Startup Knowledge – Drink Deep

Author: Larry Chester, President

Entrepreneurs creating a start-up face an almost insurmountable task. Many have little or no understanding of the finance side of business, and their experience is often limited to one aspect of the product they’re developing. Their challenge is getting enough information to clearly understand not only the creation of the product or service that they’re selling, but the myriad costs involved in building a profitable company from scratch.

Bringing Value Through CFO Insights

One incredible challenge for a business owner is how much capacity to commit to while the company is still in its infancy. Each move to a larger platform, whether that be IT, manufacturing, marketing or delivery, requires not just the increased cost of the larger service offering. It also requires the cost of making the change, which can be significant in itself. And the impact of the change isn’t just monetary. It also impacts business operations and personnel as well. Do you risk spending too much money too soon, or delay making the changes till growth leaves no other option?

• Business – Ready to eat food manufacturer
• Location – Chicago
• Sales – $475,000
• Ownership – single owner

Initial Contact –

The owner had spent 2 years developing her product and had been careful about developing budgets and a rudimentary cash flow forecast. But with no historical results to compare to, she was nervous about whether her plans would match the reality she now faced. She was unsure how to keep up with the accounting and production issues she needed to address. She was referred by a business incubator.

Significant Findings and Recommendations:

Financial Reporting

The company’s accounting system provides monthly reports, with most expenses and revenues posted accurately. There are some entries that are clearly cash basis in an accrual-based accounting system. The month-end process is ill-defined, making each month-end a scavenger hunt to determine what else needs to be done. The General Ledger lacks a detailed account layout. There are many significant categories summarized, limiting the actionable detail needed for data analytics, benchmarking and decision making that would improve company performance.

Recommendations

• Revise and expand the Chart of Accounts, so that information on Product Sales, Distribution Channels and Cost of Goods Sold are defined in sufficient detail. This provides information on product segmentation, profitability by sales outlets, and channel costs along the supply chain. It’s easier to summarize data for reporting than to create details from summary information.
• Since the company lacks historical information, updating the budget monthly is critical to planning for the next six to twelve months. Each new month’s information provides more history on how the company is progressing, leading to a more accurate forecast.
• Assure that all entries are consistent with accrual accounting. The system is either accrual or cash basis. Posting costs differently skews financial reporting.
• Reconcile distributor remittances to company invoices, to catch unauthorized or unexpected chargebacks and payment of slotting fees. Unfortunately, not all costs were anticipated, and surprises need to be reflected in the upcoming months’ budget.

Financial Analysis

Although financial reports are completed monthly, there has been no development of a standard analytics package tracking performance of the company. Analytics are always key to any management decision making. Especially in a start-up, where there is little or no historical information on which to base decisions, any data collected during a month is critical to helping plan for the direction and slope of the company’s growth.

Recommendations

• Develop detailed Income Statements by customer and by product SKU. This provides some clear visibility to margin improvement opportunities.
• Critical KPIs need to be identified. Tracking accounts receivable collections, (DSO – Days Sales Outstanding) or inventory turns, (DIO – Days Inventory Outstanding) will provide good information on those two key factors.
• Create trendline analysis for major KPI categories: track sales forecasts against actuals; margins against projections; identify incremental impact of changes in costs or additional fees being charged by channel partners. The trajectory of the tracked data allows visualization of possible future results.
• Critically assess sales and marketing expenses as it relates to ROI. Every marketing expenditure needs to be measured against sales, how they affect profitability, and their Return on Investment. Especially in highly competitive food markets, each marketing expense, whether co-op advertising, slotting fees or added distribution costs, nibbles away at margins. A company short on cash needs to make sure that there is a direct payback for these added expenses.

In a start-up, where there are so many things that need doing, many entrepreneurs focus solely on product and operations. This relegates financial reporting and analytics to the back burner. It’s true that without a well-designed product that is priced competitively and accepted by consumers, the company has no future. But if sales forecasts aren’t managed, pricing isn’t properly calculated, and financial models aren’t used to consider all of the upcoming expenses, the business is in trouble long before it opens its doors. In a world where cash is tight, having a full financial plan that can be easily modified is critical for business owners in any business, not just in a start-up.

This is an oft-beaten drum. Financial reporting, well-defined data, easily adjusted models, well developed costing and a business plan that lays out how the business will get to the next stage are important. Strategic decisions on the next steps, and the ability to move quickly reflect the flexible approach that is critical for any successful start-up.

The key issue is good data as a basis for insightful planning. The more information an entrepreneur has, the better able he or she is to make the right decisions. It’s the rare start-up that has collected “too much” information. A clear understanding of costs – all costs – in addition to operational flows and a team of well-experienced advisors are critical to the steady growth of any company. Though finance is often put off till later, a fractional CFO can provide critical advice and counsel as a member of that Trusted Advisor Team. Just having a great idea for a business isn’t sufficient. A well-laid out plan is the key to planting your idea in a well fertilized marketplace, and tending it while it grows into the success you have dreamed for.