Good news! There are pretty good reasons to build financial plans for a startup!
Here are the 7 best reasons we believe a financial plan is a great tool to use while designing & building a startup :
1. Discover key metrics (margins, volumes, costs, investments…) to build & improve your business model
Used with other business design tools, financial plan tools are very powerful to simulate your business model hypotheses. It’s a great help to understand a business deeper. As you model your business with financial hypotheses, you will face progressively questions you didn’t expect. It’s a relevant exercise to discover and understand the key metrics of your business (volumes, prices, acquistion costs, main fixed costs, key variable costs, key investments, …). And best of all, it’s always sharp issues to tackle to build a great business.
One important thing to keep in mind : work with a very simple financial model (it’s completely irrelevant to build an excel spreadsheet with thousand of cells). Remember the 80/20 rules, because it works really well with financial plans, as the main goal of a financial forecast is to test hypotheses….
2. Check potential rentability
Usually, we can hear that doing financial forecasts with long term perspective is stupid for startups because no-one is able to predict future. It’s also well known that most startups are losing money in their early years because they invest a lot to build businesses that will be one day great cash machines.
Except startups that aim to attack a worldwide multi-billion market (so it’s pretty obvious that they are probably going to be super profitable whatever it takes if they succeed), most startups should work early on their business models to analyse rentability potentials. There is rarely only one business model for a product or a service. There are multiple variables to take into account that each of these will have a potential impact on rentability. This is why it’s so important to model a business in a financial tool to test and iterate hypotheses.
Expecting a business to be profitable only by building a business model with a paper canvas is pretty impressive. Working also with a simple financial plans is obviously more relevant to do rapid prototyping to test financial impacts of business models.
3. Structure your strategy and key milestones
Building a great business model is the first key step for any startup. The Lean Startup methodology is a tremendous help to improve and refine a Business Model with market inputs. But yet it’s not sufficient for a startup to have a chance to succeed. Execution is the real key to great success.
But what is concretely a “good execution”?
The Customer Development is a good way to delimit borders between “ideation”, process of building a business model, and “execution”, process of launching and scaling-up business model with a roadmap defined by a strategy and key milestones.
Despite uncertainity, any entrepreneur needs to define a strategy and key milestones to manage a good execution. This means that planning is crucial. Modeling a strategy execution with financial forecast is then a great tool to understand financial issues behind strategy and planning. Usually it’s particularly important to work on financial details from day zero to the first big key milestone (usually around 12 to 24 months later). Modeling the next steps to other miletstones is less critical, so they can be estimated roughly. At least, you need a good vision of where you want to go in 5 years (the ambition for your business model). Indeed, it’s not necessary to define precisely all actions to undertake within the next 5 years. It would be ridiculously unreliable and useless.
Even for an entrepreneur still in “ideation” process, it’s pretty sharp to start modeling simple financial forecasts. Using 80/20 rule, the entrepreneur can really quickly estimate financial issues of his business model hypotheses (with Business Model Forecast for instance ;). The financial plan is a good exercice to get deeper and more concretely in business model and strategy understanding. Doing it early is the best way to build a great business.
4. Check relevancy of the balance between your means and goals
Strategic planning involves defining means needed to achieve goals (or at least the first key goal). And in fact, there is never just one way to go somewhere. Entrepreneurs have to deal with many alternatives and they have to define their own way to achieve their goals.
Means cost cash, therefore an entrepreneur should adjust his necessary means to achieve the priority goal. This mean that an entrepreneur should have a good strategic vision before defining his means needs (and so his cash needs). It’s only when the entrepreneur knows what is the best first goal to achieve with less means that he really know what are his cash needs.
Usually, it’s an iterative process to define the right plan with a good balance between means involved and goals pursued.
5. Check your financial needs and build your funding plan
If you have followed the previous reasons to build financial plans for a startup, you should alsmost be able to know your financial needs! With a good idea of key milestones to reach with a pretty good understanding of main ressources you will need, you have done most of the job.
Yet you still need to do financial forecast to model your monthly cash flow. Indeed, treasury management is really important to know what will be your critical cash need during this period. Don’t forget to surestimate your needs with a worst case scenario, so you would have an extra amount of cash that could be really critical if you have to face any unexpected difficulty.
With a good understanding of your ressources and financial needs, you would then be in a good position to structure your funding plan. Depending on ressource needs, you would be able to focus your funding research on most suitable financial sources. Indeed, for instance bankers like to finance “tangible investment”, as machines or properties, while “venture capital” are able to finance “intangible investments” like R&D of IP.
6. Model multiple scenarios to test alternative business models and strategies
Now, you should be convinced of the usefullness of doing financial forecasts for a startup. It’s a great help to build and refine your business model and your strategy. And as you should have notice, it’s not just a simple and boring process of filling in hypotheses in an excel spreadsheet to give pleasure to your banker… It should be a key tool to use in addition to Business Model Canvas and Lean Startup to iterate on designing a great business. Though, building a financial forecast for a startup should be an iterative process to test mutliple scenarios of business models and strategies.
Any entrepreneur should even force himself to build multiple scenarios of his business model and strategy. It’s a powerfull exercice to avoid to “fall in love” with an idea. Thus, financial forecasting should really be be viewed by entrepreneurs as a sharp & efficient “business design tool”.
7. Convince financiers that your business is well designed and that you can manage a vision despite uncertainty
Last but not least : A well designed financial plan is a great help to convince financiers!
Most financiers know that financial plans are based on hypotheses. So don’t believe that they would take all your numbers for granted! That’s not true.
However, financiers are going to challenge the way these numbers were built. They would generally also ask to discuss alternative scenarios, to test the capability of an entrepreneur to manage uncertainty. They would be reassured by a well-designed business based on serious hypotheses and thoughts. It’s a good sign for them! They would then probably consider reliable both the project and the entrepreneur.
Building a startup project with financial modeling, in addition to business modeling tools and methodolgies, is thus a great approach to get better chance to succeed.
To build a financial plan, keep in mind to stay simple (80/20 rule) as your model will always rely on hypotheses. Be sure to limit yourself with few key metrics to build your financial forecast. Otherwise, your are just going to build a big and irrelevant machinery.
Don’t forget to use our free and easy financial plan tool, Business Model Forecast, to build your financial modeling!
Good luck with your startup!