When Income Statement, Balance Sheet and Cash Flow documents aren’t relevant.
> Startups that are searching for a business model need to keep score differently than large companies that are executing a known business model. Yet most entrepreneurs and their VC’s make startups use financial models and spreadsheets that actually hinder their success. (Steve Blank)
As anyone who has launched a company knows, one way that VC’s like to keep tabs of the progress of a startup is by reviewing Income Statement, Balance Sheet and Cash Flow documents – probably on a monthly basis.
Those documents provide a snapshot of the lifeblood for an established company. Yet, that approach is largely ineffective for a nascent startup. Put simply, they don’t provide a real indication of how well an entrepreneur is (or is not) doing with the process of validating their business model.
Here’s when Income Statements, Balance Sheets and Cash Flow Statements are important for entrepreneurs:
Pitching the idea to a VC (yes, you’re guessing at this point, but it’s good to show that you can put together a financial model that shows the relationships between variables in the business model).
After a repeatable and profitable business model has been established, you are running the business, and you’re monitoring the financial health of the company as you’re executing on the business model.
Too early in the startup lifecycle, and these statements can lead the founding team to focus on the wrong numbers.
Listen, at its most basic definition, a startup is a search for a repeatable and scalable business model. As a founder, you’re testing hypotheses about customers, users, channels, product, demand, manufacturing, etc. The problem is, that information doesn’t necessarily live on an Income Statement, Balance Sheet or Cash Flow Statement.
Q: So, if you’re not going purely by the numbers, how do you know that you’ve found a solid, scalable business model?
A: You see that the cost of getting customers will be less than the revenues the customers will generate.
Keep in mind that this varies by industry. Pay attention to the market and know that these measures are best found in other startup metrics that indicate whether the business model supports the company you’re building. Those are the metrics that highlight the potential (and perhaps even actions) for your business model to scale into a successful company.
And, you ask, what are those startup metrics? Again, they vary, but you at least need a firm grasp on customer lifecycle, customer acquisition cost, marketing cost, viral coefficient and customer lifetime value. Additionally, you should be tracking cash burn rate, months of cash left and time to cash flow break-even.
Metrics matter. Accounting matters. The variance is the degree to which specific ones impact decision making at various stages of business development. Determine your priorities, align the numbers to your model, and you will have focused on what is most important in your search for business viability.