Creating a budget for your startup is an exciting task, as it allows you to have insight into what the future will bring, creating a roadmap for your success.
There are a number of mistakes that I've seen Startup's make when first setting up their budget, causing their budgeting process to be less than ideal. Let's cover a few of them, and the steps to avoid these mistakes.
Here's an example of an export from a budget that I often times see when working with a Startup:
In the above picture, there are some high-level pieces of information like hires, CAC, and customers jumbled together. This is OK if it is a custom view on your model, but not OK if this is the only information that you have.
Let's cover a few reasons why this would be problematic:
The first issue is that this is a projections only budget. It is crucial to be able to tell, not only what's going to happen in the future, but also what has already happened in the past. Much of future is going to be dependent on what has taken place thus far with the business, and you'll want to identify any trends & gaps in your data between the past and the future.
Because these projections aren't based off the financial statements from any accounting software, updating these in an ongoing basis is going to be a huge manual effort. Setting up your budget to match the chart of accounts shown in your accounting software will make it easy to update, and allow you to use an apples to apples comparison. This will become especially important when you set up a budget to actuals.
Your cash metrics (Cash Burn, Ending Cash Balance) are some of the most important metrics to keep track of. In this example, we have separate assumptions for cash burn and ending cash balance, causing another vulnerability in our budget. Your cash metrics should always be dynamic based off changes that you make in your income statement and balance sheet. For those who are familiar with accounting terms, this is best achieved by creating a Statement of Cash Flows using the Indirect Method
Probably the most important piece of advice I can offer is this: Always include an Income Statement, Balance Sheet, and Cash flows statement in your budget.
When setting up your budget to include these 3 statements, you can then easily connect this data to your accounting software, pulling in your actuals, and leaving placeholders for your projections. This will also make it easier to compare budget to actuals as the months go by.
I like to then create a summary that aggregates the data from these 3 statements:
This allows you to toggle between the detailed version of these statements (as shown in your accounting software), and a summarized basis.
Once you have all this information set up, it should be easy for you to set up departmental budgeting.
You could track who is going to be spending what, as well as what has already been spent each month, giving your department heads an understanding as to where they've been off and where they've been on with their budget.
An important thing to keep in mind when importing your income statement, balance sheet and cash flows is that it allows you to speak the language of your investors. Odds are whatever company or VC firm that's going to invest in your startup is very heavily versed with how to read an income statement, balance sheet and cash flows.
They're going to want to look at your income statement to understand how much money you are making, what is your cost of goods sold against that money, your operating expenses and your overall net income.
But that's just one piece of the story.
They would also want to look at your balance sheet to understand how much do you have in assets? How much is your cash balance, and your receivables balance? What do you have in liabilities, things that you owe to other customers or vendors? How about your equity? How much money was put into the business, how much exists in your retained earnings and net income month over month?
How about your cash movements? Are you generating a lot of income, but having a poor cash collection or maybe vice versa?
Including these three statements in your budget will answer all these questions and will be crucial in helping your manage your budget on an ongoing basis, and to report to current and future investors.
Josh Aharonoff CEO and Outsourced CFO
Hey - thanks for checking us out. We LOVE crunching numbers and providing peace of mind for your startup by managing your Accounting & Finance needs. We crunch your numbers so that you can focus on what matters the most - growing your business.
Thx for this example. One of the biggest mistakes i see with budgets is relying on the past, what you call actual numbers. People tend to forget that sometimes we have one time expenses, for example penetration costs into a new market, those shouldnt be copied to the projected budget or if you plan on penetrating a new market you wont see this expense in the previous budget. I agree the past is important to learn from but we also need to remember our future plans when we are working on our budget.