Budgeting For Early Stage Ventures - Why Should I Care?
“It is not necessary to do extraordinary things to get extraordinary results.”
Warren Buffett
In the fast-paced world of startups, budgeting often takes a backseat, especially for early-stage entrepreneurs who might think, "I don't have enough revenue to justify budgeting." However, achieving extraordinary results doesn't always require extraordinary efforts, just carefully planned and executed ones. In this blog post, we'll explore why budgeting is a crucial aspect of financial management, especially for startups and small businesses, where the margin for error is so small.
Budgeting for Material Decision-Making
Some entrepreneurs make the mistake of believing that budgeting only becomes relevant when a company hits a certain revenue threshold. They argue that with limited revenue, budgeting is a waste of time. However, budgeting becomes essential when your decisions carry significant short or long-term consequences. When you’re a large company with established revenue streams and clients, successful budgeting optimizes profitability; for small companies it can be the difference between profitability and bankruptcy.
Just Raised Capital:
Constructing a financial framework becomes critical. This framework helps you plan how to allocate the capital over time, establish goals for each cash outflow, and define your overall financial strategy. Beyond its inherent value, this process signals to current and potential investors that you are a prudent manager of their capital, making informed decisions with a solid financial structure in place. How costly of a mistake would it be to “hit all of your goals” to only find out that achievement of said goals doesn’t result in a favorable financial outcome?
About to Raise Capital:
Your revenue might not have reached a critical mass, but short-term revenue might not be your primary goal. Perhaps you're focused on establishing user adoption, improving unit economics in a local market, or other strategic objectives. In this case, a budget becomes a valuable tool for effectively managing the available cash and building a compelling story for investors, showcasing their potential capital as true "growth capital." Investors are looking to put cash behind a de-risked business model and this story can be told without positive cash flow or material revenue.
Understanding your business model and the interdependencies between financial numbers is crucial for raising capital and sustaining your business in the long run.
Early-Stage Company Budgets
A well-structured budget in an early-stage company should achieve several key objectives:
Should:
Facilitate Discussion and Collaboration: Budgeting fosters discussion, critical thinking, and collaboration across all functions within the company.
Be Achievable: Management should be able to confidently rationalize the achievement of all critical components of the budget, leveraging historical results. Throwing huge numbers on a piece of paper that are disconnected from reality signals an inability to diagnose risk and puts into question credibility.
Identify Key Metrics: Budgets help identify hypersensitive metrics within the organization that need close monitoring and foster a transparent understanding of functional interdependencies throughout all levels of the organization.
Performance Review: The budget should cascade into performance review structures, translating into departmental and individual goals. Each employee should have SMART goals aligned with the budget, fostering a sense of ownership and motivation.
Provide an Objective Framework: It offers an objective and quantitative framework to determine when things aren't working and initiate discussions about necessary changes. The budget process needs to provide ongoing operational value by migrating into a day to day operational tool via outputs such as recurring “budget vs. actual” reviews.
Rationalize Expenses: A budget rationalizes all material expenses in the company. If expenses can't be justified on the basis of creating positive financial outcomes, they should no longer be incurred.
Enable Cash Understanding: Budgets enable a clear understanding of the cash position and cash burn. Cash flow is vital, and if there's no clear path to generating cash in the near term, you may need to reconsider or plan for raising capital. A company with the “strongest metrics” can still fall victim to being cash poor.
Should Not:
End-All Solution: A budget isn't a rigid rule but a guide. It represents likely financial outcomes based on assumptions but shouldn't be blindly followed.
Isolated Finance Exercise: A budget is only as good as the thought, care, and accuracy of the assumptions feeding it. It should involve input and collaboration from all relevant departments. Finance does not “own” the achievement of departmental goals so finance should not be creating said goals in a vacuum.
Unnecessarily overcomplicate: There is generally a trade off between precision and understandability and an incomprehensible budget stands little chance to be used as a day to day operational tool within the company. The entire company needs to walk away from a budget process with a clear understanding of “what does this mean for me”.
Budgeting is not just reserved for large corporations; it's a valuable tool for early-stage entrepreneurs and small businesses. It helps you make informed decisions, manage your resources effectively, and communicate your financial successes to investors. So, don't underestimate the power of budgeting—it might just be the key to achieving extraordinary results in your business journey.
