Words Emma-Jane Willan & Simon Wheeldon
July 26th 2023 / 12 min read
Cash is the lifeblood of any business. For that reason, founders should have an acute awareness of their startup's current and projected financial position at all times. Against a background of economic instability and a wounded venture capital market this awareness is likely more heightened than ever.
But founders—while your finances demand ongoing attention, there are practices you can implement to help maintain control over your startup's financial health. Good financial stewardship comes down to a few simple habits and strategies that can help you navigate uncertainty and build a financially sound business.
In this article, we’ll lay out the foundations for a financially sound startup, and what it takes to understand the fundamentals of startup finances. We’ll cover:
Understanding your cash position
Working capital management
Tax, payroll, pensions, and other areas to outsource
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
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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…
Working capital management, knowing what is in your bank account and what is going out, is a key part of startup finances. Decisions you make may prove invaluable, particularly around maximising the speed at which you bring money in and delaying how fast payments go out. Remember, cash in the bank is better than numbers on an invoice, and can ultimately be the difference between survival and closure.
There are several ways you can manage this through your supplier and customer relationships:
Build good supplier relationships, and use this to negotiate longer payment terms. Communicate with them if you anticipate difficulties in paying on time. And renegotiate terms regularly (to improve or extend): credit terms are often shorter if your business has no prior trading history
Consider cadence and timeframe of payments—is it better to pay a 12 month invoice upfront and save cost, or better to pay monthly? Do you still need the same software in 12 months or will you be using something different?
Negotiate short payment terms with your customers to get cash in the bank as soon as you can, ideally before you do the work or deliver the product
Stay on top of incoming payments (a late payment can easily turn into no payment) and develop good relationships with customers. If you take card payments through a platform such as Stripe, consider payout schedules
Consider alternative working capital financing strategies. For some startups it may be advantageous to use invoice finance or factoring. This outsources the task of cash collection or even pays you up front for a fee—it comes at a cost, but can be useful if you're struggling to collect cash or spending too much time on it
Remember that many costs can be paid through an invoice with credit terms but some costs require cash in the bank (eg. salaries, PAYE and other taxes, or payments which require a card payment)
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:
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)
Liquidity. How quickly can you access your money?
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.
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).
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
As a founder, your time is very precious. Whilst you must always be laser-focused on cash, there are other finance areas which you should definitely outsource until you hire your first finance person in-house (which may be around Series A or later, depending on industry). Trying to manage key areas yourself when you are time-poor and likely not a qualified accountant is not a good use of limited resources. Whilst seeking external support comes at a financial cost, the time saved and higher financial burden of getting things wrong is money well spent.
Areas to outsource include:
Tax filings and claims (technical and easy to get lost in the various deadlines/requirements)
Internal financial reporting (get your accountant to tell you the ‘what happened’ so that you can focus on the ‘what happens next’)
Statutory financial reporting (annual accounts—very technical)
Payroll (fiddly and easy to get wrong—there are statutory obligations your provider should advise you on)
With all of the above, having a good enough understanding of how things work to ask the right questions will stand you in good stead. But you don’t need to be an expert.
Two tax areas it's worth highlighting as they can have a material impact on your cash position are:
VAT—unless you are a B2C business with highly price-sensitive customers, register for VAT as soon as you can. In the UK it is obligatory to register once your business is turning over more than £85k per annum, but by registering sooner you can reclaim VAT on your expenses.
R&D tax credits—for startups in the UK, the UK R&D SME Tax Credit Scheme is a government initiative designed to encourage innovation and growth through a tax credit which partially offsets the cost of R&D activity which involves overcoming scientific or technological uncertainties. If you conduct activities intended to create something new or improve existing tech you could be eligible—even if the project fails. Many costs could fall under this, including salaries, contractor fees, software, and even some utilities. Read more about what the SME scheme entitles you to.
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.
Emma-Jane is CFO at Founders Factory. She works closely with our executive and wider operations team, investors and founders across the Studio & Accelerator. Prior to Factory, she worked in financial management across different industries, including roles at John Lewis and as Finance Director at Vardags, a fast-growth city law firm. She also enjoys contributing her finance skills as a charity trustee.
Simon Wheeldon is Finance Manager at Founders Factory. A qualified Chartered Accountant, he trained at EY and spent a number of years in their financial assurance department, before moving to Sky as a commercial financial analyst.
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