I recently facilitated a training session on assessing the financials of a potential investment at the Cal Poly CIE Small Business Development Center. The purpose was to educate investors on what to look for, questions to ask and ultimately how to assess the value of an investment proposition. I wanted to share some of the key topics with entrepreneurs so they have a leg up when presenting financials to investors.
Assumptions Matter, Not Numbers
A financial plan is simply a mathematical representation of the assumptions about your business. The financial model should educate investors about your revenue sources and the key spending categories required to generate that revenue. Your model should explain how revenue and costs inter-relate and how the business scales. If done properly, the conversation with investors is about vetting those assumptions, not about math.
Where will the money be spent?
You should clearly lay out how much money you need and what you will spend it on. This tells investors two critical things. First, you are clear about priorities and the path forward. Second, it gives insight into your ability to make investments in an environment of constrained resources and unlimited requirements.
Do the financials hang together?
Make sure the financials are a true representation of the assumptions you laid out. The most common statement I hear from entrepreneurs is, “What is a reasonable revenue growth rate?”. That is the wrong question. What you should be asking is, “How can I support the number I’ve presented, and can I explain how my investments will achieve the revenue projections?” And, make sure when you show growth in revenue, you show a correspondingly reasonable growth in expenses. Will you enter three new markets without spending much more on marketing and sales? Not likely. Remember it always takes longer and more money to do anything new, plan for it.
Metrics Matter to a Point
There are limitless forms of metrics. However, experience has taught me that most businesses can be distilled down to a handful of key metrics. My advice, keep it simple. Figure out the one or two key metrics that really matter in the beginning, and track them diligently. If new customer acquisition is key, track it. If customer conversions on your website is key, track it. Showing your investors that you know the data points to monitor gives them comfort that you will know quickly if the bets you are making are paying off.
No one knows the future, and it’s never clear whether you will be able to execute, but conveying a plan based on solid assumptions that relates in a logical way helps convince investors you have a handle on your business.