28 Jul 2015 18:32 IST

Plan and economise: Else agonise

Never spend more than what you earn; and never borrow more than what you need

In an earlier article, I talked about key success factors for an entrepreneur and I had indicated cost consciousness and financial prudence as one of the key requirements, especially for start-ups. This is the theme that I intend to focus upon in this article. The saying below sums up my thoughts very well. “The financially prudent may not live forever, but the spendthrift does not live at all.” Entrepreneurs, whether big or small, should always exercise financial prudence. Never spend more than what you earn. Never borrow more than what you need.

The start-up phase is the most exciting time for a new business. As an entrepreneur, it is the first step in translating dreams into reality. However it is a fact that most start-ups fail as a result of poor financial management. Some of the common financial mistakes that every start-up needs to avoid are;

( i) Undercapitalising the business

Many new businesses are started with too little capital. Entrepreneurs are by nature a very optimistic bunch (that is an essential trait common to most entrepreneurs). Many unrealistically believe that they will be cash flow positive as soon as they start their business. Not always a great way to plan. I have found from experience that it is always a better forecast to double one’s expenditure and halve one’s forecast of revenues, in the first year of operations. The initial years are always a period of learning and emergencies. If one has the wherewithal to tide over these initial whirlwinds, one is better placed to move to the next level, which is probably far easier. To do that, the initial forecast of funds required is very crucial and it is always better to have a little extra rather than fall short that prevent one from following through with a strategy and/or falling short just when the goal is in sight. Undercapitalising the business is always far more dangerous than over capitalisation though I am definitely not advocating having a huge amount surplus cash ineffectively deployed.

(ii) Insufficient market knowledge

Most projections and estimates fail to materialise because of an improper knowledge of the context. Knowledge of one’s markets and demand for the products / services offered is an integral part of any business and is sound commonsense. But analysis of failures show that in most cases there was an improper or insufficient knowledge of consumer behaviour leading to drastically different actuals from what was estimated. This results in cash flows going awry and the resultant shortfall of funds hits any start-up hard especially on a shoestring budget.

(iii) Financial mismanagement

Many entrepreneurs are great on technology but poor on managing finances. It is very prudent to get someone in the team who is good at managing finances – collection, allocation, budgeting, accounting and reporting. Many start-ups fail to get going and scale up because of a lack of good financial management. Failing to record where and how the money comes and goes makes it hard to make realistic business forecasts. Expenses can quickly get out of hand, and untracked sales and payments can create confusion. Two other skills that are very much required but not given sufficient attention are:

> Not budgeting adequately for the hidden costs of operation: For e.g. taking office premises on lease which appears cheap but not calculating the wastage of area (and therefore actual space available) or the amount payable for maintenance, which is unduly high.

> Overspending: Many entrepreneurs are so caught up with their business idea, that they end up overspending to meet a vision of perfection. They might invest in high-end office space, instead of a more economical option. Or spend a lot on expensive design and decor, when there are thriftier high-quality alternatives. This mistake is very common. I know of an entrepreneur who raised ₹10 Mn and spent 70 per cent of it on the office. Thereafter he was left with limited money to spend for people and marketing. That is foolishness, and a sure death–knell for the idea. In this case the idea was great but the financial imprudence and faulty execution effectively killed the idea. Yes, by all means one can have a fancy office and all the frills but only after the business has started making revenues and profits. Spending capital on frills is foolishness and is a very different proposition from how you want to spend your excess cash and profits. Sounds like commonsense, but the number of entrepreneurs who make this mistake never ceases to amaze me.

(iv) Inadequate planning

No new business succeeds without a detailed and thorough business plan. This plan needs to recognise where you are today, where you want to be tomorrow, what problems might arise, and how you are going to resolve them. The value of a business plan is that you are forced to think about your potential business critically, challenge your assumptions, and research when you're not sure of your facts. A complete plan reduces all of the components to financial numbers including a projection of revenues and profits and the state of the business 3-5 years down the line. This may not be accurate but is a good guide map that requires to be revised periodically to make it current, live and useful.

There's a fine line between starting your business on a shoestring budget and letting it fail due to a lack of resources. The imperative is to both look and act professional on a shoestring budget. The trick is to determine the point at which your business runs both effectively and efficiently. This is a key issue for an organisation irrespective of the stage it is in and can determine its long-term survival and growth. For any venture, the habit of trimming expenses and reducing fat ensures overall good health (a rupee saved is sometimes far more than a rupee earned) and will serve the company well as it grows.

Vision and practicality

Overall, you should match your entrepreneurial vision with practicality. You can’t depend on just luck to make you a success. A good roadmap backed up with diligent hard work and a hard grasp of finances, are equally important. While there are a number of factors that can determine the success of a business, financial management is arguably one of the most important factors.

In summary, to rephrase Benjamin Franklin, “A penny saved is more than a penny earned”.