The Importance of Financial Statements for Startups in Africa
One among the reasons why startups failed or unable to continue their business further is the non- presentation of financials and book keeping. We all know that the main criteria when performing due diligence before investing in a fundraising round is the verification of financials statements (Historical vs. Actual), metrics (CAC, margins, traffics, revenues, burn out, etc..), performing financials analysis and overall corporate governance.
Entrepreneurs always want to know what investors will look for in the companies they will be funding. Other than looking at the basic information of a company’s product and business model, historical financials are key supporting documents investor require in their underwriting process.
Reason why many companies failed during the due diligence process is because the entrepreneur is unable to produce financials evidences.
As an entrepreneur, you’re running fast, lean, and you’re resource-strapped. Having your financials cleaned up and organized in a certain way may not be your top priority. Plus, you may not have yet set up your accounting function.
But to be able to fundraise effectively, you’ll need to get your company’s financials in-order so that the potential investors can have an overview of the business and can digest the information quickly and easily. Not only are sound financial documents used for your terms and pricing, they also indicate how savvy you are as an entrepreneur, and how well you understand and operate your business function. Good book keeping helps you fundraise in the long run, and direct your business strategy.
Below are common issues we have noticed that prevent startups producing sound financials:
- Many Startups do not use accounting software.
Using accounting software helps you keep your income and expenses (Chart of Accounts) organized in a central repository. We often see early stage companies tracking financials in Excel. This may be fine when your business is just starting out and you’re not sharing detailed financial info with third parties, such as a VC, investor or lender. But as an investor, we need to be able to verify and reconcile your numbers from your bank statements, which creates extra effort for both parties. Using an industry-accepted accounting software package make verification and reconciliation a much more straightforward process.
QuickBooks (either Online or Desktop) is a recommended accounting software to early stage tech entrepreneurs. It’s a low-cost solution that is easy to use, and includes great features- allowing you to centralize payroll, bill paying, and tax filing capabilities.
- Projections are being sent, but no real financial data.
Investors always like to see actual financial statements instead of projections. Projections from early startups are 75% wrong since they have not yet penetrated the markets and their products are still not marketable. Historical figures are also very important. Presenting actual financials statements vs. historical financial statements ease the process of comparison.
- Incorrect financials.
Very often, when reviewing financials, they are just incorrect. The inaccuracy comes from mismatches between the accounting line items and the accounting method. When building up your financials, you should make an early decision whether you want to adopt cash or accrual accounting basis. The biggest distinction between the two is the timing in recognizing revenue. We have notice that the level of materiality errors are very high and errors in calculation of depreciation and revenues (According to the principle, revenues are recognized when they are realized or realizable, and are earned – usually when goods are transferred or services rendered, no matter when cash is received.
- Monthly financials are not generated.
Early Startups can produce financials on a quarterly or yearly basis especially when the business may not have much variability month-over-month. But, when you see that the business start scaling and seeking outside capital, monthly financials reporting is very important to investors. It shows that you are monitoring your business closely, and adopting the best accounting practice.
- Financials and Metrics are mixed up.
We have notice that many Startups mixed their financials and metrics. This is a bad practice since the metrics show the operational side of a business and the financials show the accounting side of the same business. Both reporting should be done separately and expenses are treated separately. For example, depreciation, accruals, provisions and prepayments are recorded in financial statements and not in metrics reporting. Metrics reporting should be sent on a monthly basis.
What investors want to see!
The purpose of financial statements is to communicate the state of affairs of your business. The three most common and important financial statements for a startup or any businesses are:
Balance Sheet. Balance Sheet A balance sheet is a financial statement that summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by shareholders. A number of ratios can be derived from the balance sheet, helping investors get a sense of how healthy a company is. These include the debt-to-equity ratio, working capital Ratio and the acid-test ratio, along with many others.
Income Statement. A summary of a management’s performance as reflected in the profitability (or lack of it) of an organization over a certain period. It itemizes the revenues and expenses of past that led to the current profit or loss, and indicates what may be done to improve the results. In contrast to a balance sheet, an income statement depicts what happened over a month, quarter, or year. It is based on a fundamental accounting equation (Income = Revenue – Expenses) and shows the rate at which the owners equity is changing for better or worse. Along with balance sheet and cash flow statement it forms the basic set of financial information required to manage an organization.
Decisive interpretation of the statement requires complete accounting of income, direct and indirect expenses, manufacturing expenses and other costs associated with operations of businesses, so as to determine the correct profitability. It is always advisable to account all transactions on chronological basis and the income statement should be prepared on monthly, quarterly and on an annual basis. This will help in assessing the financial implication of your strategies on the business.
Cash Flow Statement. This statement is a summary of the actual or anticipated incomings and outgoings of cash in a firm over an accounting period (month, quarter, year).
It answers the questions:
- Where the money came (will come) from?
- Where it went (will go)?
Cash flow statements assess the amount, timing, and predictability of cash-inflows and cash-outflows, and are used as the basis for budgeting and business-planning.
The accounting data is presented usually in three main sections:
- Operating-activities (sales of goods or services),
- Investing-activities (sale or purchase of an asset, for example), and
- Financing-activities (borrowings, or sale of common stock, for example).
Together, these sections show the overall (net) change in the firm’s cash-flow for the period the statement is prepared.
Lenders and potential investors closely examine the cash flow resulting from the operating activities.
One important example that I want to share: when a company makes a sale on credit this will be reflected as revenue in the profit and loss statement but the actual cash on that would be collected later. Thus, it will not be reflected in the cash flow statement. It is always advisable that cash statement should be prepared on a monthly basis to check the cash position at the end of each month for adequacy to meet the cash requirements for the following month.
What Savannah Fund is offering…
Savannah Fund has launched its Virtual CFO Services in October 2016 – e SABU and is offering a wide range of services on preparing financial statements, operational reporting techniques, enable startups to better understand their business and consequently make better business decisions for growth across Africa and become more globally competitive and many more services.
To learn more, please connect on http://savannah.vc/2016/10/07/announcing-e-sabu-cfo-service-and-govervance-platform-for-africa-tech-startups/#.WHM53FN96M8