Do the Math—Prepare Financial Assessment
By now, you should’ve already developed your startup business model and have an idea what you will sell and to whom. The next step is to understand your startup’s expenses.
Calculate your fixed costs and evaluate how they can change over time.
Calculate what monthly expenses (such as rent, advertising, insurance, and office supplies) you have independent of your sales volume. The concept of lean startup suggests avoiding fixed costs in early-stage startups, especially if you have negative cash flow. Always stay lean on expenses. If it’s not necessary, don’t spend money on it.
2. Calculate your variable costs and prepare your budget draft.
Variable costs are those costs that vary depending on your production or sales volume; they rise as production increases and fall as production decreases. Variable costs can include direct material costs, direct labor costs necessary to complete a certain task related to the product or service, and third-party costs (for example, the more potential customers you have, the higher the price you pay for marketing automation tools, and the more product you sell, the more you pay for product delivery). Customer acquisition and servicing costs are probably the largest variable costs at the moment. Calculate how much you have to spend to acquire a new customer and how much you also need to service this customer.
3. Calculate your cash burn rate, break-even point, and time remaining to reach it.
Cash-burn rate shows how much money you lose each month and helps you know how much time you have until your funds will be totally depleted and your venture closed. Cash-burn rate defines the time frame until you have to reach a break-even point and start earning a profit. If you find out that there is not enough time to achieve any particular results, it’s better to not even start yet or reduce your costs dramatically.
4. Calculate needed investments and how exactly those investments will be used.
Prepare a plan for how much funds you will need and how they will be used. Be ready to show the benefits to investors if you are planning to attract outside funding. Usually, investors expect to see not only immediate profit but also reduced cash-burn rate, growing the customer base, and achieving a competitive advantage. Ask yourself the following questions:
• How much investment do you need, and for what purpose will the investment be used?
• When are these investments needed? They might not be needed all at once, but only after reaching particular milestones. For example, you’ll need to allocate the actual marketing budget only when you have a product-market fit that we‘ve talked in Lesson #5.
• What is the expected payback period? What is the projected return on investment? Nobody wants to invest money and then forget about it. You must have clear answers about when your startup will start generating profit.
• What if you won’t get any investment? What is your Plan B?
Once you have your fixed and variable costs on paper, you can prepare your monthly and yearly budget. Remember that you are creating just a budget draft to get an idea about your possible financial situation in the near future. Don‘t spend too much of your precious time on preparing the most detailed and accurate set of financial documents.
Stay till the end of the course, and you’ll get a link to download not only the Excel spreadsheet for your financial assessment but also all other related templates and swipe files to stay on track and save your time.
Startups should act on the survival instinct: build products, attract paying customers, deal with competition, be lean on expenses, and have in mind that future funding may not be available. Therefore, you should clearly know what your fixed and variable costs, cash-burn rate, break-even point, and how much time you have for achieving it. Have a clear plan of how much to invest, for what purpose, and when you will need it.
In the next lesson, we will talk about how you should plan the whole process of building your startup and what important milestones should be taken into account.
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