The Reason Ventures Struggle Pt 2: The numbers you need to know as an entrepreneur
In my first blog in this series, I discussed the importance of having financial expertise early-on in your journey of launching a new business; the lack of this is a contributing factor to start-ups struggling.
This next article summarises the key numbers you should know about your business to be a successful entrepreneur.
Finance for Start-Ups Blog 2 of 4
As an entrepreneur or founder of a new business, you don’t need to be a financial expert or become an accountant, but the most successful entrepreneurs do know their business’s key numbers.
Below are some of the most important numbers you should know about your business:
Know your market segmentation and addressable target market share. There is nothing more annoying seeing a business plan that refers to the global market size of some multi-billion-dollar industry as your addressable market. NO – you will be targeting an explicit sub-segment of this where your offering has something relevant to offer that this sub-segment does not apply to the rest of the broader market. You need to be able to rationalise your assumptions for this segmentation and your target share of this with a strategy for reaching it and your growth rates over time. Then you can build your numbers around this story.
Knowing your break-even revenue ($ or volume) on a monthly basis is extremely important for two reasons:
- Every month you are below this figure your available cash runway shortens. Time equals money when you are below break-even.
- Focus until you reach break-even. Unless you are skilled enough to have attracted pre-revenue investment, then while you are driving your car (business) in the general direction to reach your destination (success), you need to drive economically and in a straight line as possible (focussed and lean) to get there without running out of fuel (cash). Having a petrol gauge (knowing your monthly break-even number) is essential to not running out of fuel.
Your break-even figure is the number of products (or hours) you need to charge to cover your fixed costs. For this, you will need to know your product margin (or average hourly rate).
Knowing your cash burn-rate allows you to predict the number of months’ cash you have left if you keep operating at the current status quo. Using our above analogy, knowing your petrol consumption rate gives you a better chance of planning a route that has a gas station so you can refill in time before you run out.
Understanding your cash cycle is an essential element to forecasting your cash flow. This relates to the key difference between when your reported profit versus your cash flow. Making $10,000 profit this month does not mean you will also make $10,000 cash this month. Your cash cycle reflects the number of days from when you must first pay for the materials or services you need to make whatever it is you sell, and the date when you finally get paid by your customer after you sell your product or service. Product-based businesses typically have much longer cash cycles than service-based businesses. If you purchase locally you could have a 60-90-day cycle, if you purchase from overseas this could be as long as 120-160 days depending on your terms of trade.
Know your product margin. The longer your cash cycle, the higher your profit margins will need to be to have a sustainable business model. You need to generate enough cash to fund your cash cycle (working capital – debtors, creditors, inventory). If your margin is too low, your cash will never catch up. There are financial products available to assist you to shorten your cash cycle e.g. debtor finance.
Understand your cost to acquire and cost to serve. A key part of building up a view of numbers for a new venture is working through costs associated with setting up and gaining your customers and/or distributors. This cost to acquire consists of the non-recurring costs to onboard new business. This might include business development staff, travel, marketing materials, costs to provide demos or samples, etc. The cost to serve is then the ongoing costs to maintain your customer base. This may be regular visits from a sales team, technical support, or compliance/admin cost for larger customers, to name a few. If you approach for financial modelling through this lens it will help you to construct more realistic budgets and timeframes. Acquiring your customer base as a new business with a new product offering almost always takes longer than you think. Time equals money!
Know your competition. The best way to be more confident about your numbers and give your investors’ confidence in your forecast is to know how they stack up compared to your competition in terms of price versus features and benefits. Be clear on your price positioning strategy. A premium price, niche volume strategy can be as valid as a price-driven, high volume strategy, providing you have enough addressable market in each case. So, do lots of research and benchmark, benchmark, benchmark.
My next blog in this series will focus on what investors look for in your financial plans.