Three Financial Planning Mistakes Founders Should Avoid
Don’t play at entrepreneurship
I recently began mentoring other founders after three profitable years for my own SaaS startup. It’s been a fascinating insight into how the minds of other entrepreneurs work but I see the same mistakes in the crucial area of financial planning over and over again. For most of them, one negative shock would have caused them to run out of cash and close their business until I encouraged them to change their ways.
I understand the excitement of the growth stage of the company means some of the underlying fundamentals can be neglected. I was no different. I was oblivious to how fragile our cash reserves were and it was dumb luck that prevented us from folding in this period.
Everything changed when our new CFO came on board. She gave us the reality check we needed and set us on a path to greater financial stability. I credit her interventions as a major reason we are still around today. I point out the same mistakes she did to my mentees but hope through this article to help more startups to become more resilient and increase their chances of success.
All you need to do is avoid these three mistakes:
Lazy forecasting
Entrepreneurship can be a storm at times. It’s easy to get swept up in it if you don’t ground your expectations. There are always a million things to do and exciting new projects to chase. The problem is when you let business happen to you rather than being intentional about it.
Everyone knows the importance of forecasting but it’s not something you can do a few times a year and forget about. In a growing startup, the financial realities can change significantly in a short amount of time. This can make even forecasts from the previous month useless for decision-making. It’s dangerous to plan based on out-of-date information.
When our new CFO recalculated our forecasts, she found there was a risk we wouldn’t have enough money to pay all of our employees. We immediately decreased our spending in other areas such as marketing to move back to a healthier position. I felt foolish because it was only the week before when I had trebled our budget for Facebook ads.
The underlying reason behind our failure to forecast more regularly was that it was so labor-intensive. The CFO had to chase different people within the business to receive the latest numbers and add them all to Excel. While the new CFO was willing to do this, it began to take up too much of her time and we needed to look for another solution.
If you feel the same way, there are tools out there that can help. We use DataRails which automatically pulls in data from our sales software and the other data sources we manage. It then uses AI to update the projections dynamically saving us significant manual work. It’s made the process far less painful and means we can make better-informed budget decisions.
A weak emergency fund
44% of small businesses have less than the recommended three months’ cash reserves according to Goldman Sachs’ 10,000 small business survey. This puts them at significant risk should revenues dry up or costs balloon unexpectedly. Even three months is on the lower end of the industry standard with six months preferred. A few years ago we would have been in the 44% but our balance is now far safer. I struggle to understand how I ever let us reach reserves of under 30 days in the past.
Last week, one of our servers went down which meant 30% of our customers had no service at all for almost two full working days. It was the most difficult day I’ve ever had as an entrepreneur as I worked hard to speak to customers to maintain their confidence in us. To show our genuine regret at the situation, we offered all companies affected a free month of service which means our revenue for the month will be much lower than anticipated. This is only something I could propose because I knew how healthy our balance sheet is. I believe this gesture will go a long way to keeping our customers loyal and protecting our long-term future.
3–6 months of cash reserves may feel like a lot especially if you are focused on growing as fast as possible but it’s more manageable than you may think. It only took us a few months to build ours and it’s been more than worth it in the number of times it’s saved us from tough situations. Make building the reserve a priority early on rather than expanding the team too fast. It also gives you the peace of mind that you can adequately provide for all your employees even if something goes wrong.
Consider the period where you build your reserves as a challenge to maintain your performance whilst spending less. You may discover new efficiencies you wouldn’t have known about otherwise.
Trusting customers too much before extending credit
My naivety once meant I was forced to write off over $20k from one of my early clients. When we brought them on board, we were desperate for customers so ignored too many red flags. They negotiated for a free trial for 3 months. At the end of this period, they told us they loved the product and would be willing to pay. Their service continued for several more months but there was always an excuse why they couldn’t pay their invoices. I knew shutting them off would crystalize our loss so kept delaying. Then one day the company website disappeared and any emails I sent to the founder bounced. I couldn’t find any trail of what happened but we’d certainly been taken for a ride.
Fool me once, shame on you but fool me twice, shame on me. I wised up and retired my ultra-friendly approach in favor of one that respected my time. We followed the 5 Cs of credit framework by default for all of our customers. I didn’t invent this, I learned about it from other blogs but it is widely used within the loan industry.
- Character — This is subjective and often where I fail as I am too trusting. Yet you want to look at your customer and their credibility and general trustworthiness. Do they seem to have a long history in business and paying their suppliers?
- Collateral — This is difficult for a small business to demand from a high ticket customer but it is critical. If they have significant assets, it makes it more likely you can recover the money if it comes down to that.
- Capital — When the customer confesses to investing their life savings, they have more to lose by closing the business and it makes them more likely to pay back in a reasonable time frame.
- Capacity — You can get a good general idea of how much cash flows through the company from doing a bit of research. Have they made claims to a certain revenue figure or customer number?
- Conditions — When the customer tries to make the terms of payment too lopsidedly in their favor, it rings alarm bells. Healthy businesses won’t need to ask for a complex payment schedule because they have enough cash to feel comfortable. Fighting hard here implies they are worried they can’t meet normal terms.
We use Oracle Engagement Cloud for our CRM which allows us to score our leads. We add all our best judgments in each of these areas to a form that spits out a trustworthiness score. We won’t do business with anyone who scores below 50 on this and we are cautious with anyone below 70. The weighting of our formula is unique to us but this option should be available in whatever CRM you use.
What to take with you
Learn from my mistakes! Financial planning is a must for serious entrepreneurs. Here is what you should do:
- Update your forecasts regularly with the latest information. This means you can make budgeting decisions more accurately.
- Build up at least three months of cash reserves, ideally six months.
- Analyze customers creditworthiness before accepting any payment schedule where they pay after services are delivered
