Alex Wu, is the Founder of CFO Advisors, a leading Fractional CFO practice serving startups from pre-seed to Series C.
In the high-stakes world of startups, the creation of a robust yet flexible financial operating plan is paramount. As a fractional CFO for various startups, I’ve witnessed firsthand how a well-constructed plan can guide a young company toward its growth targets and sustain its financial health. In contrast, an overly complex or vague plan can confuse the management team and even misdirect resources.
Here are five essential tips for constructing a usable, dynamic and realistic financial operating plan.
1. Balance usability with complexity.
The urge to cover every conceivable financial detail in your plan is common among founders, leading to highly complex models with dozens of tabs. However, in the startup world, less is often more. An overly intricate model can be a liability rather than an asset. These models are difficult to maintain, often outdated and struggle to evolve with the company.
As a startup leader, you are navigating a fast-changing business landscape. You need a financial model that is detailed enough to be accurate but lightweight enough to adapt to changing circumstances. The rule of thumb here is that if your operating model isn’t updated every month because of the overhead to do so, it likely needs a revamp.
2. Focus on key drivers and abstract everything else.
In most startups, I’ve found headcount and sales and marketing expenses drive over 80% of the operating expense burn. It’s important to double-click into these areas and understand their dynamics deeply. While the temptation to analyze every other minor cost will be strong, make sure to keep the focus on these critical areas that significantly impact your burn rate.
Smaller, less impactful expenses should be abstracted to maintain model simplicity and focus. The headcount plan should be constantly updated to reflect the latest known reality, but items like bank fees and postage can be abstracted to broader general and administrative (G&A) expenses with directional assumptions.
3. Leverage sensitivity analysis to determine your priorities.
A strategic tool often overlooked by founders in their financial modeling is the “tornado” analysis, a visual representation of sensitivity analysis. It showcases the impact of changes in variables—like pricing, customer growth and retention—on key metrics such as cash balance, annual recurring revenue (ARR), margin and runway.
By running sensitivities, founders can develop heuristics, providing insights into how a +/-1% change in various metrics impacts their business. This exercise is invaluable in identifying your business’ significant drivers and prioritizing initiatives accordingly.
4. Use scenario analysis to increase management velocity.
Running scenario analyses can help founders understand the range of potential outcomes, allowing for agile decision making. Simulate the “best case,” “base case” and “bear case” scenarios to help you prepare for worst-case scenarios while also being ready to invest aggressively when growth opportunities present themselves.
This proactive approach not only helps manage risks effectively but also ensures the business can seize growth opportunities as they emerge.
5. Consolidate “buffer” into a single corporate contingency line.
One common pitfall in financial planning is the dispersal of “buffer” or “cushion” across all line items. This approach makes it challenging to analyze the business’ actual performance versus the conservatism baked into each forecast.
However, it’s also vital not to under-budget, as businesses evolve rapidly and must be prepared to capitalize on high ROI investment opportunities or cover unexpected expenses.
The optimal solution? Forecast as accurately as possible across all line items, and consolidate the “buffer” into a single “corporate contingency” line. This line, typically representing 5-15% of operating expenses, serves as a tactical pool of capital that can address unexpected variances or investment opportunities. In my experience, this method ensures transparency, accuracy and the availability of a contingency reserve for strategic agility.
Creating a financial operating plan may seem daunting, but remember, the goal isn’t to create a document set in stone. It’s to build a dynamic, evolving tool that provides guidance as you steer your startup toward growth and success. With these tips in mind, you can create a plan that is not just a theoretical exercise but a practical, powerful instrument for financial decision-making.
Forbes Business Council is the foremost growth and networking organization for business owners and leaders. Do I qualify?
Read the full article here
