 Namaskar. I'm Professor Devdeep Purkayastha from the Indian Institute of Technology, Bombay. Welcome to my course, Business Fundamental for Entrepreneurs Part 1, Internal Operations. As part of the course, I'm very pleased to welcome Professor Umakan Jayaram, who is a very illustrious finance industry veteran to share a few modules. Professor Umakanth is an alum of IIT, Bombay, and he went on to do his MBA, post which he has 30 years plus of industry experience in various aspects of finance. He has worked extensively in the banking industry, he has founded his own company, he has sold his own company, and he serves now as a public interest board member at the Bombay Stock Exchange. So it is my pleasure to hand over to Professor Umakanth for his module. Welcome to the module on finance for tech entrepreneurs. My name is Umakan Jayaram and I shall be your instructor today for walking through two modules on finance. My background has been in engineering but I've actually lived my entire career in finance and banking and have also got a first-hand experience of running a firm as an entrepreneur. It is my experience that has been in my guideline on setting this module together and what I would like to stress upon is these modules are not intended to actually teach you finance to the level of being a professional but is a sensitization and an appreciation course for founders and non-finance executives to know their sense of finance. My emphasis has been to actually focus on those issues that all founders need to know or must know about finance and accounting. Let me walk you through the five objectives that I've laid down for these modules. These are the five things that I feel that every founder needs to know. One is around the literacy that every founder needs to have about the terms in finance. By literacy I mean he should be able to actually read and talk with a financial accounting or a financial analyst or even an investor in terms that they understand about his business. The second objective is the basics of accounting, the whole accounting cycle to the point of financial statement preparation. The third objective is a very operational and important objective for a founder and that is to actually manage cash flow. Whilst your literacy and basic accounting is something that you will pick up over the course of time and needs a little bit of orientation but the basics of managing cash flow is a must have. You've got to start your business with that approach because cash flow is very important for startups. The next module is what is very, very popularly used in startup terms for describing a business model in terms of the revenues and expenses that it may have to incur repetitively and the profitability potential of a particular business. This is called unit cost economics. It basically looks at the business at a unit level and it identifies and tracks all the costs and expenses on one side and all the revenues that may come into the business on the other side and sees whether one basically compensates for the other note. This approach is considered to be the standard among startups to describe how a particular business is presenting itself to various levels of investors at various stages of a startup. The final and the most important one and this is what founders always ask me about is how do I value my business? Well, valuation, whether it's pre-revenue or post-revenue is all based on what price you can give to the business in the eyes of the investor. But there are some more all basic approaches for valuations and what we'll share with you and the basic concepts are drive valuations. We shall cover that in the core of finance, the axioms of finance and we shall also look at an example of how to plan or to raise or to put together a financial forecast plan for your business so that you can share with an investor where you want to drive this business to and how you will actually make this profitable in some years to come. These are thought by the five main objectives that every founder needs to know at the very basic level for finance in your business. That said, let's move to the first topic. Before we go into literacy, it's important to realize that from a finance perspective all businesses seem to be looking the same way. They all seem to have the same characteristics from idea to listing. And the characteristic we show through a red line is what is known as a hockey stick curve. This is the amount of income and sometimes even the cash that the operations of the firm will go through over a period of time. In the phase of the development of the product or the service that you're putting together this is the phase of investments. So idea to development, the downward movement, you know, red curve is essentially the curve for investments. I'll show it here. This is when you're actually bringing together resources to build your idea. After the investments are being fully invested the marginal investments required to make your idea complete through a whole cycle of product market fit is considered to be reducing. It's considered to be reducing because not because the marginal investments are less at the latest age of your product development. It is because by that time you would have probably started citing revenue. You would have suddenly started citing at least your first beta clients. Then you got validation and now you move towards betting some kind of revenues. These revenues basically compensate for the additional investments that you're making. And so the curve starts moving upwards. You will have a go-no-go decision, some kind of a personal checkpoint gate which answers the question as to whether your product has been successful in the marketplace or not. And really that time you should not be spending any more money. That is called the point of market fit. And from market fit to scale, businesses are supposed to at least the innovative businesses are supposed to have exponential growth in income generation or in cash flow which means the slope of this line is going to be very steep. A normal business would probably be seeing a growth like this but an innovative or a tech-based startup is expected to actually grow steeply. As the steep growth starts translating in the marketplace the whole concept of competition comes in. There will be me-to-products and other follow-on investments coming in from others which will actually make the product a little bit more mature will have to compete with other products and therefore the income generation will start tapering off when the business becomes mature. Most businesses do not operate in isolation. There is always a contest. So if you have to put things in perspective, this whole journey seems to be the pursuit of a unique business opportunity in the midst of constraints. The first constraint, the pursuit of opportunities and this opportunity is usually a client need or a problem that has not been solved by the market currently and you have to pursue this opportunity through your ideation and through your innovation but you also have to experience constraints. These constraints are fund constraints, funding constraints and they are also the constraints of the right risk that you have whether the market will accept your product or not. We don't know there are constraints around that so it's not natural that this curve will be transcended in just the same way without any uncertainty. The biggest uncertainty that most startup entrepreneurs need to actually overcome is this uncertainty around whether these investments will pay off. So in startup terms, this is called the value of death and most people, most founders are really challenged to how as to how they are going to transcend this value of death. At least in finance terms, this is the main question that will be asked by investors and also by owners of themselves such as the way that we will look at a business or a startup. This is quite different from how a founder or a technologist or a marketer will look at a startup. The marketer will be looking at whether a product or idea is going to have a customer acceptance that fulfills a customer need whether it's going to be having a value proposition that is going to be translated into a scalable, profitable opportunity. The technologist will be really trying to look at a new way or a new innovative way of solving what he calls as a problem that is there in the marketplace. Whereas a finance person, his main objective is to see whether this is a worthwhile investment and can this curve be transcended without any risk? This is the main perspective that we are basically going to hold on to in our sessions on finance and accounting. Moving on, we have to understand that in all businesses, finance comes into play at three different levels. The three levels in which finance is actually conversed in is one of the level of strategy. This is when the startup itself has been conceived and very quickly the founders need to raise cash they need to raise equity, what is known as the seed capital by presenting an idea. They need to actually at least be very clear in their own mind as to what is the pathway for founders to distribute the risk of investing in this business themselves. More importantly, how will they split the rewards? And these are known as cap tables. They also need to know as to how they can create value. Eventually a business is nothing but the agglomeration of several assets. And assets as we will see very soon as defined in finance is nothing but something that generates cash flow in the future. Generates a stream of cash flow. So this bunch of assets that go together to form a business is what the founders need to put to work in order to generate cash flows in the future which will be valued in the eyes of the investor. The founders therefore will be actually coming out with strategies at the operating level as to how he should run his business from time to time and explain to all the stakeholders including the owners as to what is the pathway, how far are we from profitability. Just the same way as a GMAP will tell you how far you are from a destination. Financial reports usually serve that purpose of supporting a strategy. At the operating level, the next level, it's about the day-to-day decision making that needs to get done which have consequences in the long term. Such decision making is something like capital budgeting, buying a capital asset, something like pricing, how do I price my products into the marketplace, something like capacity building, how much of capacity should I actually have in-house, how much should I outsource, what assets should I buy and what assets can I lease. These decisions are usually done at the operating level. Finance plays a role here as well. It plays a role here through a bunch of analytics that sits on top of the accounts that the company will prepare. We will see examples presented in this session as we go along. One or two examples of how finance helps us and helps owner's decisions at the operating level. The third level in which finance helps is the tactical level and this is very important to know. For a startup founder, his biggest concern in most times is that does he have enough cash to run his business? Cash flow is the key. Managing cash flow on a month-to-month basis, on a week-to-week basis and even a day-to-day basis for your survival is the first objective. You may have the best plans but if you don't have the cash you're pretty much run out of business. So finance gives you the ability to manage your liquidity. Liquidity is a term that we use for firms to describe that aspect of cash they need to survive for the foreseeable future. So in short, finance is used at all three levels that is important for the business owner. And how this is actually translating for business owners to actually make use of and how much can the business owner actually know all of this himself and how much can he depend on professionals is a balance that he should actually look at himself. Some of the businesses are started up by people who have a prior experience in finance. For them, they have a head start advantage. But for technologists and entrepreneurs who do not have a background in finance it is important to know that amongst all the languages that is spoken in business there are three languages in the disciplines of accounting, finance and economics that go together to call the trifecta language of business. How accounting and accountants look at a business is very typical with terms and concepts which is unique on its own. This is very similar to how marketers look at products and consumer behavior. They speak in terms which are drawn from psychology or sociology. Accountants have a discipline of their own. That discipline is basically looking at the data around all the expenses all the incomes, streams, all the investments which are individually made in transactions that actually sum up to many, many millions in a course of three months. An average company would probably transact about 15,000 to 16,000 transactions in a month. And what are these transactions? These are transactions which make changes to the essential two aspects of finance in a company. You should see what those aspects are. These aspects are called assets and liabilities. You should know what these terms mean. But the important point to know is having dealt with this information in a particular way the accounting function basically prepares through classification a set of three reports. One is a balance sheet. This report basically tells the owner what is the state of affairs of his business as on a particular date. It tells the owner whether he is solvent, whether he has got adequate forthcoming cash flows to take care of all his forthcoming obligations. We shall look at the balance sheet very closely in the next unit. The second statement is the income statement. And the income statement gives the owner a flow description of how the business has performed over a period. I.e. how much income has been generated by the business and how much of expenses has been spent by the business. The net of these two is the profit that is made by the business. The third statement which is very, very important for a startup founder and indeed for any manager is a statement of cash flows. And this statement basically gives you the amount of cash that the business is generating and the amount of cash that it is spending or is attracting from investors. These are the three statements or three basic views of the business in financial terms. I'll beat historical information prepared in a particular rules-based algorithm approach that constitute a common way of looking at all businesses. And why this is needed is because investors who need to seek different opportunities to invest in various companies need to have a common benchmark to compare how a particular business is performing related to the other businesses. This function is constantly performed by the accounting department and the accounting function. The language of accounts, as you will see shortly when I share the terms and terminologies and the approaches to you is one of rigor and the purpose is basically to fulfill a fiduciary responsibility, to build credibility in the eyes of the investor that his funds when invested in this business is taken care of. The green box here is basically the language of finance. In finance, the approach is little different. Finance concerns itself first in future information. Financials are always forecast of the future. They concern themselves with cash flow as opposed to income. And they concern themselves with terms like growth. How much is the cash flow growing? Is it steep growth or is it not so steep growth, flat growth? It concerns itself about riskiness. What is the certainty in which we can make this forecast? How risky is this forecast? What is the chance or odds that this kind of an estimate will not be achieved? And finally, it concerns itself about returns. When I invested something as an input, what do I get in current terms for an output? How many times is my output measured in cash terms greater than my input cash invested in the business? These are the questions that are asked by people in finance. And then there is something which is actually associated with the two and the terms is the language of economics. And actually the language of economics spreads across other areas of the business as well. But it is important to know that we must know a little bit about economics before we handle issues and problems and build tools in the area of finance. Sometimes in the area of accounting as well, especially when accountants need to deal with emerging issues. Such as building in reserves, specific reserves. The economic issues are generally external to the business. They are concerning themselves with this overall supply demand behavior for the products, offerings or services. They are also concerning themselves with the prices and the behavior of prices. How elastic will they be with changes in circumstances or changes in certain micro structure of the business? The one aspect that really is important, drawn from economics, but actually has a telling impact on how you manage your finances and indeed how you present your accounts is what startups basically do all the time. And that is the view of unit cost economics. This term itself needs some explanation. We shall be actually dwelling a little bit more detail. But like I said before, unit cost economics is nothing but looking at the business at one unit level. Unit flow of inputs and unit flow of outputs. And then gathering and tracking all the expenses as well as revenues that are associated with these unit flows. We then build a picture of an operating statement or an income statement at the unit level. Once you understand how this income statement behaves, you can make some good estimates on how it will behave in scale. And this is what people like to know in a startup. This is broadly the world of finance and accounts in startups. For a person or a founder or a business which is actually scaled up as business and then given it on to a mature CEO and has become a real success, you will see that finance and accounts plays a continual role. This continual role is what is known as sustainability. To make sure that business sustains to earn profits in just the way it was set out to do without any further or any new risk presenting itself to the investors. This is the aim and the holy grail for all startups. How do I end up with in five years time or ten years time to be a business that really runs on its own? That's the key to success. So the world over successful startups have the feature of sustainability. The role of finance and accounts to actually achieve this objective is significant. And that is what we will see in one particular example that I will not go into detail, but I shall actually show you a flavor of how finance decisions can be made better by accounting as well as their understanding. Let's, it is called break even analysis. The decision has to be made as to what point in this case it is price. It's not volume of sales. At what price can I actually offer a product that I mean bring into the market. It's such a way that I can get my demand, but I can undercut everybody else. What's the least cost in which I can actually bring out the real reason you want to do this? How do I deal with competition as well as deal with the requirements of profitability that the business has? And this is a balance that you everyone needs to do. Look at constantly. This balance comes from a very important concept called the value stack. The value of your business product or offering. If it is at V, usually this is more than what the price of the product and offering. This is what induces a customer to buy the product in the first place. This level of difference is what creates a compelling proposition for your business. If this difference is very high, then your business is sure to succeed. If the business is not so high, then you'll have to contend with ways in which you can expand the difference. You have another issue. You have to look at how you can provide a product to the market at a price in which you can take care of the cost that go together to make that product. So prices have to be more than the cost. So there are twin objectives. You have to reach this objective as well as you have to meet this objective. Most business owners are faced with this prospect at all times in their business. And they may actually deal with this with their own strategies. Initially at the launch, you may find that prices are actually lower than the cost. The difference is a loss which is invested in as a necessary investment to clear off all of the competition. Such an approach is what we are looking at through an example. Let's suppose that you have a business idea to start a new digital eco-mouse trap. Ecological mouse trap, a mouse trap that doesn't kill animals but traps it so that you can take it to another place and let it live separately from humans. The digital quotient here is to track the movements of the mouse and to actually capture the data points as to what will go into the entrapment schedule, so to speak. It's a data sciences approach of laying down the pathways in which a mouse can be trapped. If you are looking at this idea and you come out with an eco-friendly e-trap, let's see, there surely is going to be an innovative potential for this product. Your sessions in marketing would have to do that. You know this kind of an idea needs to be sized in terms of its appeal through several means and you can actually have what is known as the serviceable operating market that you have which gives you the opportunity size. Lots of rodents in the world and lots of rodents that need to be cleared off from human existence as far as possible. Surely there's something to this. Suppose you went about, you know, building a product idea and your market research just said that all other means of actually trapping mice through currently offered products are offered at prices between 2 and 5. That's 2 per trap and rupees 5 per trap. We need to know at what is the lowest price in which we can actually bring a product to market with volumes enough for us to take care of our setup cost. The setup cost over and above development is obviously to give back the money that goes into development and to continuously provide enough value, cash for maintaining the further upgrades. If such is the case, we go about doing a costing schedule. We identify what are known as the setup cost, which are known as a fixed cost. These costs will have to be incurred no matter whether how many units of the traps we sell. Even if it is zero, these costs will still be occurred in the same way. And the directly attracted variable cost. These are directly attributable to the product. At the same time, they keep varying with the volumes sold of the product. By actually looking at these two cost lines and adding them up, you find out what the total cost is. Total cost is nothing but the fixed cost plus the variable cost. And a target profit. We want to optimize for the target profit. We want to make the profit at the lowest which can sustain my business. By drawing schedules of these cost behaviors at different levels. One at a low level of volume and the other at a high level of volume. I have different cost structures. This you get up by the accounting statements that you either have in your own business or by proxy businesses. You're in a position to make an estimate as to what will be your profitability. How does it respond to prices and volumes? We see a graph here which basically tells us at what price of the product offering. This is at 6 rupees and this is at 2 rupees. How much of the traps can be sold? As you can see if it is 2 rupees, you can sell as many as 1000 traps and if it is 6 rupees, you can sell as many as 100 traps. This is what is the cost leadership side of the strategy and this is what is the differentiation side of the strategy. So you can either be competitive on a pure pricing basis if you can be better than this point onwards which is 500 units minimum. Or you can be profitable and distinctively powerful if you are able to actually sell at least this much at the price point of 6. These are the two conclusions you can draw from the strategy and that's how you actually make a decision. A mature owner of a business will have with him the knowledge base to conduct such an exercise. This is what finance and accounts can do. Having said this, how do we get there? What is the starting steps? What is the whole pathway for improving our financial literacy? We shall see that in our next unit in this model.