How to assess your startup’s financial health? In other words, how do you assess how financially healthy your startup is?
Financial health is the lifeblood of any business. Just like for humans. The vast majority of businesses, and especially startups, fail because they run out of money. In fact, just about every cause of new business failure in the first five years can really be tied back to financial management. It’s also what takes down even large incumbents with billions of dollars.
It is vital to keep a handle on the pulse of your company’s financial health. There are many reasons for this. Though you can’t improve on what you don’t know and measure.
So, how do you measure it? What are some of the specific metrics to keep an eye on? How can you improve your company’s financial health, and keep it healthy?
The Ultimate Guide To Pitch Decks
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Why It’s So Important
Understanding the financial health of your company is critical internally, just as it is knowing how it can affect external perspectives and interactions. Including both public and private capital markets.
If you don’t know how healthy your business is or not, how can you improve on it, save your business before it dies financially, or needs to go to the ER or ICU?
If you know, then you can manage your company well. You know when you have the capital to grow and invest in new areas and grow your company. You know the types of returns you need to be demanding from your capital.
It also gives you the foresight into effective planning, understanding your upcoming financial needs, and helps in staying ahead of the need to raise more funding.
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Knowing your financial health reveals the strength of your positioning in negotiating financial transactions, provides more optionality and helps you understand how lenders and investors will view and value your business.
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When To Assess Your Startup’s Financial Health
The time to wake up and be alert to the financial health of your company is not when the checks are bouncing; your payroll service tells you that you are out of money, or invoices are 90 days late, and collectors are calling.
Founders should have a constant view of their startup’s finances, and what it means.
Even before opening a business, you should be working on your business plan to know how much startup costs are going to be, and how much it is going to take to stay alive and to reach important milestones. For, example, how much is it going to take to fuel your company through to the breakeven point? Make sure you add some financial cushion to this, as it always takes longer and costs more than you think.
Then be sure you are regularly reviewing your finances on an ongoing basis. Depending on the stage of your startup and the size and depth of the team you have, you might need to have a serious review of your finances every month, quarter, and year. As well as having a dashboard for a real-time view on demand.
Then you will certainly want to take a more in-depth look into your financial health before a new financing round or other major events.
Anytime there is a major change in the economy, world, and capital markets, a fresh review is needed to anticipate how this may impact you going forward.
How To Assess Your Startup’s Financial Health
Obviously, this is extremely important. In fact, it is probably the most important task a startup founder has. So, how do you do it?
The most obvious is to be constantly monitoring your accounts and reviewing your financial reports. Looking at your capital, expenses, and income.
Your bookkeeper and accountants should be providing you with regular reports and financial documents. Especially around tax time, and ahead of running a fundraising campaign. Including your balance sheet, cash flow statements, and P&L.
At certain times you may need or benefit from outside audits as well. Such as verifying your finances for certain platforms, SEC filings, going public, M&A transactions, and more.
How To Measure Your Startup’s Financial Health
Here are some of the core ways and metrics to look at to evaluate your company’s financial state.
All of them are important. Some are more pressing than others for different scenarios.
Startup Burn Rate
This metric reveals how much money your startup is burning through each month. It is how much your expenses are, and what it is currently costing to keep the machine on, and the doors open.
It also specifically reveals how much money you are losing each month. If you are not yet at least breaking even, then it shows how much capital you are bleeding out, and that needs to be paid out each month.
You must know your expenses. You can’t just swipe the company credit card and write checks without limit.
Your startup’s runway is how many months left your company can survive based on your current spending.
This is one of the most critical metrics for startups, and their potential investors to know.
It reveals how many months they have left before going bankrupt based on their current expenses, and the money they have in the bank.
For example, if you have $100k in the bank and $10k in monthly expenses, you have 10 months of runway left.
This is vital for knowing when you need to begin running a new funding campaign. As well as for investors to assess your strength, and how much they should be investing to keep you going to the next round.
Money In The Bank
How much cash does your startup actually have in the bank?
This is one of the most important measures of health for a company. Expenses can be cut, and income can be increased, or cut off at any time. Your bank balance will show how well you are prepared to weather all of this.
It is also worth contrasting this with the liabilities and debt obligations your company owes to get a true idea of your startup’s net worth. That’s another great starting point for how to assess your startup financial health.
How much net profit is your company bringing in?
Profit margins are a great insight into the financial viability and competitiveness of your company. Gross profit can be a benchmark for investors and lenders to look at, as well as potential acquirers of your company.
However, net profit shows how much real profit is coming into your company. This is money to build up your reserves and expansion capital, improve your overall financial health, and cover emergencies.
Financial Modeling & Forecasting
You can also use financial modeling software to forecast the financial health and performance of your startup.
This can be based on continuing the way things are now, to account for various internal and external changes, and to forecast returns for potential investors when fundraising.
You’ll be including financial forecasts in your pitch deck every time you go out to raise another round of funding for your startup.
There are various reasons to have your company valued. This may be for borrowing and raising equity, licensing, preparing for an IPO, or for a merger or acquisition.
There are also a variety of valuation methods for startups. The most applicable will vary depending on why you are doing it, and who for.
It may include the above metrics, or be based on your product, sales, and the defensibility of your company in the market.
Working out the financials for an established startup is the easy part. The more challenging aspect is how to present financials for a startup with no revenue. If you need more information about how to do that, check out this video I have created.
Tips For Managing Your Startup’s Financial Health
How can you best manage and improve your company’s financial health now, and along the journey? The first practical step is to know how to assess your startup financial health.
Cut Your Business Expenses
If you are not in the healthiest position or can benefit from tightening up, one of the first questions will be how can you trim your expenses. That may be optimizing your sales funnel, better marketing, eliminating office space, or layoffs.
Increase Your Income
If you can’t reduce your business expenses any further, then the only other option is to increase your income.
There are a variety of ways to do this, from releasing new products, adding new price points and service levels, offering sales and discounts to drive more cash flow, focusing on presales, or offering prepaid discounts for those that pay a year in advance.
Raise Well Before You Need It
Raising more capital before you really need it will help keep your company in good financial health. Those who raised right before COVID lockdowns, or the downturn in capital markets, positioned themselves to survive the tough times, and really grow while others were struggling.
It’s going to be a lot harder to raise when you are desperate for money. Investors and lenders will smell it, and the terms they will offer will be much worse.
Raise When The Market Conditions Are Good
Regardless of your own plans or current financial position, it is wise to take the money when it is available, and the market is healthy. When investors are desperate to deploy capital, they will provide more money, with fewer requirements, the process will be easier, and the terms much better. The reverse is also true.
Review Your Finances Regularly
Even if you hate watching the numbers and the details, it is absolutely vital to keep your eyes on your financial health. If you ignore it, it will not be healthy. The outcome is not likely to be what you are hoping for.
Hire A Great CFO
If this isn’t your strength or passion, then one of your early hires should be a very strong CFO to stay on top of this and manage your finances well. They can keep you in great shape, and free you up to focus on what you love doing the most. You may even offer some equity or hire a fractional CFO to make it more financially viable in the early days of your startup.
Keeping Investing In Your Personal Growth
Even if the financials are your least favorite part of business, you will reap great benefits from constantly investing in, and improving your knowledge of these topics. It will gain you more respect among your team and investors, enable you to really go the distance with your mission, and make that vision a reality. If you don’t, it doesn’t matter how great your product is. If you are bankrupt, you won’t be able to make it or get it out there
How do you assess your startup’s financial health?
Understanding your company’s financial health and the situation is vital. It is your most important job as a founder.
There are various metrics and valuation methods that can be involved in this. It really depends on the situation, stage of business, and why you are measuring.
Keeping a pulse on this will help you keep your company alive, enable you to grow intelligently, stay well ahead of your financial needs, and be able to optimize your finances at every step of the way.
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