Understanding Basic Finance
What we'll cover in this guide:
Learn how the first year of finances for a startup is different than any other year.
Dig into how startup finance is a combination of “forecasting” for the future and “accounting” for the present.
Begin an accounting system that’s easy to understand and manage.
The fundamentals of finance are this simple – we record every income item (what we sold) on one side and then record every cost on the other side. We subtract the income from the costs – and presto! We have a profit or a loss. In the early days it’s usually a loss.
You’ve probably seen complicated spreadsheets or financial software that looks harder than figuring out the theory behind blockchains and NFT’s.
The spreadsheet we’re going to use (called an Income Statement) is nothing more than a place to capture all the income items on one side and the expense items on another. The spreadsheet will automatically tally all the values and tell us whether we made any cash.
Why First-Year Finances at Startups are so Weird
The first year of finances at a startup company is very different from any other year, that’s why we spend a lot of time on the nuances. If you’re in your second or third year, this track will still apply because it’s really just explaining how good finance works.
If we had a finance gig at an existing company there are so many aspects to startup finance that wouldn’t apply. At an existing company, we already know how things work. We know how much people make, how much our customers pay, what products they buy, and how our finances worked last year.
In Year 1 of a startup – we don’t know shit.
We have no idea if our customers will buy the product we just developed - What they’ll pay, how much it will cost to acquire them, what people we will ultimately hire, how long (if ever!) we’ll earn back the money we invested, and more. It’s all questions and no answers.
Therefore, we need a model that is less about "tracking our financial transactions” and more about “how to make some wild-ass guesses about how things might go and then quickly changing everything when we find out how wrong we were.”
Forecasting vs. Accounting
It's important to understand that startup finance is a combination of “forecasting” the future (which is very uncertain) and “accounting” for the present (what just actually happened). There is a constant back and forth between guessing about the future and tallying up the results.
There is so much forecasting involved because it takes years before all of the variables of a startup are proven out. We have to constantly make guesses, test our assumptions, then refine the numbers as quickly as possible to adjust our financial forecast.
At a big company forecasting is often done on an annual basis. While those are still guesses, they are at least based on a lot of history and previously-proven assumptions. A big company may not know how many units of the product they will sell, but they know how much customers will pay, what the product will cost, and how many people they need to employ to run the company. We don’t know any of that.
Therefore, startup finance is heavily weighted toward tons of forecasting and tons of revision.
There’s no version where we just make a single forecast for the year and let it play out. We’re going to be revising our forecasts daily which means our Income Statement will become so important to our operations.
The Basics of Startup Accounting
While we may not know all there is to know about our business yet, there’s still going to be some good old fashioned accounting to do. So let’s break out our calculators.
At its core, in order to be an accountant, we need to be able to collect all the sources of income and expenses and translate those into a spreadsheet. When the numbers are small, this is so easy to do we’ll wonder why people get paid to do it. When they get large, we’ll wonder why anyone is willing to do this for any amount of money.
Here’s an example of how startup accounting would work:
We add up all the money we earned.
We hop into our credit card processor’s website and look to find out how much gross revenue we collected. We then look at our bank statement to see where we’ve deposited checks or cash or other forms of credits (income) that came our way. We put that into a field on our spreadsheet (so kindly provided by the awesome folks of StitchCrew!)
We add up all the expenses we incurred.
We look at our bank statement, credit cards, and anywhere else money would have transacted (which could include personal receipts). We then populate our handy spreadsheet with the expenses by simply putting the name and the value into each row of a spreadsheet. This includes things like salary costs, payroll taxes, rent, marketing costs and our Starbucks bill.
We find out if we made money.
Once all of our income and expenses are loaded in the spreadsheet, through the wonders of code and math, we’re told whether we made or lost money. Typically we find out we lost money, we cry, and we go back to work. That’s how startups work. Don’t blame the spreadsheet.
That’s it. That’s literally how startup accounting works. If we can put numbers into a field in a spreadsheet (especially one set up to do some math for us – like what we provide) then – we’re now a startup accountant!
It Gets More Complicated – But Not until Later
Does startup finance get more complicated later? Yes. A bunch of complicated accounting may eventually come upon us – probably a year or two from now. We’ll start dealing with far more complicated versions of taxes, health insurance, receivables, and cash flow. For now, we don’t have to worry about any of that so we’re going to start with an accounting system that’s very easy to understand and manage.
Summary
And just like that, we now have a crash course understanding of the basics of startup finance! So what have we learned?
Well, we learned that we don’t know squat and that that’s perfectly normal for a Founder of an early-stage startup.
If we’re plunging headfirst into Year 1, it’s entirely reasonable going into this not knowing things like how much our customers will pay for our product, how much we need to spend to acquire them, or what our net margins are. How could we?
What we do know, is that early startup finance is all about building wild guesses around these amorphous costs and values, using those assumptions to forecast for the future, and constantly iterating until we get close to something right.
If that sounds tremendously vague and scary, never fear. Here’s the thing: everyone who’s ever put an ounce of effort into startup finance begins here. But unlike everyone else who’s had to go it alone, we’re going to help walk through the process every step of the way.
