At some point, every founder of a start-up business discovers that instinct is no longer enough.
In the beginning, you can run a business from your gut. You know what’s in the bank. You know what’s going out. You can tell whether there’s enough momentum to keep moving. That’s fine when things are small and simple.
But growth brings complexity. More people. More projects. More moving parts. Suddenly the gut isn’t enough, and the old habits don’t give you the clarity you need. And that is when many founders find themselves on The Treadmill.
Here is what the treadmill looks like.
Everyone is working harder. Orders are coming in. Revenue is rising. Things seem to be going well in terms of the objectives the founder has set for themselves. Progress is clearly being made.
Except.
Except that there is no cash left at the end of the month. And since cash really is the main metric that most founders at this stage use to measure progress, something is not right. You are running faster but not going anywhere.
If the situation persists for too long, it can be the start of going out of business. More often, it’s the start of a period of real frustration — the company is growing, but the bank account isn’t. And nothing that the founder tries seems to fix the problem. Despite having gotten where they wanted to be, they are not going where they want, ultimately to go. And all of the things that used to work no longer do.
This issue has one of two root causes. Unless you know what to look for, they are very hard to distinguish. BUT while the symptoms are the same the cures are very different.
To put it simply, if you are working harder but making less money then one of two things is true, either
- You don’t have enough business to cover your overhead; or
- Or you’re not charging enough margin to pay for the overhead required to do the work you have.
Companies almost always start with the first problem. Which is a problem that you can grow your way out of. BUT it is very common for companies to slip into the second situation without knowing it. AND the second problem is NOT one you can grow your way out of. And if you try, you probably make it worse. So, unless you know which problem you have, you are flying blind – with no instruments.
Most founders only notice the trap because there’s less cash in the bank than they expected. And if your financials are just a reflection of cash-in and cash-out, that’s all you’ll ever see. So, at this point it is time to admit that “going with your gut” is not enough. It’s time to get serious about accounting.
Getting serious about accounting
And getting serious starts with converting from cash accounting methods to accrual accounting. Cash accounting is fine in the early days. When you’re small, the money in the bank is a pretty direct measure of how you’re doing. But the moment complexity grows, it stops being enough. It is not possible to use cash accounting alone to diagnose where the problems are coming from and so it provides no guidance on how to get off the treadmill.
That’s because cash accounting only tells you what happened. It doesn’t connect what you spent with what you earned. It doesn’t tell you whether today’s effort is actually creating tomorrow’s revenue.
That’s where accrual accounting comes in. Accrual accounting is the type of accounting that most businesses use. It is a system that lets you “accrue” expenses when they are incurred and to “recognize” revenue when it has been earned, rather than waiting for things to show up in your bank account. In effect, accrual accounting lets you match expenses to revenue — to see not just what went out the door, but why it went out, and what it should bring back in return.
Until you make that shift, you’ll never get past the simple (and frequently misleading) story your bank balance is telling you.
But switching to accrual accounting is only the first step in the process of learning how to use your financial data as a management tool. When companies reach this stage, the situation has become too complex for it to be handled by “gut feel.” They need to use clear information to make decisions. The information is there, but it is not necessarily clear where in all of the data it is, or how to find it.
All costs are not created equal
So, the first thing that you need to do if you are going to manage by the numbers is to make sure you are collecting the right information. This is less a function of collecting more actual numbers and more about collecting enough supporting data to know how to categorize those numbers in various ways and in enough detail to reveal the underlying patterns you need to be able to see.
The first distinction that you need to learn to make is the difference between Direct Costs and Indirect Costs
Direct costs are all those expenses that you incur ONLY because you took a particular order. This includes materials, of course. But also engineering hours, testing and verification, project management, and the time spent resolving acceptance issues or chasing payment. All of it.
Indirect costs are the ones you’d still have even if you had no orders at all. Rent. Admin staff. Software tools. Utilities. Insurance. Marketing. And your own salary — especially if most of your time is spent fundraising rather than building products.
You need to divide the costs this way for the simple reason that the Survival Equation for every business can be reduced to:
Your direct work has to generate enough margin to cover your indirect costs.
Here, margin means the difference between what you get paid and the direct costs of the job. If this equation is not true, then you can grow revenue forever and still end up broke.
The next tricky part is that for most young companies, the single biggest direct cost is time. It’s tricky because it is also the hardest to track.
Founders often avoid time-tracking because it feels like overhead. For a small team, it can seem unnecessary — everyone is busy, why add another layer of process? Besides, most formal systems are expensive, unwieldy, and demoralizing.
But ignoring time is dangerous. Because time-spent is money spent, whether you measure it or not. And when you don’t attach time to specific projects, you lose sight of how much each job is really costing you – which means you lose sight of which jobs actually make enough money to pay for themselves – and their share of the indirect costs.
This is often the hidden root of the treadmill trap. A team keeps chasing contracts, working long hours, and believing they’re building momentum — only to discover, much later, that each job consumed far more effort than anyone realized. The margin evaporates. The returns diminish.
But the indirect costs do not.
This is especially true if the job took longer than expected. Because if it did, it consumed more of the resources that generate those indirect costs. It is way too easy to start a job believing that is “High Margin” only to discover it actually, in the end, cost more than it earned.
How much money did we make today?
Now, it is important to remember that when tracking time, the goal isn’t perfect precision. A spreadsheet, a weekly team check-in, even a personal habit of logging your own hours is enough at the beginning. What matters is visibility. Because when you actually see where the time goes, the results are almost always surprising.
So far, we’ve talked about costs. But managing by the numbers means more than tracking expenses.
The harder part is knowing when and how you’ve actually EARNED revenue.
Not invoiced. Not booked. Earned.
This is where many founders make the critical mistake: they assume value earned is simply actual work so far divided by the original budget. In other words:
Value Earned = Actuals ÷ Planned.
It isn’t.
The true measure of value earned depends on how much work remains, not on how much has been spent. That’s the only way to tie expenses and revenue together in a meaningful way. This is a challenge though, because while you know how much work you have done, you always have to estimate how much work remains. AND that estimate will keep changing (spoiler alert, it does not usually go DOWN).
So, to get to the point. To make any use of your financial data, at each financial review, you need three things for each job:
– Actuals: the amount already expended (including ALL labor hours).
– ETC (Estimate to Complete): the effort still required to finish the job.
– EAC (Estimate at Complete): Which the sum of the previous two items.
From those, you can calculate how close you are to being done as:
Proportion Complete = (1 – ETC) ÷ EAC
Multiply that proportion by the agreed contract price, and you have the value you’ve EARNED so far.
Yes, it requires estimating. And yes, “estimating” is a polite word for guesswork. But it’s also accepted accounting practice — provided the contract has agreed requirements and an agreed price. So, with these numbers you can match your earned revenue to your accrued expenses. This is essential if you are going to get off the treadmill of working harder for less return.
Most founders discover the trap the hard way. By the time they realize revenue isn’t keeping up with effort, the damage is already showing up in the cash flow.
The way off the treadmill, is not instinct, not hustle, not “more.” The way out is in the numbers.
How exactly to use the numbers is good topic for another day – so watch this space – but for now, if you are running a small company ask your self if you can actually extract this information from your financial system, easily, consistently, in a useable format. If you can’t, probably time to figure out you will – because it will be essential eventually.