Pitfalls in Financial Planning of Start-ups

Pitfalls in Financial Planning of Start-ups

Poor financial management and planning during the initial stages of start-ups' operations may cause underperformance or even failure. Dunn and Cheatham (1993) identified several factors, which are characteristic to overall poor financial planning by small and start-up businesses along their development stages:

1. LACK OF INITIAL FINANCIAL RESOURCES: Many entrepreneurs fail to match maturities (durations) of long-term investments in assets to appropriate long-term sources of financing. Similarly, the need for long-term investments to finance basic current assets and inventories is often underestimated by new ventures.
2. LACK OF SURVIVAL CASH: Entrepreneurs tend to raise just enough cash to open up the business and start the operations. They do not necessarily take into account foreseeable cash requirements from the business by anticipating future events.
3. FAILURE TO ANTICIPATE GROWTH: Due to optimistic attitude of entrepreneurs, business growth is seen as necessary requirement. However, while controlled and reasonable growth rate is beneficial for the business, many entrepreneurs miss out on planning for additional investments required to support popular hockey-stick growth rates.
4. FAILURE TO MANAGE ESTABLISHED BUSINESS: Once the business has established itself in the market and has experienced profitability and excess liquidity for the first time, it has to be properly managed from a financial point of view to enable long-term growth of the firm. Many start-ups fail to match maturities of financing requirements for extensive capital investments or fail to control working capital at this stage.
5. IMPROPER PERSONAL FINANCIAL DECISIONS: The problems for some start-ups arise once the entrepreneur and its family commit to permanent personal life-style changes as a result of the temporary increase in prosperity thanks to initial business success.

Source: Dunn, P. and Cheatham, L. (1993) "Fundamentals of Small Business Financial Management for Start-up Survival, Growth, and Changing Economic Circumstances". Managerial Finance 19(8) pp.1-13