Startup finances: A glossary

There are many similar terms to describe money, and how it's managed, in a startup. Here’s how to differentiate between these different terms. 

Cash—liquid (immediately or near-immediately accessible) currency and currency equivalents. The money in your bank account being the best example

Profit—revenue minus all expenses over a certain period

Working capital—the day-to-day cash available to fund your operations

Burn rate—the pace at which a startup not yet generating profits consumes its cash reserves, typically calculated per month

Runway—the number of months a startup has before running out of cash

Cash flow—the amount of cash that comes in and goes out of a company over a given period of time

Understanding your cash position (AKA cash is king)

At the heart of a financially sound startup is cash. It’s crucial to understand the difference between cash and profit. Both are important, but as a founder you need to be laser focused on your cash position at all times. It’s the most important financial metric of your business: cash will enable you to pay your team, suppliers, buy stock, and invest in the future growth of your business. You need to keep a very close eye (a daily look) at your bank balance, and what is expected to flow into it and out of it. This will help you keep a firm grip on your current burn rate and runway. 

Profit is defined as revenue minus all expenses over a certain period: it is shown on your financial statements, after accounting adjustments. Profitable businesses can still run out of cash—they may have bad (irrecoverable) debt from their customers, be holding too much stock, or be servicing loans. Loss-making businesses can continue to operate as long as they have cash—see Uber, Twitter, Deliveroo etc.

Here’s a simple and stark illustration of the differences between cash and profit:

• Company A is very simple. It receives cash in when it makes a sale, and pays cash out when it incurs an expense

• Company B is a more realistic example in the startup world. Although not profitable, it is making clever use of its ‘working capital’ (more on this later), recovering cash on sales at a more efficient rate than paying cash out on its expenses

• Company C has reached profitability, and is investing in capital expenditure and its future growth

Understanding your working capital position (the day-to-day cash available to fund your operations) is therefore crucial to staying afloat as a startup, which leads us nicely onto…

Treasury management

At the core of a financially sound startup is good treasury management: managing your financial resources in order to achieve your strategic and operational objectives. Treasury strategy goes hand-in-hand with cash-flow forecasting—deciding where to keep your cash should be informed by your projected cash flows. A robust financial model is the beating heart of any planning process. We’ve written extensively on the advantages of forecasting and financial modelling, as well as how to build your own financial model, which you can read here.

Once you have assessed how much cash you require to support your operations and when you need it, consider the three principles of treasury management in the following order:

1. Security. How safe are your funds? This is the overriding priority: the main risks are counterparty risk (i.e. will the counterparty repay us) and market risk (i.e. the risk of losses on financial investments caused by adverse price movements)

2. Liquidity. How quickly can you access your money?

3. Yield. What will your funds earn you? Providing security and liquidity objectives have been satisfied, only then should you think about optimising yield. There is often a trade-off between yield and liquidity. 

We would add a fourth principle—operational friction. Consider this both in terms of platform setup (how long will it take? what level of KYC is required?) and ongoing usage. A banking platform with difficult UX may not be such a problem when you are making a handful of transactions a week: but if you scale quickly, the last thing on your to-do list will be changing banks. 

Generally speaking, challenger neo-banks have quick setups compared to the high-streets, and it’s easy to be seduced by their design-led app platforms. On the other hand, the more established providers currently offer more than a simple current account - access to debt financing, deposit/notice accounts and complex FX products which you may choose to use as you scale. Most large-scale businesses don’t yet rely exclusively on neo-banks for their day-to-day banking—but this is changing.

We would always recommend diversifying your treasury, not least because it enables you to take advantage of the FSCS deposit protections (covering up to £85k per entity per bank in the UK) and FDIC insurance (covering up to $250k per bank in the USA) in the case of a bank failure. On top of this, in a world of increasing bank regulation and fraud protections, there is a high possibility accounts and transactions can be frozen at short notice whilst checks are carried out, which could adversely impact your day-to-day operations. It’s prudent to have at least two banking relationships; even more if you are holding larger funds (e.g. if you’ve recently closed a funding round). 

Consider the following when choosing a bank:

• Is it actually a bank? Financial technology/e-money companies are not regulated in the same way. They may have safeguards over your cash, but you should investigate whether this is as secure as regulated depositor protection. 

• Customer service and friction of onboarding. Some online banks offer account opening same-day or same-week but thereafter have poor customer service and it can be hard to get hold of a human to speak to. Most of the bricks-and-mortar banks in the UK take around a month to open a business account, but you'll get a relationship manager to support you

• FX services. Consider If you are dealing with a lot of foreign currency transactions

Generally, notwithstanding depositor protections, high-street banks are considered relatively secure. But, black swan events do happen and you should certainly be conscious of the current instability in the banking sector. We suggest checking your bank's credit ratings at least twice a year (you can do this on Reuters/Bloomberg or a simple Google search). Banks are usually rated BBB-AA. 

Types of bank account to consider:

Vanilla current/checking accounts

High liquidity, low yield. Like a personal currency account you can access your company funds on demand, but interest on balances is minimal, if paid at all.

Savings/deposit/notice accounts

Medium liquidity, higher yield. Deposit and notice accounts allow you to lock your funds away for a period of time - normally from as little as 30 days and up to 1 year+. They pay moderate rates of interest, variable based on the length of time funds are held on deposit for. Some accounts may also require minimum deposits to access better rates. Whilst rates are generally similar across the market it is worth asking your bank for their latest rates sheet and comparing this to competitor banks to get the best rates.

Foreign currency account

Generally, FX brokers offer more competitive published rates than banks on both current (spot) and future (forward) trades. The fees they charge are factored into the rate so you should compare this with that offered by your bank. You will likely need to put up collateral if executing FX forward contracts, typically 5-10% of the value of the contract you are hedging and some trading history (management accounts/stat accounts). 

Other options:

• Investment products: If you have a lot of cash which is not needed for working capital, consider money market funds (MMFs): medium-liquidity, higher yield, will require relatively high minimum deposits. MMFs are highly diversified and the reputable ones (£1 bn + in assets) have high credit ratings (AAA). Although deposits are not technically insured (like the FCSC bank protections), they are considered a very secure place to hold material amounts of cash by treasury and industry experts. The interest rates should be higher than a bank’s offer, but there is a liquidity trade-off

• Cash management solutions: intermediary platforms which manage funds, diversifying across a range of accounts/products. These are very useful for companies that have a lot of cash, require varying degrees of liquidity and are happy to pay platform fees, and forgo some yield, in return for these services.

Other things to consider:

• Key person risk: do the relevant people in your team all have the appropriate access to instigate/approve transactions? Make sure your bank mandates, permissions and access are up-to-date

• Ensure all your banking details and mandates are saved offline somewhere securely

• If holding or trading in cryptocurrency, consider best practice safe storage. Generally cold-storage, hardware wallets are considered the safest place for your crypto - holding funds on exchanges is ill-advised. When using a hardware wallet, consider who should have access to private keys and where the keys will be stored

It’s worth ending by stressing this: technical financial mastery is not a prerequisite to entrepreneurial success. Managing your startup’s finances requires an understanding of finance fundamentals, diligence and attention, but often doesn’t require specialist financial expertise. Stay focused on your cash, and for those areas that do require deeper knowledge, expertise should be sought, outsourced and hired. 

Financial challenges are inevitable. So while they may not be avoidable, with the right tools, approaches, and processes in place, they are certainly navigable.