Have you ever thought, despite the rich funding available globally, yet a lot of startups failed within the first 3 years?
Why is it so?
Start-ups and early businesses often put more weight on analysing its Profit and Loss statement (“P&L”) and Balance Sheet (“BS”) to gauge their financial performance for the period. There is no doubt that these reporting numbers are important to the financial health, however, a start-up should not neglect the importance of cash flow management.
A well-managed cash flow is essential to the success of a business. It is like a blood stream (cash) that flow to our limbs to function and allow us to reap the outcome (profit and loss) to feed our vital organs (balance sheet) and stay (financially) healthy.
What more is that reading just the P&L may not reflect truly your business financial health. This is because P&L are prepared on an accrual basis, which may have included accounting adjustments. Example, for a 12-month annual subscription prepaid for $120, the cost charged to the P&L is $10 per month. whilst in fact, there is an actual S$120 cash outflow in that same month.
So, what is cash flow management? It is not simply a record of collection and payment out from the bank account but a management of cash availability to meet its liabilities when they falls due. It is expected that a start-up would need to spend a huge amount of cash to promote its product or services to the market at the initial stage of business cycle and acquire market share. This would need a good cash flow management, which is to forecast the timing of inflow to meet the outflow of cash to the business, also known as cash burn rate or popularly known among the startups as runway.
This leads us to the key area of cash management, which is forecasting the cash flow requirement. A start-up should do an on-going cash flow rolling forecast for 13-weeks. The forecast can pre-empt the start-up to take critical actions when there is a cash deficit and hence, allowing businesses to plan how and what type of financing is required to resolve the cash deficit situation.
You may wish to take note that forecasting is different from budgeting where forecasting is planning the resources required to grow / expand business, whereas budgeting is planning the restraints for a better financial performance.
Successful start-ups are those who managed their runway for the longevity of the business with the right cash forecasting tools. Without cash management, businesses cannot sustain into the long run even when they are profitable.
How does a CFO help?
A CFO usually embody two Chinese proverb in their practices, namely: 未雨綢繆 and 居安思危. The former means, “getting prepared for the rainy days” and the latter, “being wary of the danger even when you are in a safe environment.”
Referring to the first Chinese proverb “未雨綢繆”, a CFO work with the business to develop a financial framework for a sound business model and in the case of a startup, more importantly, on the profit model. The CFO convert the business strategies into numbers and test its viability through the numbers, which is an objective approach when handling business model.
Let’s take a segment of the P&L for example, Wages and Salaries. Different level and requirements of workforce is usually planned for different stages of growth for start-up. We must justify the headcount cost by looking at how this cost is financed and what is the foreseeable economic benefit contributed from these headcounts. One tip on this, the business should only incur additional cost when it can afford and not when it is needed.
By incorporating basis and justified assumptions like the above, it would form part of a robust financial model. Next, we add in scenario planning and its impact to the simulated financial results. Business would then be prepared for an optimistic or pessimistic outcomes of the business strategies since it has considered risks coming from all angles.
Lastly, we know there are numerous financial modelling software available in the market that can do the “magic” as we described in a click of the button. However, an experience CFO is needed, even with the use of the software, to input and interpret the relevant component of the financial model.
Whilst referring to the second Chinese proverb “居安思危”, a CFO can assist businesses to identify and mitigate risk, even in times where the startup has comfortable runway. The underlaying danger that a startup would face, even in a healthy financial state, is cost it incurs when it is expanding. Startups have tendency to incur whatever cost (especially with the mindset of “whatever its takes to achieve the goals’) just to achieve a fast growth objective and is blind to the long-term risk that is associate with such move.
CFO can help to mitigate the risk associated with “fast growth” by assessing the financial capacity of the company to support its growth objective. To support the “fast growth” strategy, CFO could propose ways to raise funding, whether if it is from internal or external source and at the same time, weight the benefit and cost of the different manner accordingly.
Another area of business that possesses underlaying danger is corporate governance. Over the past few years, high performance startups have been put to spotlight for its weak corporate governance. CFO can assist to devise and advise internal controls, statutory compliance and tax planning, which forms the basis for a good governance. Regardless of the objective of the startup, being able to show it has good corporate government would certainly increase its valuation and at the same time, reputation.
In conclusion, a qualified CFO played an essential role to safeguard the startup financial viability, acts as an advisor for the direction of the strategy that the startup is heading to, interpret and forecast financial results, to ensure the success of the startup.
