I've spoken to many people looking to start businesses over the years. Many of them fell into the same track I did when I was fresh out of graduate school. They started their planning by writing a business plan. There is nothing wrong with business plans. They can be very useful and they certainly have their place. But they are a bear to write and a bear to read and as soon as you start working on your financial model you'll be changing it again and again and again.
So save yourself the effort and turn the order around. While you're going through the effort you might determine if you're busienss endeavor is financially fit and if you present it to advisors and potential investors you might figure out if its attractive at all.
A great venture capitalists I've had the privelage to work with has told me that he always has a new company create a "cash watch". The focus is on cash flow. Cash flow is simply tracking revenues and investments into your business and costs that pull the cash out.
Your financial model needs to focus on these inflows and outflows of cash.
Summary of Actions
- Make a list of all the sources of cash (this includes each thing a customer pays for, money you personal put into the business and money from outside investors)
- Make a list of all the sources of cost (this includes payroll, rents, research and development, marketing, etc.)
- Use a spreadsheet program to lay out all your sources of cash on a monthly schedule. Put in numbers and assumptions on the revenue for each month (i.e. sell 5 of something at $1,000 each month one and 6 of something at $1,100 month two, etc.)
- Line up your costs directly under your sources of cash for each month and "plug in" your numbers with your assumptions (hire 1 admin month 3 for $3,200 salary plus benefits, etc.)
- Create simple formulas in the spreadsheet that will automatically subtract costs from sources of cash totals.
- Change your assumptions (how you get money and how you spend it)
- Change your schedule (when you get money and how you spend it)
- Save each version of changes as you add and delete assumptions, sources of cash and expenses
- Project out for at least 3 years (you'll have 12 months for each year and total each year separately)
Once you've locked in your financial model you'll be confident in talking about how much capital (cash) you'll need and when you need it.
Potential investors are always interested in how much money do you need, when does your business "break even" (finance itself) and how long until they recover their investment. You're financial model needs to be able to answer these three critical questions before you speak formally to potential investors PLUS you need to know this for yourself.