Why Every Startup Needs a Financial Plan

Assumptions are Important

money-down-the-drainHaving a financial plan for your startup is based on a simple concept. It says “If these assumptions prove true, then these financial results will occur.”

In other words, a financial plan is the place where you determine whether or not your business idea could possibly result in financial success.

To start a business without a financial plan would be like sailing out of port in a sailboat with no navigational tools and no idea where you are going. In the case of the sailboat, your life would be at risk. In the case of a startup company, any money or time you are about to invest is likely to go down the drain.

Notice that I am not saying you need to have all the facts before you launch your company. But you need to at least document the assumptions you are making about the business and verify that if those assumptions end up being valid you have a viable business.

In The Lean Startup, Eric Ries provides us with sound advice for starting a company: State your assumptions and then make many small iterations. For each iteration,

  • Invest as little as possible
  • Build a minimally viable product (MVP), i.e., build something you can show your customers
  • Learn which assumptions are valid
  • Pivot and repeat

Innovation Accounting

As a metric for determining that you are making progress, Ries recommends using innovation accounting (IA). IA is basically checking that assumptions are being verified, the product is progressing toward viability, and the startup is learning – all good things.

Traditional Accounting

I would add just two steps to his advice:

  1. Before you launch, build a financial plan based on your assumptions to verify that financial success is at least possible.
  2. At the end of each iteration, repeat the financial plan to verify that the revised assumptions are still sufficient to support financial success.
 Iteration Ia

A company following the traditional lean startup approach is iterating and “making progress” but it is unclear if it is heading in a financially viable direction.

No Financial Plan;
No Knowledge

 Iteration II

By creating a financial plan, you can learn that the path you are considering cannot result in a great financial result.

Financial Plan Shows Poor Results

 Iteration III

By recreating the financial plan with different assumptions, you can determine that charting an alternative path could result in a far better financial outcome.

Change Path & Financial Plan
Shows Good Results

My advice makes sense only if creating a financial plan is not overly time consuming. The secret is to use a tool that supports automatic generation of financial statements directly from your business assumptions. By doing so, financial planning costs you little but saves you a lot.

???????????????????????????????Davis is a serial entrepreneur currently in his fifth startup. He is also an angel investor and author of six books.