Finances of a startup – The basics

Over the last two years entrepreneurial finance crossed my way quite often. I didn’t really recognize how much importance lies into it, despite of the facts that of course we planned the finances at the beginning of our first startup and that I attended to a university course “due diligence with excel”. Maybe I couldn’t see behind the glasses, because every entrepreneurship book only talks about the vision or because we only did the due diligence for stock-exchange enterprises… But I don’t want to deny. Startup finances are a definite lesson learned for me.
A huge problem with this subject is that you don’t learn what it really means to do your startup finances in most of the university seminaries – you only do it theoretically. In my opinion it’s very difficult to understand what you actually have to do in reality. And when you don’t study economics, you don’t know anything about controlling and financial planning of a (young) company at all.

Fortunately recently a young professor joined our university and started the professorship…Entrepreneurial Finance. Yeah! Thanks to Prof. Braun I got a fairly new and interesting perspective on the topic. Most of all, because we completely went through a real startup case based on an excel sheet and spoke about actual positions in the specific calculations. Unfortunately time was limited, so it was hard to defer to particular startups of the participants. And there were quite a lot of founders in the rows.

I’ve done a good deal of research since then and tried to intensify my knowledge about entrepreneurial finances, because it’s so essential for every company – whether you work for a market-listed corporation or with two colleagues on a new project. To sum it all up I want to give you a short overview about what are some “pillars” of finances in a startup. I will engross the thoughts later on, but let’s keep that in mind as a start and see what’s coming up!

So let’s start: Why is this subject so important to you as a founder?
A financial overview gives you both the opportunity to see the weak spots of your business model in retrospective and also lets you know which resources you have to spend in the future.
Finances of a startup are most of all based on a balance sheet, an income statement and a cash flow statement which can be complemented by researches about the market, product analyzes, operating numbers, etc. But these three are the ones you should know inside out. You’re a lucky one if you have a finance expert in your team, but every co-founder should understand the basics. There even exists an entire job for the details – the accountant or further on the auditors who do official finance review for big companies. But back to our topic – what do these three calculations exactly do?

1. Balance sheet
Divided in assets and liabilities, a balance sheets shows you, where your money comes from and wherefore you spend it. The liabilities consist of owner’s equity (money you got without any time restrictions – e.g. the capital brought in by the founders team) and liabilities itself (debt capital – borrowed cash which has to be paid back to a bank or a supplier). On the other site you got your assets – current ones (like cash) and non-current ones (cars, machines, manufacturing plants… – everything which cannot be brought to liquid cash very fast). If you want to know how much equity your startup has, you have to subtract the liabilities from your assets  the residual amount is your owner’s equity. The balance sheet is a great tool to see in which values your capital and your incomes are placed. Based on that you can calculate if you e.g. have too many products stored in your warehouse or whether or not you’re liabilities towards your main suppliers are in a good frame.

2. Income statement
The next part, the income statement, is meant for every business transactions affecting your net income, so you sell products? It will appear in your income statement. You had some depreciations on assets in the last year? Income statement-worthy! How many taxes do you have to pay? Featured in the income statement! Result of the whole process is your overall profit, or loss. Very interesting is that you can see how strongly your remaining amount of money is affected by depreciations and taxes after withdrawing your operating costs like bought material and expenditures for sales.

3. Cash flow statement
The cash flow statement is my favorite one, because it shows you how much cash you’ve earned by operations and where you can spend it. It’s separated in cash flow resulting from operating activities, cash flow resulting from investing activities and cash flow resulting from financing activities. The first one – operating activities – includes all of the costs you need to keep your business running. Personal expenses, taxes paid, interests paid to name some output factors and received payments and generated cash from operations for some input examples. This part covers the process for producing, selling and delivering your product or service. Second part: Investing activities. Sale and purchase of assets and made/received loans are part of that. Everything you do to invest in the future of your company. The financial activities are mostly not as necessary as the other two ones for a startup, because they aim for dividends and company shares, so this reflects how your company is financed. In most of the cases a young startup is financed by founder’s capital or maybe a bank credit.

How do all three correlate?
They’re all sections of a bigger system – the annual accounts. Intersections are on the one hand the change of cash and cash equivalents between the cash flow statement and the balance sheet and on the other hand the profit/loss among balance sheet and income statement. Cash represents an asset in the balance sheet and the cash flow statement complementary reveals the reasons of changes. Whereas the income statement explains how a profit or loss is achieved, the balance sheet displays shifts in equity based on net profits or deficits.

As you can see from balance sheet to income statement to cash flow the calculations tell more and more about your stock of liquid cash – one of the most important resources in your startup. You can earn as much as possible, if you have no cash left over in the middle of the year (due to investments or because your customers haven’t paid already) it can be very, very difficult to get new money in a short period of time. And even if you find an opportunity to borrow you some, you often have to pay a lot of interests on it.
So do your finances, make your planning and never run out of company’s lifeblood 😉