Financial projections. Why do startups need to prepare them? And why are they the least favourite task for most founders?
Why prepare financial projections?
The obvious answer might be that they’re needed to secure investment. And yes, that is one of the major reasons why startups need to put the numbers together. But they should also be used earlier than that to ask yourself if you even have a business to start with. So if you assume there are X number of customers the company can attract, and you think these customers would be prepared to pay €Y for the product/service, can this really be a business with the ability to scale?
Let’s assume that you believe you’re building something or have a service that enough people will use and hopefully pay for. You may decide that you need investment to help you along that road. That might be bank finance (good luck with that!), government support, venture capital or a combination of all of these. Whatever route you go, there’ll no doubt be an expectation that you prepare some numbers for them to look at.
The least favourite task for most founders
The old saying that ‘traction speaks louder than words’ has never been more true among investors today. They all want to see those first few customers actually using the product. Which means that a startup’s main focus is generally on building a great product and getting those first crucial people to use it. And rightly so. Just how many customers the company will have in month 27 or what the company will be spending on advertising in 31 months time, isn’t really high on founders’ priority list to start with. And in reality investors aren’t so much concerned about that either. Their main concern is that you’ve actually thought about these things. It’s as much about the assumptions (if not more so), as it is about the detailed 36 month projections. And taking that a step further, it’s about the ability for the founders to demonstrate that they have considered the impact of what changes to these assumptions will mean for the business. For example, if sales are only 50% of what we expect them to be, what does this mean for the cash requirement over the next 18 months? And what would this mean for staff numbers? Or if your conversion rates are only 1% instead of 3%, and the churn rate is actually 15%, what does this mean for your customer numbers and monthly revenues? Having the ability to stress the projections is key.
Having said that, preparing detailed financial projections is a necessary part of building a business, both from an internal monitoring perspective and an external investor requirement. The more time you spend on thinking about your assumption (eg how much you charge, what will the staffing requirements be to deliver the product, how much will it cost to acquire customers, etc), the better the output at the end will be. Building a profit and loss account or cash flow statement should not to be the only goal in the process. Being able to see what affect changes in the assumptions will have on the business should really be of equal importance.