Key Outlines on How to Understand Financial Statements and Budgets for Startups
How much does it cost to start a business? What do I need to understand financial statements and budgets for startups? These are the questions the startups often ask. Preparing a budget for a business isn't necessarily rocket science. But don't build up your hopes that drawing the financial statements will be an easy task to do.
Read on to pinpoint the areas most in need of startup finance development. Here are described the basic things of how to budget company expenses at a startup.
What is a startup budget?
To a beginner, setting up a business budget seems to be a black box. Informational chaos surrounding this topic may route you the wrong path.
So let's define a startup budget. It is a document that describes the estimation of expected income and expenses, as well as cash needs. The starting budget should cover the initial launch expenses. It also defines the variable and fixed costs for its running.
Creating a budget for a new or ongoing business is a good practice. To prove it, here are a few reasons:
- Get a business loan. This document will show how much money you need and how your cash flow would look like in the next few years.
- Overview of your spendings. You'll see how your future expenses look and what you'll live on. It is also helpful in developing further strategies for startup growth.
- Know the required profit. With this goal, you can track the earned revenue and compare it to your expenses. Once they have met, the rest of the cash is your net income.
What are the startup costs?
According to the online business dictionary: startup costs are the non-recurring costs associated with setting up a business. To enlist a few: accountant's fees, legal fees, registration charges, advertising, promotional activities, and employee training. It is also called startup expenses, preliminary expenses, or pre-opening expenses.
Typical business startup costs are two-fold: structural and productive.
- Structural or pre-launch costs are helping your business to go live. That is market research, legal fees, and other operating costs.
- Productive or running costs actually cover the expenses on making a product or service. These are staff hiring, marketing and training expenses, employees' salaries, and the like. Depending on the industry and business type, these costs vary and impact further business scaling too.
To define the startup costs, you can sort them out:
- One-time fees and recurring costs. One-time expenses compile the "Day One" budget. Those are all the up-and-running expenses, for example: incorporating fees or equipment purchases. The recurring or ongoing expenses are paid on regularly - monthly or annually. Usually, their amount doesn’t change. These expenses are a web server, hosting, or SaaS tools.
- Essential and optional costs. Some expenses are uber important for business growth and product development. Optional expenses are software licenses or subscriptions that don't impact business flow dramatically. You can get such things or services later.
- Fixed and variable costs. The fixed expenses are stable from month to month as the office rent. In contrast, the variable costs are scalable and depend on the number of clients, closed deals, or sold products.
What are the basic expenses and assets?
What's special about the basic elements of the startup business budget and why they are critical? Long story short: there is no single, fit-all-businesses cost estimation method. But there is a set of basic expenses and assets that should be included in every business plan.
The list of the essential costs applicable to your business may look like this:
- Tech startup expenses cover development, design services, administration, and hosting costs. If you think about building a mobile or web app, you can get a quick estimation of development and design costs.
- Marketing expenses include the research costs, and marketing and advertising budget.
- Office space expenses encompass rent, equipment, utilities, phone, supplies, and cleaning services.
- Payroll usually deals with employee salaries/wages and bonuses. Thus, here we can also add insurance, licenses, permits, and taxes. While working out expenses related to this aspect of your operations can be tricky, if you use this free employer payroll calculator it becomes a breeze to manage from day one.
- Professional services cover various specialists: recruiters, startup consultants, mentors, attorneys, and accountants. Many startups lack resources. So if you don't have a developer team, you can hire an outsource tech agency to create your product.
- Other expenses can be travel, entertainment things for team building, meals, thematic conferences, and the like.
Expenses vs assets: is there any difference? Yes, there is. Accounting and taxation law treats these two categories differently.
- Expenses reduce the taxable income, yet you can't depreciate them. Many business owners strive to decrease the tax burden. They try to get more deductions as expenses, not assets.
- Assets don't reduce taxable income. But you can depreciate them as their value declines as time flows. Once when you sell your hardware or inventory, it becomes a cost of sales and cuts down the income.
Spreadsheet vs accounting tool: How to make a budget plan for a company?
Estimating startup costs seems to be just a detailed forecast and expenses comparison. However, if you run this comparison every month, it shows you
- how your business performs towards the set goals
- what expenses have grown and better to be cut down on or replaced by a cheaper option
- what tools aren't used and can be suspended, and the like.
When you choose the startup cost calculation approach, there are two popular ways:
#1 Excel Spreadsheets or Google Sheets. This is a quite balanced way to track and estimate all categories of costs your business is going to have. What’s more, there are dozens of startup budget templates out there on the web. You can download and cut these samples down to your business needs.
It is fine for the startup to run a financial statement spreadsheet for monthly and annual estimations. As well, you can have separate sheets for revenue, balance sheet, asset purchase, payroll, marketing budget, and cash flow. Either way, it reminds the bookkeeping of the initial stage of business running.
#2 Accounting SaaS tools help to track balance sheets, sales and sales taxes, manage customer contacts, billing, and reporting. You can check up Wave (free), QuickFile (has three freemium plans). Or paid options such as Freshbooks (from $6/mo) or QuickBooks (from $8/mo).
The drawback of the accounting tools: they are useful when your business has already done some spendings. So you might still need the spreadsheet for the pre-launch expenses estimations.
Sales and marketing in the startup budget
Many business owners underestimate the importance of the sales and marketing budget for startups. Those two will be dominant in driving the revenue of your service or product. Sticking to the point, the business can be B2B (sales-driven) or B2C (marketing-driven).
- Sales-driven startups require a dedicated sales team who will make calls, show product demos, and run outreach campaigns. So you should get a ballpark number of closed deals in relation to the made calls. That will help you to get an average selling cost of the product and forecast the monthly expected revenue.
- Marketing-driven startups need a creative pool of marketers who will run media campaigns and viral initiatives. To succeed in B2C, you should know your customer and get a customer portrait for each demographic group. However, be ready to set considerable budgets for ads and remarketing. Nowadays, people are too much bombarded with various content and offers. It takes a lot of effort and money to reach the targeted audience.
Once you’ve settled the type of your startup, it’s time to define the marketing budget and the customer acquisition costs. Run a test campaign to see how much you have to spend to get a paying customer. Having this data, you can review your forecasting and plan your sales and marketing budget and revenue.
What are the types of startup financing?
The financing is relatively connected to the startup costs. Still, to develop your business you need to consider the external investing sources. Let’s enlist the options of startup financing:
- Business loan programs
As a rule, banks offer these types of loans and have the lowest return interests. (All because banks use the depositors' funds as a source of their loans.) Though you should prepare a detailed business plan that proves - your business is on the success route.
What's more, be ready to show that you have invested your own money. And they may ask you to provide hard collateral, like real estate, equipment, or inventory. Banks can also require the other qualifications you have to pass to get a cash injection.
- SBA loans
Let’s say, you don’t look at a business loan as an option. Then, you can try to apply for a government-backed loan called the Small Business Administration loan or SBA loan. They have a lot of various loan types so you can find something suitable for your startup. The cons of SBA loans: it takes a lot of paperwork and time to get approved. Note that in the current COVID-19 situation, startups can receive a PPP loan.
How to get the investor for your startup? The search for a specific person sounds like an easy thing. Although, in real life, it is far from that. So check up the entrepreneur and angel investor websites to find your match. You can start here: Angel Capital Association, Gust, Carrefour Capital Connexion, Canadian Investment Network, and The BC Angel Forum.
Looks like finding your angel investor wouldn’t make sense? You can try to find support at the crowdfunding platforms like:
- Kickstarter (overall crowding)
- SeedInvest (technology startups)
- Republic (startups that strive for diversity)
- Indiegogo (tech and innovations)
- Patreon (artists and creators)
- Personal loans
Another way to get money is to apply for an online small business loan. Many banks review your personal credit history and approve the request. So your business gets fuel to grow and reach the market. But your credit score should be rather high to make this possible.
- Family and friends
Many startups opted for this outside funding source. The drawback is obvious. When your business would go low, be prepared for awkward family gatherings and celebrations. Despite the amount of money you need, think twice about the pros and cons before stepping on this path.
How to set up financial statements: Examples to check out
Starting a business has a lot of important steps, and drawing your financial statements is one of them. Here is a list of documents you may need to include in your financial plan:
- Startup costs worksheet collects every purchase (i.e., equipment, supplies, fees, permits, and the like) you need for your business structure (LLC, Sole Proprietorship, S-Corp, and others) and setting everything up-and-go. In addition, when setting up financial statements, consider regional factors affecting business structure and costs, including the best state to form an LLC. A variety of jurisdictions offer different regulatory, tax, and business-friendly advantages. Plan your startup costs accordingly for a comprehensive financial strategy.
- The Balance sheet depicts all your assets, liabilities, and owner's equity.
- The first-year budget brings an overview of month-by-month sales and business expenses.
- The profit and loss statement (aka P&L) shows a detailed year review of income (pre-tax and after-tax), expenses, and tax liability.
- Break-even analysis helps you to spot the point where your sales are equal to your expenses.
On top of that, be ready that your lender or bank may request these and other types of financial statements. Figure out what else is needed before applying for investments or a loan.
The bottom line
The true purpose of a startup is to turn bright ideas into products. To make it so, you have to deal with the financial part first. The understanding of financial statements and budget for startups makes all the things different. You know what are the constituent parts of your startup costs, expenses, and assets. Besides, these basic things give you the ground to managing the various types of financial statements.
Frequently asked questions
Are startup costs capitalized or expensed?
You can capitalize your start-up costs if:
- you incurred them to operate a business (and deduct these cost), and
- you paid the costs before the day your business begins.
What are the startup assets?
The assets can be tangible and intangible.
- The tangible assets have a physical shape. For example: cash, land, buildings, inventory, equipment, vehicles, and the like.
- The intangible assets have no physical form. For example trademarks, patent, goodwill, the right to use a brand name, marketing collateral, and all types of intellectual property.
How do you evaluate startup finances?
The financial health of the startup can be evaluated according to the following metrics:
- Cash flow (describes the difference in cash amount at the beginning with the cash amount available at the end of the selected period)
- Revenue growth (detects the increase or decrease of sales between the selected periods)
- Run rate (is a prediction of financial performance based on the current data. To calculate the quarter run rate, multiply your data by four)
- Burn rate (describes the money loss calculated each month. To calculate it, take the operating costs from the revenue)
- Profit margin (shows the difference between the total earned costs and the price it is sold for)
What are the basic technology expenses?
The list of basic startup technology expenses includes:
- Software licenses
- IT team
- Website hosting
- Data storage
- Email accounts
- Mobile phone contracts
- Payment gateways
- Third-party integrations or services
What are IT expenses?
IT expenses deal with the development and maintenance of systems, applications, and services.