From Financial Statements to Financing (Common Mistakes & Bootstrapping)

From Financial Statements to Financing

Tips to Avoid Common Mistakes & Bootstrapping For Tough Times
By Helen Hirsh Spence and Debra Yearwood

Whether starting off flush or with next to nothing, close attention to finances will provide your business with more stability and longevity.

When creating the business, be as realistic as possible. With as much detail as practical, map out expected cash inflows and outflows. If feasible look at the year ahead to estimate the first six months. This will allow you to arrange for sufficient financing.

Unfortunately, the primary reason so many small businesses fail is often financial. Reduce risk by minimizing the top six avoidable mistakes.

Top Six Avoidable Mistakes

1. Insufficient Capital

New small business owners are similar to new parents. They both suddenly have so much to juggle and to learn about the wellbeing of their business or baby, they tend to lose sight of the cumulative impact of their costs. Unanticipated costs can catch them short of funds.

Too many small businesses start without enough money to cover the costs of legal fees, insurance or utilities. They also don’t consider the lag time between cash coming in and the time when bills and salaries have to be paid. Be clear on how much cash is enough cash.

Once it is determined how much is needed, if there isn’t enough to cover your costs, consider the following options:

• Borrowing from family or friends.

• Be conscious of the added stress borrowing from friends and family brings.

• Getting a small business loan from a bank.

• Receiving additional cash from a new partner.

  • With partners comes shared decision making. Make sure you have an agreement in place.

• Investment from external sources.

• Government grants and loans.

• Using bootstrapping techniques as described below.

• Accessing crowdfunding (the collection of multiple small

  • This approach can attract money and publicity.

  • Be very specific in your funding focus.

  • Use targeted emails and social media to get attention.

  • Expect to work to reach the targets. This is not an easy task.

  • Don’t forget to include administrative costs.

  • Pay attention and comply with the associated regulations and rules.

2. Poor Cash Management
In order to manage funds, anticipate the predictability around expenses. Cash flow forecasting creates predictability. It is the estimated amount of money earned over a given period of time; typically this will be 12 months although it can be shorter.

The forecast can help manage decisions around expenditures, tax preparation, hiring, or it can indicate that additional funds will be needed. When building a forecast, always consider a best and worst case scenario. If done wisely, the forecast should indicate if the right decisions are being made for the business. It will become obvious very quickly if sales targets are not being reached or if costs are higher than expected.

How to prepare a cash flow forecast:

• Start by estimating how much revenue you expect to make. If not sure how to get started, take a look at others in your sector by seeking information at the local library, local BIA, or at your local bank branch. They should be able to provide some insights.

• Make sure that you consider whether you have new competitors or if there are new products in the market that might affect sales.

• Estimate the timing of when you receive payments. Keep in mind that payments are often late.

Estimate fixed costs (costs that do not change):

•  Building rent

•  Equipment rentals

•  Utilities

•  Insurance

•  Advertising

•  Loan repayments (including borrowing costs)

•  Investing surplus funds

Estimate variable costs (these costs change depending on activities):

• Number of customers

  • Look at expected population growth.

  • Is there construction in the neighbourhood?

  • Conduct a survey of potential customers.

  • How much will they spend per visit?

• Labour: Are your workers earning minimum wage or higher?

• What is the cost per customer?

• Mall hours: will they be longer or shorter for seasonal reasons?

• Packaging costs

• Utilities

3. Improper Product Pricing

As noted earlier, many new businesses underestimate their real costs. When setting costs, identify pure costs and what the market can bear. Ensure that the cost structure can hold up against market pressures. Price is determined by three things:

• Cost: The cost of producing the product or service.

• Profit: The reward you get for doing the work.

• Value: The value the customer places on the service or product received.

Cost-plus pricing looks at costs

and then adds on the desired profit.

Cost of materials	$75.00
+Cost of labour	$40.00
+Overhead costs	$55.00
=Total costs	$170.00
+ Desired profit	$40.00
= Sale price	$210.00

There are other factors related to your market that will impact your pricing decisions including but not limited to your competition.

4. Poor Record Keeping

Poor bookkeeping can create a variety of problems ranging from trouble collecting accounts to difficulties getting loans. Both investors and bankers will expect to see the books if you approach them for money. Business taxes will also require accurate record keeping. Invest in the success of the business by hiring a bookkeeper. The costs will save a mountain of grief and could save the business.

Develop a system for tracking inflows and outflows. There are many programs that can do this automatically. Remember that what is put in will be what comes out. The more discipline and accuracy used in entering data, the better and more reliable the information you get back will be.

Key Questions to Answer:

• What are labour costs?

• How is inventory being tracked?

• How many hours have employees worked?

• How is their time being tracked?

• Who is owed money immediately and what are the pending bills?

• What monies are owed to you now and what is pending?

5. Controls
Controls are those things that are put in place to ensure that you are making informed decisions. They take into consideration legal and regulatory requirements and help avoid costly mistakes. There are three main types of controls: visual, procedural and embedded.

• Visual controls are visual communications that are used to ensure people are following the procedures and rules you have put in place. They can include:

  • Dashboard, an at a glance view of your key performance indicators

  • Budget

  • Checklist

  • Chart with monthly revenues

• Procedural controls are those things you put in place to standardize behaviour. They are processes that must be followed for a given task. For example:

  • What is the standard onboarding process for new staff?

  • Which methods are used to keep employee and customer information secure?

  • What safeguards are in place to keep cash and equipment secure?

• Embedded controls are also standardized and do not require additional effort. They happen automatically. They can include:

  • Automatic backups of website and data

  • Standardized contracts

  • Use of passwords on company computers

6. Uncontrolled growth

It’s hard to believe that growth could actually be a cause for a business to fail, but this happens when growth is uncontrolled. There are a number of factors that contribute to failure due to uncontrolled growth:

• Cash Flow may become compromised if a large order is received and subsequently equipment or supplies need to be purchased to fulfil the order. This may force the business to use credit which can quickly escalate costs, particularly if there are delays in payment.

• Operational inefficiencies that were previously unnoticed may surface when demand rises. More space, a faster process, more employees may be needed (which means more training time). More sales also mean more customers and, subsequently, more customer service.

• Customer service failures that are a result of the inability to meet demand or manage issues as they arise. These failures can do reputational damage and result in a long term reduction of sales.

• Employee exhaustion can follow as a result of efforts to meet increased demand, especially if the decision is made to not bring in additional staff.

• With increased demand, business pressures can result in leadership work being ignored. This can result in delaying important decisions, missing opportunities or not preparing for business challenges.

Bootstrapping

In lieu of taking out additional loans or using credit to cover business costs, some businesses employ bootstrapping methods to save money. Bootstrapping is a discipline or approach that is taken to run a business with as much efficiency as possible. Bootstrapping means that you prioritize what’s important, plan your activities with care and use patience to reach your goals. Some of the key components of bootstrapping are as follows:

• Manage spending.

• Focus on customer acquisition.

• Manage the business efficiently.

• Bring in the right competencies.

• Establish work-life balance.

Manage Spending

Start-up costs require careful planning. No matter how unique the product or how high the demand for services, until you make sales, keep costs low. This can be done most effectively by considering the following:

• Research the costs in advance.

• Look at your own salary to determine what is really needed versus what

• is wanted.

• Look at production costs. Are there places that can be cut back? Can

• you use just in time inventory?

• When organizing contracts, try to get a 90 day payment process in place for suppliers and ask customers to pay on invoice. They may want to negotiate an extension of 30 days which would still give you more manoeuvrability.

• Keep business cards simple, no special paper or design.

• Buy only what is needed at the outset even if there are lower costs for

• bulk purchases.

• Don’t pay for things that will sit idle.

• Work from home if possible. Go to customers to meet with them rather

• than having them come to you.

• If working a day job, keep it at the start of your business.

  • How much time will the business require?

  • Is money needed immediately?

Tips:

• If working from home or having a home mailing address is not possible, the following may be useful:

  • Use a virtual address. For a relatively low fee, business mail can be

  • sent to a business address instead of your home address.

  • Try your local business accelerator or hub. They occasionally have free or low cost space for startups.

  • Use flexible rental arrangements that allow for the use of office or

  • board rooms only when needed.

• Look for less expensive ways to package products. For example, rather than using custom designed paper, bags or boxes, consider using simple brown paper and stamp it with a custom design.

• Can you sell leftover waste such as cardboard or metal?

• Lease unused space to someone else.

• Use free or inexpensive software like Skype.

• Hire freelancers rather than full time employees.

Focus on Customer Acquisition

Customer acquisition is the job of getting customers. As a start-up, the best way to ensure that you have the resources you need is to focus on getting customers. New entrepreneurs sometimes get bogged down in efforts to make things perfect before launching. They want to have a nice office to greet potential clients or they want the product to have multiple features before its initial release. The problem is, the more time spent tweaking means the less time spent earning money.

Get the word out; let people you know you are in the market. Wait to add additional features to the second or third release of a product. Once you have customers, take care of them. It costs you five times more to acquire a new customer than to keep an existing one. Also remember that word of mouth can work for or against your business. Even if your revenue model is focused on one-time sales, make sure that customers with concerns are well-managed.

Manage the Business Efficiently

Managing your business efficiently means saving money by carrying as much of the load personally. It may necessitate cleaning your own office space, working out of a basement room, taking very little in salary. Any means to keep costs down and to remain focused on your priorities will serve you well in the long run.

Having said this, some jobs should not be attempted. Acting as your own lawyer or even your own accountant can result in costly mistakes. If you don’t have the money to cover these costs, determine if there is anything you can barter for these services.

The best way to determine whether something is crucial to a business is to ask whether it contributes to sales. For example, while a fancy colour printer may not be necessary, a website and business cards are critical. Don’t skimp on the important stuff.

Acquiring Competencies

Bartering is a great way to manage project based services, but what can be done when it comes to employees? Consider giving employees equity in the company in exchange for lower salaries. Not only does this provide the expertise needed, it also means employees are more invested in the company’s success. They profit when the organization profits. At the outset this may not seem significant but it’s surprising how many companies do grow quickly in their early years.

Variable pay is a different approach. With variable pay, compensation is tied to the success of the company; in good times pay rises and conversely, when times are rough, pay decreases. Typically it is a mix of a low fixed rate with a variable portion which should be based on predefined objectives. Those objectives should be associated with increased revenues which employees should have the ability to influence. If they reach their goal, you know you are making more money and they get paid for their hard work.

If you have no money at all for staff, you may have to partner with someone. Make sure they have the skills you need to succeed. Here you could also look at using variable pay.

Financial Statements
Financial statements are a result of accounting done over a stated period. They will help you understand all your transactions. There are three types of financial statements which report the operations and financial position of a business. All of these statements capture a stated period of time:

• Balance Sheet: This provides an up-to-date account of the business’ assets, liabilities and net equity at a given time.

• Income Statement: This is often referred to as the Profit and Loss Statement. It provides the net income of the firm over a stated period of time, usually not longer than a year.

• Cash Flow: This statement connects the other two and shows the money coming in and going out as a result of the business’ activities.

Balance Sheet

What items of information are stated in a Balance Sheet?

• The assets owned by the company

• How they were paid for

• What’s owing (liabilities)

• Equity

Assets = Liabilities + Equity

The above is known as the accounting equation. The Balance Sheet is structured to show the amount and type of assets and how these were paid for.

Income Statements
The report that measures revenue less expenses over a period of time is the Income Statement. The formula to understand the Income Statement is revenues less expenses equals the net income.

Usually a Balance Sheet is organized to show assets and liabilities. It is further divided into short term (current assets) on the top and longer term (usually longer than a year) towards the bottom.

• Current liabilities are due within one reporting period, usually a year, whereas loans that extend over a year or years are known as long term liabilities.

• Equity is what is owned (assets less liabilities). Equity is always shown below the liabilities on the right hand side.

Revenue – Expenses = Net Income

What vocabulary is used in Income Statements?

• Net Income refers to the income less (net of) expenses.

• Other terms that are often used that mean the same as net income are: net profit or net earnings.

• Revenues can include Sales of product or Fee income in the case of time-based billing.

• Retained earnings is an accumulation of net income earned since the company was formed, less any dividends paid over that time. It is also equal to assets less liabilities.

• Operating expenses are those which are needed to support the operation (e.g., salaries, office equipment and marketing advice).

• Dividends are paid out as part of the profit to business owners (shareholders).

• Cost of goods is a term used to describe the cost of the items sold.

Simply put, revenues have to exceed expenses. If expenses exceed revenues for very long the company may not be able to survive. If someone is willing to fund the shortfall by loaning to the company or investing in its shares the company may be able to sustain losses.

Cash Flow Statement
The statement of cash flow shows the results of the period on a cash basis. The Income Statement is prepared on an accrual basis, with no regard to actual timing of cash received or paid.

The operations section of the Cash Flow Statement represents the additions and subtractions as reported on the Income Statement.

What other parts of the Cash Flow Statement follow the operations?

Investing

• The investing section refers to the money spent on those capital equipment items that show up as assets on the Income Statement.

• Investing can also include investments made by the company in other companies.

Financing

• The financing section shows the money that has either come into or out of the business through the sale of stock or proceeds of a loan.

Reconciled cash balance

• The reconciled cash balance is then added to the previous cash account balance which is reported at the top of the asset column on the Balance Sheet.

The Cash Flow Statement reconciles the operations reported on an accrual basis to the cashflow for the period.

Putting it all together, financial statements usually include a Balance Sheet, Statement of Income and Statement of Cash Flow. They also include notes to the financial statements which explain items that may not be clear from the other statements.

Understanding how to manage cash flow as outlined in these financial statements will have a direct impact on your financial success.

Resources
Document Templates

• Google Docs that will help https://docs.google.com/spreadsheets/u/0/?ftv=1&tgif=c

• Microsoft Office Templates https://templates.office.com/

• Score Templates that will help https://www.score.org/resource/business-planning-financial-statementstemplate-galler

• Simple Invoices http://www.simpleinvoices.org/

Financing

• Canada Business Network – Crowdfunding https://canadabusiness.ca/grants-and-financing/crowdfunding/

• Helping Small Businesses Get Loans  https://www.ic.gc.ca/eic/site/csbfp-pfpec.nsf/eng/h_la02855.html

• U.S. Government – Finance Your Business  https://www.usa.gov/funding-options