of the above-mentioned points in a crisp and easy way. It will give you guidance on how to set up your financial processes with guidelines and templates in a short time and get things done without worrying about formats or wordings. Founders need to focus on growing their business and not sorting out receipt chaos. With this online toolbox with videos, plenty of excel templates and pre-written guidelines you will learn in ten chapters how to create order and structure your finances from day one and without re-inventing the wheel. It also includes helpful and ready-to-use templates for financial planning, a business plan for fundraising, financial accounting and bookkeeping for startups, simple financial reporting, accounting advice and everything about entrepreneurial finance in early-stage startups.
Finway Liquidity Planning
Another recommendation is the Finway Liquidity Planning tool. Finways offers a free liquidity management tool for automated cash flow planning. It helps you to take back control over your liquidity with an easy-to-use cashflow management solution that consolidates your online bank accounts, automates manual processes and provides you with the insights you need for better, future-proof financial decisions.
About the authors
Jana Ludwig-Martyushev: Jana is the finance specialist when it comes to implementing accounting and controlling procedures, tools and processes. The calling of her business life is bringing structure into finance departments and helping the management to steer the businesses. For almost 15 years she has been cleaning up accounting and setting up controlling structures. She implemented financial processes in various companies. From medium-sized companies to startups, she held several leadership positions and always brought order to the initial chaos. In her latest startup omni:us, a VC-backed high-growth AI start-up in Berlin, she was the VP finance for over four years. She managed a successful A Round and prepared the ground for the upcoming B Round. Today Jana is working as a freelancer to help as many start-ups as possible to fulfill her mission: No start-up should fail because of finance issues. Finance is not rocket science, but can be even fun: www.startfinance-now.com.
Florian Huber: Florian is a founder, entrepreneur and startup investor based in Berlin. He is the founder of united-domains (sold to 1&1 Group in 2015), neubau kompass (Germany’s leading real estate marketplace for new residential constructions) and is an investor in more than 50 tech startups. In 2018, he was awarded "Business Angel of the Year" by the German Business Angels Association (BAND). Florian is also the Venture Partner of Signature Ventures – a VC fund investing in early-stage crypto startups across Europe and the US.
Disclosure: Jana is the creator of “Start Finance Now”, Florian is an early investor in finway.
Apr 11, 2022 by Florian Huber Jana Ludwig-Martyushev