A few weeks ago, I was talking with one of the first-time entrepreneurs I mentor as a Kauffman Foundation Entrepreneur In Residence. As we were working through the details of getting them ready to start their first funding round, they asked me a really great question.
“Tom, if you were starting a new business today, what is the first thing you would do?”
As I started to think about the answer, I found myself getting really excited. Even without having a specific business concept in mind, my mind was flooded with some great ideas for getting a new business off the ground. At the same time, the answer to their question was obvious, because every plan I could come up with was built on the same cornerstone: Getting the financials in order.
I always start with the financials when planning a new company. Without a clear financial model in place, you really don’t have a business, you just have an idea. Only when you’ve done the financials can you see if it’s possible for that business idea to realize a profit. Putting your financials together is really just a matter of defining that pathway to profitability.
That’s not to say that every startup has to come out of the gate being profitable. You don’t even have to be cash-flow positive in the early days of the business. If every early-stage startup was held to the standard that they had to be profitable or cash-flow positive from the start, there would be practically no startups. It’s not impossible to be profitable from day one, but it’s rare to actually see it happen.
The important thing is to have a solid, realistic and fact-based plan for getting to profitability as quickly as possible. This is why you start with the financials. Financials are where the rubber meets the road on any business model.
One of the first questions that any startup founder is going to get asked in a pitch by a sophisticated investor is “How are you going to make money?” A surprising number of entrepreneurs have trouble answering this question, even when they have great business ideas and truly innovative products or services to bring to market. A great idea alone just isn’t enough to create a successful business.
A great point of reference here are restaurants. Do you know what differentiates a good restaurant from a bad restaurant in a business context? It’s not the quality of the food or the competence of the servers. What sets a restaurant apart for an investor is how well the owners understand and manage their costs.
In the restaurant business, you always know what your costs are. The big corporate restaurants know exactly how much the quarter slice of a pickle on the side of your plate costs. Managing those costs, sometimes across thousands of franchise locations, is exactly the kind of planning that allow those brands to stay profitable. That same profit-driven thinking works even down to the level of a small, independently owned, single-location gastro pub, diner or pizzeria.
It’s not the food that makes or breaks a restaurant. Being a great chef doesn’t mean you know how to run a business. Buying the best commercial cooking equipment, renting out a great location, designing top-notch menus and hiring the best staff doesn’t guarantee success. Even rave reviews from customers don’t really matter all that much from a business perspective. What does matter, and what will ultimately decide if the restaurant’s doors stay open or not, are the financials.
One of the biggest reasons so many businesses fail in their first few years is because they were focused on everything else except how they would actually make money. It doesn’t have to be that way. In my next post, I’ll explain some of the key concepts in creating a path to profitability.