Why founders neglect finance functions and why they shouldn’t
Most startup entrepreneurs keep finance in low esteem. The rationale behind it is that finance is a back-office, non-revenue generating function that is not crucial in the early stages of the business. But this can be a big mistake. It is far from the truth that finance is a pure back-office function and does not generate revenue.
Most startup entrepreneurs commit the mistake of neglecting finance, which can turn out to be very costly to their business. It is imperative for startup entrepreneurs to know a certain amount of finance and accountancy, mainly for two reasons – one is to keep abreast of what is happening in their business in terms of its performance and outlook, and the other is that they cannot afford to hire a finance professional in the early stages.
If entrepreneurs find it difficult to master finance at a level that is required to run a business, they should get a good finance hand. If startup founders don’t have the budget to onboard the finance team, there is no choice but to be their own. In this catch-22 situation, finance knowledge or finance hand, at least part-time or virtual finance, is required to help the entrepreneurs engage in meaningful conversations with their potential partners, investors, auditors, authorities, employees, customers, suppliers, and other internal and external stakeholders.
Managing costs, cash flow, invoices, vendors, collection, taxes and payroll probably may not be what startup entrepreneurs imagined they would do when they decided to launch their own business. But neglecting these critical tasks is equivalent to committing entrepreneurial suicide.
For almost all organisations, accounting and finance influence nearly every facet of their business. Whether you’re applying for a business loan or grant, managing payroll and employee benefits, paying expenses like rent and utilities, invoicing vendors, pricing your products or services, seeking investors, projecting growth, invoicing customers and collecting money, the accounting forms the basis of everything you do in business.
If articulated concisely, finance and accounting help you in:
- Strong understanding of assets and liabilities
- Strategic decision-making based on data from Profit and Loss Statement (Income statement in the US), balance sheet, and cash flow statement
- Making the business ready for fundraising
- Preparing the business to manage costs, working capital, and risks
Most founders – particularly in the early days of their business – are focused on acquiring and retaining their first customers and generating traction.
In the absence of a full-time accountant on board, you may outsource the bare minimum accounting tasks to accounting service providers. However, working capital management that includes management of cash, credit lines, customer collection, inventory wherever applicable, vendor payments etc, cannot be easily outsourced. Another mistake that many entrepreneurs commit is keeping accounting and compliances pending unattended, leading to a mess that is capable of killing your business.
Be in control
Business owners having financial literacy will help them have full control of their business. If you are not, you should get help. If you try to save money by not hiring or sourcing help, it will cost you.
As a business owner, gaining some degree of financial acumen gives you the best chance of building a business that can thrive and can prepare you for a number of the challenges that you will naturally encounter on your journey. Even if you have a good finance hand, an entrepreneur having a basic understanding of finance gives an edge.
When you scale-up
All entrepreneurs need adequate financing to scale up their businesses. Access to loans or credit lines or funding is a key factor in the process of expansion and growth for startup enterprises. When the time comes to talk to private equity firms, banks or investors, going for IPO will undoubtedly prove to be invaluable and it calls for either financial literacy on the part of non-finance entrepreneurs or having a finance professional on board.
Finance and accounting help entrepreneurs not only with formulating their overall strategy but also with staying on top of nitty-gritty details of day-to-day operations like customers who haven’t paid up, suppliers who have billed too much or are not paid in time, delay in supplies, current liabilities that need to settled immediately or numbers that used to be black slipping to the red in your Profit and Loss statement.
All startup businesses need to grow profitably to succeed. The ability to sustain the business during the crisis and scale in a profitable way calls for certain insights that come from finance and accounting.
Entrepreneurs cannot neglect crucial financial elements
Managing cash flow
This is arguably the most important element in a business, particularly in its early stage. For many businesses, especially the new ones, where credit lines are limited and financing is difficult, internally generated cash proves to be one of the most critical assets. You need cash to pay suppliers and employees, maintain inventory, reach customers, and grow the business.
It is unwarranted to reiterate the need to give attention to cash inflows and outflows to enable entrepreneurs to plan and manage sustainability and growth, prevent any unnecessary cash shortages, and reinvest or use excess cash judiciously to grow the business.
The reasons why you don’t have the luxury to neglect cash flow are the following:
- Many startups fail because of poor cash flow management, resulting in a cash crunch.
- Regular cash flow analysis and monitoring will help you identify the risky situation and alert you to take measures to come out of such difficult situations.
- Monitoring and reviewing cash collection, cash disbursement, and cash position is one of the most difficult and critical aspects of running your business.
- However good your idea may be, you shouldn’t run out of cash.
Strong balance sheet
The balance sheet provides a snapshot of a company’s financial health and position at a particular point in time. It allows those running the business to quickly see what resources are available, how those resources were financed, and show both the assets and liabilities.
Entrepreneurs should review the balance sheet to keep their business in control. Sales may be increasing exponentially but keeping an eye on the liabilities side of the balance sheet is important for the long-term success of the business. Even though investors care about growth potential, they also care about how much the company owns versus how much it owes. The balance sheet gives investors and potential buyers a solid understanding of where the company stands.
- A balance sheet is a report card that shows the financial position and health of the business.
- A balance sheet helps you calculate the value of your company. Having an idea of the value can give you an insight into your plans.
- A review of the assets and liabilities on your balance sheet can help you with an early warning system.
Path to profitability
Profitability is defined as how much money is left from the sales after all expenses have been subtracted. This can sometimes become a lower priority during the early stages of a company.
The business may take a loss early to reach a target market, acquire and retain customers, increase visibility, or launch products successfully, but this cannot be a long-term strategy.
However, even when your priority is growing business over profitability, you must have total control over expenses and limit your fixed expenses. A piece of sound knowledge and understanding of finance and accounting is a must to control cost by analysing avoiding what expenses can affect the business and what expenses should be avoided.
Costs, margins and pricing
A business owner, particularly in the early stage, must know how they should price their products or services, and how that impacts profitability. If the business has competition, the market decides the price, but the entrepreneur should be aware that price takes care of the costs and margin. If it is a new product or service, they should know what could be the ideal price at which profit can be made, and what the customers will be willing to pay for the products.
Entrepreneurs should have a basic understanding of cost accounting techniques and applications to ensure the following:
- There is availability and understanding of data about the cost to produce a good or deliver a service that is dynamic and constantly shifting due to internal factors or external factors like economic conditions.
- Prompt and accurate decision-making to make necessary adjustments to the pricing structures.
- Have a sound understanding of fixed and variable costs and contribution margin analysis.
If you don’t give due importance to compliance with various tax and corporate laws, and regulations, there is the possibility that you will end up in trouble. Non-compliance can cause damages by way of penalties, raids, scrutiny, and even prosecution.
Not only that, an entrepreneur should keep themself updated on various incentives, tax benefits that central and state governments declare from time to time, and through finance bills (budgets) for businesses, particularly for startups.
Communicating with stakeholders
Solid communication skills are essential in business, but they’re particularly important when dealing with finance and accounting. As an entrepreneur, you must be comfortable and able to discuss the financials of your business—with employees, vendors, and investors, authorities, auditors, or other stakeholders.
Forecasting the future
For most entrepreneurs, growth is a key motivation. To grow successfully, the enterprise must be capable of forecasting the future outlook of their business. Accurate predictions about future revenues, future operating costs, future resource needs, and future profit levels are necessary to attract investors, secure funding, hire employees, allocate funds for marketing and capital expenditure, and onboard new clients or customers. Finance plays a pivotal role here.
Capital expenditure vs revenue or operating expenses
The enterprise must be able to differentiate between capital expenditure and revenue expenditure. Understanding the difference between the two gives you an insight into whether each expense affects your profit or balance sheet report. It also throws light on how an expense impacts future cash flows, and has an impact on taxes and planning.
This is one most important thing that most startup founders are bothered about. Valuation helps business attract funding and financing at a lower cost or on favourable terms. An entrepreneur must have reasonable knowledge of valuation techniques or source professional help to make sure that their business is valued such that the business is worth. Valuation is mostly done when the company is looking to sell a business or acquire or merge with other companies or dilute equity by acquiring funding or going for IPO.
A business valuation might include an analysis of the company's management, its capital structure, its future earnings prospects or the market value of its assets. Common approaches to business valuation include a review of financial statements, discounting cash flow models, and similar company comparisons. In the case of a listed company, the value of a business is its market cap.
Edited by Kanishk Singh
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)