Lesson 5: What Are Investors Looking For?

Introduction

Being comfortable with and having a firm grasp on the financials of your business isn’t just good business practice. It indicates to potential investors that you know what you’re talking about. If you’re hoping to impress investors, make sure you review the following before pitching to them:

  • Net profit
  • Margins
  • Cash flow
  • Debt
  • Accounts receivable turnover
  • Break-even point
  • Personal investment

Let’s look at each of those in turn.

Know exactly what they want

The first thing an investor wants to know is “Are you making money?”

Net profit

They’ll review whether you are making profits or losses and judge your business accordingly. Remember that unsustainable profits can be viewed as a negative, while losses that can be improved if you’re on track to scaling might be seen as a positive. Net profit refers to the amount of money that is left after you subtract your total business expenses from your total revenue.

Margins

Sales are worthless if you aren’t making money. Investors will want to see your overall profit margins as well as profit margins at an individual product level. Higher margins tend to lead to a better return for investors. Low profit margins means you’ll need to prepare a plan that demonstrates just how you intend to improve them. As an early-stage entrepreneur, you would need to demonstrate how economies of scale will reduce your costs as you grow.

Cash Flow

We’ve touched on this before, but the old cliche is true: cash really is king. Cash in the bank is a sign that, as a startup, you can deal with unexpected problems and have the necessary financial assets to capitalise on new opportunities. A sure sign of a sustainable business is free cash flow, i.e. the amount of cash that’s left after you meet your expenses each period.

Debt

Debt tends to scare investors for two reasons:

1. Debt payments eat up a business’ cash, and high debt payments can hinder your ability to meet payroll and other necessary expenses during slow periods.

2. If you go out of business, debt holders will get their money back before equity holders have a chance to claim what’s left.

A simple way to measure debt is using the debt ratio. A debt ratio is a financial ratio that measures the extent of a company’s leverage. To calculate this ratio, you need to look at your current assets (excluding your inventory) divided by current liabilities. A quick ratio of 1 denotes that you can just meet your obligations. The higher the ratio, the more flexibility you have.


Accounts Receivable turnover

Investors want to know how long it takes for you to collect money from customers. It tells investors two important things:

1. Are you willing to do what’s necessary to make sure you get paid?

2. How stable are your customers?

Too often, people feel awkward or even guilty for asking to be paid. As a startup business, you can’t afford to ignore non-payments. For customer stability, an investor wants some sort of indication of what your customer turnover is and whether you have a high percentage of customer write-offs (customers who don’t pay).

Break-Even Point

Break-Even Point (BEP) indicates the sales amount (either as a unit or revenue) that is required to cover a business’ total costs – both fixed and variable costs to the company. Total profit at the BEP is zero. While investors might accept some short-term losses, they would prefer to see a profit on their return sooner rather than later.

Personal Investment

It’s important to investors that you have a personal stake in the business. Putting in hard work to keep the business running is admirable, but investors want to know that you’ve also made a financial contribution.

Financial Tools

Numerous financial management tools are available to help you keep accurate financial records, plan ahead for future expenses, and make sure you maximize your business’s profitability. Here are some that you might find particularly useful:

  • For bookkeepingWAVE or Quickbooks
    Wave and Quickbooks will help you to track transaction, create estimates, generate receipts and even manage your payroll.
  • For forecastingPlanGuru
    Forecasting plays a huge role in how you sell your business to investors and will impact the way you strategise your spending and liquidity requirements. PlanGuru helps to model revenue and expenses and automatically generates key financial ratios and break-even analyses.
  • For filing documents: A shoebox or FileThis
    Yes, some people use a shoebox to store their receipts and other such files, but it’s not really recommended. A great alternative to this is a paperless document storage program called FileThis. File This automatically collects and organises bills, tax receipts, and any other financial documentation you might need to have stored.
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