Performance Engineering Series: Mastering Financial Fundamentals
February 23, 2023
This post is the second in a series focused on Performance Engineering for startups. It focuses on financial fundamentals including oversight and decision-making.
As an entrepreneur, you know how important it is to maintain a clear view of the direction and performance of your business. Your capacity to understand your financials and make sense of how revenue and spending impact the business ties directly to your ability to make decisions. It also shapes the outcomes.
In an uncertain market, clarity becomes an actual survival mechanism. It can be the difference between struggling through a down market and using it to build resilience. Despite that gravity, you don’t need to have a sophisticated understanding of accounting to manage your financials well. With a few specific and practical questions, metrics, and incremental efforts, you can be nimble and smart with how you use your finances to reinforce the health of your business.
In this post, we look at the priority financial considerations. For each, we offer resources that can produce the data and insights needed to make confident decisions, move with agility, and measure your progress.
- Setting and tracking KPIs
- Balancing costs and cash flow
- Budgeting with optimism and a worst-case mindset
Take an Honest Look at Your Financial Situation
First things first, level-set. Begin by conducting a hard and rational assessment of your current financials. Confirm that you are using your limited resources wisely, budgeting realistically, and operating with discipline. You will likely discover that you need to do some housekeeping. As you go through this review process, rest assured, companies almost never see financial performance that is straight ‘up and to the right.’ What’s more, regular financial reviews and adjustments are normal as market forces and internal performance impact your business.
Whatever your financials look like now, embrace the reality. Acknowledge that no matter how excited you are about your platform or product, honesty and incrementalism are safer than a ‘growth-at-any-cost’ strategy, particularly in an unstable economic environment. (Though we’d argue that it’s rarely an intelligent approach.)
Engage your management team in a detailed assessment of the business and financial health to encourage transparency and a culture of financial discipline. Remember, you can’t manage what you can’t measure.
Financial Health Questions
- Are you generating or burning cash each month?
- What happens if your sales slow or stop?
- What are your worst-case scenarios and how would you handle them?
- How can you control your spending?
- What are your biggest cost areas and their current run rates? (Chances are, they are people.)
- Where can you be leaner? (For example, do you have resources like software on your books that are nice to have but not essential to the business?)
- How can you prioritize your spending?
Know and Monitor Your KPIs (Obsessively)
Founders must always understand and analyze the business and monitor Key Performance Indicators (KPIs). Put simply, a KPI is a measurement of how well your business is performing relative to the specific goals and objectives of the company.
To set up and maintain your KPIs, use a tracking framework. Know that macroeconomics, market forces, and competition will be key considerations. But they are not your performance indicators. Your specific KPI framework, insights, and decisions should be informed by the key drivers of your business. Make sure to implement KPIs across the core functions of the business, including product development and customer success – not just for go-to-market activities. You may want to consider things like sales pipeline activities, customer churn, customer usage, development efficiency/speed, support ticket resolution times, and platform uptime. Start with your current numbers as a baseline.
Once your KPI framework is set up and you’re monitoring trends, pay careful attention to your leading and lagging indicators. Leading indicators predict future conditions. They are tied to inputs like processes, skills, and operations that need to happen to ‘lead to’ measurable performance outcomes. To know whether your leading indicators are pointing toward growth or a slow-down, keep an eye on things like your top-of-funnel pipeline growth and pipeline velocity as well as the activities of customers in that phase, such as whether they are participating in demos, trials, and sign-ups.
If you do nothing else, you must know what your leading indicators are. You must track them. And if you notice any softening in those KPIs, you need to be ready to work quickly to make decisions and take action.
What you do with your leading indicators will absolutely impact your lagging indicators – the current state of your business performance. Essentially, lagging indicators are output metrics such as revenue, cash flow, ARR, and retention rates. They can be easier than leading indicators to measure but they are significantly more difficult to change. They will, however, provide insight into current financial performance or outcomes of key initiatives or projects.
You may not be able to control market factors. But agility is built by setting KPIs based on the most imperative targets for your business, monitoring your indicators, and having a plan to respond in a timely way.
Remember, be realistic. This may not be a year to set aggressive goals – it may be a year when success is measured by being steady.
Balance Costs and Cash Flow
Just as it is essential to set and track your KPIs, it’s necessary to know where every dollar is going and coming from, particularly in a year when the markets are down. Breaking even or extending your cash runway (e.g., cash balance divided by trailing three or six-month cash burn) might be the best target outcome for your financials.
A lot of people talk about controlling costs and managing cash flow. The daily efforts of running the business can sideline these good intentions. But try. If you do, your business is more likely to survive to work another day.
If you are not at break-even, start with a straightforward calculation: how could you create an X% reduction in costs and an X% increase in sales?
Calculate how to shift those variables to reach the break-even point or the desired extension of a cash runway to build your plan. Realistically, it’s simpler to reduce costs than reliably increase sales. Start there. Create a cash flow projection so you know if you need to cut costs. As you do, you may find you need to reduce spending or hiring. The calculation will dictate how deep you may need to go. Be careful to avoid cutting to the bone in any area or position, because you want to retain adequate muscle in critical functions to take advantage when market conditions improve.
Making cuts to the bottom line and/or driving new sales are not the only way to put more money in the account. There are (simple) things you can do to improve cash flow.
- Send invoices earlier. If you are invoicing in batches at the end of each month, consider invoicing throughout the month. Send invoices well in advance of renewals so that the customer has them and can process them in a timely manner. And remember to put in place a process to “remind” your customers when invoices are due.
- Offer incentives to prepay. Cash is king. Instead of offering discounts, try to identify and offer “credit dollars” customers can use for benefits that don’t have a hard cost for you – valuable intangibles like an extra user license or access to gated online training in exchange for early payment.
- Talk to vendors about extended payment terms. You may find them being more generous with customers to ensure you stay. Your only cost is the time it took to ask!
- Consider leasing equipment purchases. Purchasing equipment upfront can impact short-term cash flow. A lease can help reduce this upfront outflow and spread the cash flow on a more even basis
- Remember that people are your most expensive cost. No one wants to think about reducing staff but it’s a necessary exercise, especially if the alternative is the risk of going out of business. Think about how you can outsource certain business functions, which may be more cost-effective than hiring another full-time person. And make sure everyone is needed and contributing. Emotions often cloud our ability to objectively assess employees, which is another reason why using a framework can be so valuable.
Plan for the Worst but be Optimistic with Your Budgeting
As you assess and build your break-even strategy, balance being realistic with being optimistic. Be optimistic about your great idea, the reasons customers love you, and the changes you’re making in the marketplace. So that you can have the confidence these things will become even better as a result of a challenging market, be realistic with your assessments, decisions, and actions. (It’s better to be conservative with your target and lean into overachievement than to have to manage a missed target.)
Consider what market forces are likely to do (or not do), and importantly, assess how many years you’ve hit your financial targets. Build a budgeting framework that is based on probabilities and a range of outcomes such as best, likely, and worst case. Go ahead and assume sales and revenue growth will slow or drop. Run the numbers to identify the point in a worst-case scenario at which you no longer have enough cash if business conditions get tougher without significant expense reductions or a fund raise.
Taking the time to think through the business drivers that push you down or elevate you up can help to build a spending plan that is in response to, instead of spending in anticipation of. You’ll end up with a better sense of where and when you can afford to be ambitious and where you should be more conservative. Lastly, remember to keep your eyes on the revenue and expense run-rate at year-end. It establishes the base for budgeting and managing the following year.
This is an Opportunity for Leadership
All the reminders, frameworks, equations, and tips in the world cannot overshadow the singular point you need to remember: you are a leader. Character is made in times of challenge. Don’t ignore your numbers or your instincts. If you feel like things are off, they probably are. Still, keep close to the data before acting. As the leader of the company, you are making decisions for the good of the whole. Be sure to leverage expertise from other sources such as your board of directors, peers, and investors as you think through the strategy.
Create a culture of consistent monitoring and thoughtful expense control. Encourage your team and employees to view spending as if it is their own money and to ensure the company is getting appropriate value for each dollar. If you have to make cuts, make them quickly and make sure they are deep enough. Communicate constantly, transparently, and with ownership. And most importantly, stay unemotional but treat people with compassion and fairness – you are setting the tone.
Read Post One in the series here: You Can Build Resilience in 2023 – Consider These 4 Fundamentals