At the outset, startups and new businesses have to operate with limited resources, sometimes making difficult choices between operational outlays and administrative needs. However, no matter how strapped you are for time and money, getting your accounting and bookkeeping affairs in order when starting a new business will help you avoid any potential pitfalls. So prior to making your first business purchase, hiring your first employee or, even better, signing your first client, make sure you’ve managed your finances.
Your finances in the early stages of your business are crucial because they are a key driver of growth – which is what business is all about, particularly in the beginnings. There are just so many things that rely on the finances of your startup including:
Your potential for growth. The healthier your finances, the more likely you are to be able to grow.
Your reputation. If you’ve got a good financial footing, creditors and potential business partners can see this and will view the company more positively – this is fantastic if you’re looking to borrow in order to grow.
Your capability. You might have grand ideas, but there’s not much you are able to do if all of your money is stuck in an endless stream of unnecessary expenses and overheads – good finances mean using your money sensibly.
The financials of your startup are integral to the company, and it’s important not to underestimate the role that they play – especially in regards to how other companies, creditors or investors view you.
Balancing the books
In order to balance your books, you have to keep careful track of these items and be sure the transactions that deal with assets, liabilities, and equity are recorded correctly and in the right place. Balanced books may not be sexy, but they provide small business owners with the grounding they need to make smart decisions about expanding the business, making large purchases, and hiring new employees. The language of accounting professionals can be intimidating, especially if you’re the type of person whose financial record keeping consists of handing a box of receipts to your tax preparer once a year. Don’t despair! At the most basic level, you only need to understand three words: assets, liabilities, and equity. Throw in some simple addition and subtraction, and you’ve balanced your books.
Assets = liabilities + equity
The accounting equation means that everything the business owns (assets) is balanced against claims against the business (liabilities and equity). Liabilities are claims based on what you owe vendors and lenders. Owners of the business have claims against the remaining assets (equity).
Your first task is to choose your accounting period. Most businesses balance their books for each calendar month or each quarter. When you are new to the process, balancing your books each month will make the task more manageable.
If you use a cash accounting system, as many small-business owners do, and you want to start at the most basic level, you can simply write two columns of numbers on a piece of paper: assets on one side and liabilities on the other. Total each column, subtract liabilities from assets and the resulting number should equal your business equity.
Accounting software can simplify your bookkeeping since most banks will allow you to download account information directly into the program. After you load the data, your only task is to review the entries and make sure each one is tagged with the correct category. Keeping a separate business bank account makes this process easy and efficient.
Whether you do your accounting by hand on ledger sheets or use accounting software, these principles are exactly the same.
Step 1. Keep your receipts.
Comprehensive summaries of your business’s income and expenses are the heart of the accounting process. But they can’t legally be created in a vacuum. Each of your business’s sales and purchases must be backed by some type of record containing the amount, the date, and other relevant information about that sale. This is true whether your accounting is done by computer or on hand-posted ledgers.
From a legal point of view, your method of keeping receipts can range from slips kept in a cigar box to a sophisticated cash register hooked into a computer system. Practically, you’ll want to choose a system that fits your business needs. For example, a small service business that handles only relatively few jobs may get by with a bare-bones approach. But the more sales and expenditures your business makes, the better your receipt filing system needs to be. The bottom line is to choose or adapt one to suit your needs.
Step 2. Decide on your method.
You will have to decide which type of accounting method to use for your business and then apply this method consistently. Cash basis accounting means that income is recorded when funds are received instead of when the income is earned. Likewise, expenses are recorded when they are paid out instead of when they are incurred.
Using the accrual basis means reporting income and expenses as they are earned even without the actual exchange of cash for goods and services. Expenses are recorded at the time they are made instead of when they are paid off. The accrual basis is the required method for businesses that handle inventory and bigger businesses generating at least $1 million in annual revenue. Professionals in business for themselves such as lawyers, doctors, accountants, and others are exempt from this requirement regardless of their annual income.
Step 3. Setting up and posting ledgers.
A completed ledger is really nothing more than a summary of revenues, expenditures, and whatever else you’re keeping track of (entered from your receipts according to category and date). Later, you’ll use these summaries to answer specific financial questions about your business such as whether you’re making a profit, and if so, how much.
Most businesses carry accounts for cash on hand, a checking account used for rolling revenue and expenditures, and ancillary accounts as necessary to properly manage their funds. Your ledgers can be in accounting software; personal finance software, which is sufficient for some small businesses; or the old school paper ledger. If you find it difficult to keep accurate and complete records on a computer, use paper as a temporary holding place until you can enter transactions into your software.
You’ll start with a blank ledger page (a sheet with lines) or, more often these days, a computer file of empty rows and columns. On a regular basis like every day, once a week, or at least once a month, you should transfer the amounts from your receipts for sales and purchases into your ledger. Called “posting,” how often you do this depends on how many sales and expenditures your business makes and how detailed you want your books to be.
Generally speaking, the more sales you do, the more often you should post to your ledger. A retail store, for instance, that does hundreds of sales amounting to thousands or tens of thousands of dollars every day should probably post daily. With that volume of sales, it’s important to see what’s happening every day and not to fall behind with the paperwork. To do this, the busy retailer should use a cash register that totals and posts the day’s sales to a computerized bookkeeping system at the push of a button. A slower business, however, or one with just a few large transactions per month, such as a small Web site design shop, dog-sitting service, or swimming pool repair company, would probably be fine if it posted weekly or even monthly.
To get started on a hand-entry system, get ledger pads from any office supply store. Alternatively, you can purchase an accounting software program that will generate its own ledgers as you enter your information. All but the tiniest new businesses are well advised to use an accounting software package to help keep their books (and micro-businesses can get by with personal finance software such as Quicken). That’s because once you’ve entered your daily, weekly, or monthly numbers, accounting software makes preparing monthly and yearly financial reports incredibly easy.
Step 4. Creating basic financial reports.
Financial reports are important because they bring together several key pieces of financial information about your business. Think of it this way – while your income ledger may tell you that your business brought in a lot of money during the year, you may have no way of knowing whether you turned a profit without measuring your income against your total expenses. And even comparing your monthly totals of income and expenses won’t tell you whether your credit customers are paying fast enough to keep adequate cash flowing through your business to pay your bills on time. That’s why you need financial reports: to combine data from your ledgers and sculpt it into a shape that shows you the big picture of your business.
Aside from your records, it could also help that you have templates or actual documents for purchase orders, receipts, invoices and similar paperwork depending on your type of operations. Make sure that your forms include your contact information such as a physical address, email, and phone numbers. Many templates are available online, allowing you to customize the forms as needed. You can also take the traditional route, which is ordering customized forms from a printer.
Step 5. Anticipate your credits and debits.
Create an upcoming payment schedule of all future payments anticipated by your business, such as rent, utilities, and other recurring payments. This is called your Accounts Payable, or AP. If you have upcoming one-time expenses which you would like to make, you can also use this ledger to budget for them; for example, if you would like to spend $5,000 on renovations in January, you can book that as a $1,000 set-aside for the months of August through December. Many businesses book their AP with two dates: the date it is due and the deadline which is it actually due before penalties are incurred.
Furthermore, create upcoming monies received in a schedule, which anticipates future receipts. This is called your Accounts Receivable, or AR. This ledger is most important for businesses that process invoices to their clients, and hence do not receive payments until their clients actually cut the checks. If you are using software, it is crucially important that AR payments do not automatically roll over into actual payments received ledger. You do not want to book a payment scheduled for 7/15 that does not actually arrive until 7/22, or you risk bouncing checks drawn against that amount.
Step 6. Checks and balances.
Reconcile your ledgers with your bank statements. This is where accounting software truly shines over paper ledgers; most software will automatically download your bank records and allow you to quickly mark which payments and deposits are already recorded in your ledger, and which must be separately accounted. This is typically done on a monthly schedule, but with software and online banking, it is not onerous to do this on a weekly or even daily schedule—and this is not too often for a small business.
If all of this seems to overwhelm you, it could be beneficial to get the service of a professional accountant to do the nitty-gritty for you. Your accounting needs will change as your business grows, but as a startup, it may be helpful to have an accountant to guide your set-up process. You may prefer to do the bookkeeping yourself to save costs, but at least, have a professional assist you with setting up and defining accounts for easier recording, tracking and data analysis.
Accounting services for new businesses may also include assistance for filing incorporation papers, obtaining the necessary business licenses, establishing policies, procedures and guidelines for record-keeping and system implementations. Your accountant may also help you choose the accounting software that is most suitable for your company. As the business grows, the accountant’s role may change to include payroll and tax preparation, analyzing data and preparing financial and management reports.