How can good food entrepreneurs know if their startup will be profitable? Lorne Noble from Simple Startup, a firm specializing in financial management for entrepreneurs, joined GFIdeas to help founders learn how to use financial modeling to answer this question and grow their businesses.
As Lorne puts it, good food entrepreneurs are probably more passionate about developing delicious products than they are about poring over spreadsheets. Here are some of his tips to the GFIdeas community for how to turn their passion into numbers:
Your roadmap to growth
A financial model is a roadmap to growth for a startup. It can point your business in the right direction by:
- Creating a budget that helps track growth and monitor progress;
- Identifying critical levers and metrics to inform strategy;
- Enabling you to test out different scenarios (Lorne warns that this can be addictive);
- And calculating your cash shortfall, aka when you don’t have enough cash on hand to cover expenses to suppliers, emergencies, etc. (this helps you figure out how much money you need to have to keep doing what you love to do).
Different types of financial models serve businesses at different stages. Lorne suggests that a simple cash budget is effective for early-stage startups, whereas a full-blown financial model is better suited for a company ready to raise funds.
So let’s start with the basics:
Does your business make sense?
A cash budget model tells you if your business makes sense by analyzing whether you will be profitable in the future.
Lorne breaks down this big-picture question into three main categories of cash flows (aka, money being transferred into and out of a business): operating activities, investing activities, and financing activities.
1. Operating activities
Operating activities are the day-to-day operations of the business that drive your product revenue and costs. To calculate net revenue (the main measure for determining cash flow from operating activities), you must determine:
- The number of outlets through which you’re selling your product (Are you selling on Amazon? Are you in stores, and if so, how many?);
- The velocity at which you sell your product (How many units per month per outlet?);
- The price of products;
- Refunds, returns, allowances (Lorne suggests these should amount to about one percent of gross revenue);
- Promotions (These could be as high as 12-20% of gross revenue and depends on how you sell your products).
To calculate operating costs, you will need to measure the cost of goods sold. This is the cost required to make your product, which should equal about 45 percent of gross revenue. You'll also need to calculate operating expenses for administrative functions, sales and marketing, and research and development.
2. Investing activities
Investing activities refer to how your company is investing your money (for example, in equipment or other assets). If you plan to buy or sell equipment, you should include this in your model as a cash outflow or inflow.
3. Financing activities
Lastly, financing activities record the amount of money you plan to receive from funders. To estimate how much money you want to raise and by when, it is helpful to look at your forecasted cash flow. Don’t forget that cash will be driven by your expected monthly revenue over time, product splits over time (meaning a breakdown of total sales by each of your products), and gross margins (gross margin = net sales - cost of goods sold).
While creating these models, Lorne recommends keeping track of the assumptions you’re making in a separate tab. These assumptions could relate to sales velocity or the cost of equipment you need to purchase. Keeping track of your assumptions and the underlying research not only helps you stay organized, but it also inspires more confidence in funders reviewing your model. The more confidence you can give a funder the better terms you can negotiate!
Hungry for more expert insight? Want support from a community of plant-based and cell-based entrepreneurs? Join GFIdeas and tune in for more industry advice!
If you’re interested in how to make the step from a simple cash budget model to a full-fledged financial model, Simple Startup offers a course to walk you through the process. While GFI cannot endorse any particular products or courses, we want to make these resources available to anyone who is interested!