Module 4: Startup Finances

• Pro Forma Financial Statements
  • Cash Flow Statement
  • P&L
  • Balance Sheet
  • Key Concepts: Pro Forma Financial Statements
• Projected Financial Statements
  • P&L, pt 2
  • Sources and Uses of Funds
• Competitive Analysis
  • Resources: Competitive Analysis

In the facts in Module 1, we are told that NewCo will need to hire 3-5 engineers for research and 1 marketing officer to start doing customer validation. Together these 6 positions will each cost at least $100,000 per year plus equity incentives.

We are also told Baker and Carter each put in $50,000 worth of cash and assets: “… enough to get them a full year of rent, a small travel budget, and any additional equipment they might need.”

Pro Forma Financial Statements

There are three documents that comprise the Pro Forma Financial Statements: the Cash Flow Statement, the Profit & Loss Statement (“P&L”), and the Balance Sheet. These documents flow into each other. The Cash Flow leads into the P&L which leads into the Balance Sheet. How so? The cash flow statement literally shows what categories were cash in and cash out for the time period. That flow of cash is then presented in more detail in the P&L which breaks cash flow in and out into more granular details represented by the accounting legders for double-entry bookeeping. Each ledger (e.g., “wages”, “utilities”, “goods sold”, etc.) is categorized as an “Asset,” a “Liability,” or as “Equity.” These Assets, Liabilities, and Equity are then set up in the Balance Sheet where Assets = Liabilities + Equity.

Cash Flow Statement

A cash flow statement summarizes the movement of cash and cash equivalents that come in and go out of a company. It is used to assess a company’s ability to generate cash to pay its debts, fund its operations, and make investments. By presenting a clear picture of how cash is being used, the statement provides crucial insights into a company’s liquidity, solvency, and overall financial health.

P&L

A profit and loss (P&L) statement, also known as an income statement, summarizes a company’s revenues, costs, and expenses over a specific period, such as a quarter or a fiscal year. Its primary purpose is to show a company’s profitability by detailing whether it made or lost money during that time. Stakeholders use the P&L statement to assess a company’s financial performance, identify trends, and make informed decisions about its future.

Balance Sheet

A balance sheet provides a snapshot of a company’s financial health at a specific point in time, presenting what it owns (assets), what it owes (liabilities), and the owners’ stake (equity). It is governed by the fundamental accounting equation: Assets = Liabilities + Equity. Stakeholders use the balance sheet to assess a company’s liquidity, capital structure, and overall solvency.

For high-growth startups, key balance sheet ratios focus on liquidity and capital structure. The current ratio (current assets / current liabilities) is crucial for assessing the company’s runway and ability to cover short-term obligations. Additionally, the debt-to-equity ratio (total liabilities / shareholders’ equity) is scrutinized by investors to understand the startup’s reliance on borrowed funds versus equity financing. These metrics provide a critical view of a startup’s financial stability and its capacity to fund aggressive growth.

Key Concepts: Pro Forma Financial Statements

While the documents themselves are standard, what is included in them needs to be specific to your company and situation. For example, see Carta’s Summary of Financial Statements. They point out: Your startup may use other metrics to track success or benchmark against competitors. Here are some examples of additional elements you might want to include in your pro forma financial statements: Key performance indicators (KPIs): This can include customer satisfaction ratings, profit margin, customer acquisition cost, number of customers, or website traffic. Churn: Account for customer turnover in your pro forma to get ahead of investor questions. Ratio analysis: This helps assess your company’s profitability, liquidity, financial leverage, and operation efficiency. Comparative analysis: You can evaluate your relative performance and identify areas of competitive advantage or weakness by comparing your company’s financial ratios or key performance metrics with industry averages or top competitors.”

• EY’s Manual on Pro Formas (pdf) is probably a little more technical than you’re looking for.
• Netsuite’s Summary of Financial Statements includes some examples so you can see what they look like.

Projected Financial Statements

When preparing to raise funds, investors will want to see projected financials. Typically this includes, at a minimum, a project P&L and a Sources and Uses of Funds statement.

P&L, pt 2

Projected P&L statements are often projected monthly for 6-12 months post-raise, and summary for years 2 and 3. While you may often see 5-year projections, frankly anything beyond 3 years is extremely speculative. The P&L should demonstrate how you envision revenue growth for the company and should clearly show which expenses are funding that growth. Moreover, they need to be realistic based on your ask during fundraising. You might also include options for underselling or overselling the round.

Sources and Uses of Funds

The Sources and Uses of Funds statement does exactly what it says - it says this where the money is going to come from (e.g., SAFE + Preferred + Convertible + Loan) and then sets out the uses of those funds (e.g., 4 engineers + 1 marketing director). It should, of course, do so in a much more specific format indicating how much is raised as a source under each type and the timing of those raises, then should include the timing and amount of those payments. In this case, I would probably include the amount either proposed or actually raised and then a yearly run of how much will be spent (i.e., $100k per year). Since it isn’t a use of funds to compensate with equity that designation would not be appropriate on this document, but would be found in a fully-diluted captable in addition to vesting schedules attached to a restricted stock agreement.

Competitive Analysis

The classic text for performing a competitive analysis is Michael Porter’s Competitive Strategy. It outlines four basic/generic approaches to competition: Cost Leadership, Differentiation, Cost Focus, and Differentiation Focus. Together these form the basic framework for looking out at how the customer is solving your problem and evaluating those solutions against yours. This competitve analysis then forms a very important part of how you talk about your company when talking to others, including in pitches. Basically, you want to identify what the others do well and poorly. But, importantly, within that landscape, what do you that is unique to the customer’s problem that makes you uniquely valuable. Or, stated differently, what is your value proposition?

Resources: Competitive Analysis

There are a lot of great resources about competitive analysis. In addition to the book/links above, the following can get you pointed in the right direction:

• Asana: How to Create a Competitive Analysis
• Carnegie Mellon Schwartz Center for Entrepreneurship (pdf)
• Cambridge University Decision Support Tools