Now that we know how to set up our income statement and what the major parts of our financial statements look like, let's create a little monthly accounting system to manage the financial records of your own business.
This is where most people freak out and shout “Good God! It’s Accccounnttttinnnnng!”
Yes, friends, it is indeed the sneaky devil that we call "business accounting". But guess what? Accounting for startups, or just keeping track of basic financial health isn't that hard because initially it'sj ust basic bookkeeping. Our bank accounts aren't exactly processing "millions" (yet!) so we can stick to some startup business accounting that's easy.
We like to keep startup accounting easy, so that as the business entity grows, the same bookkeeping process we use for just a few transactions works when our new business even requires complex financial accounting.
But before we get into the process of accounting for startups, let’s just make sure we cover a few caveats and concerns:
While we can’t cover the ins and outs of every tax issue, it’s worth making a note of which taxes we’re going to be liable for so we don’t make the cardinal mistake of not filing taxes. The IRS and other taxing authorities get upset if we mess up how much we paid them. But they go full Eliot Ness Untouchables if we don’t pay them at all!
Employers (in the U.S.) are subject to a separate tax on their payroll in addition to what employees pay and what is withheld. We recommend using a payroll service in tandem with your bookkeeping software or our financial statement template to ensure you're compliant.
Most tax obligations and financial records can be stored with your payroll provider. Startup Founders whose business regularly pays full and part-time employees will use a third-party service.
Employers withhold a certain amount of taxes on behalf of employees that are then paid directly to the Federal, State, and Local taxing authorities. It’s our job as a startup founder to make sure we are properly withholding and paying these taxes at each level.
These taxes can be set aside in a separate bank account if we choose to be paid later, or withdrawn automatically as we process payroll. Reconciling bank statements to do this later is rarely easy. Everyone from bootstrapped to venture-backed startups outsource this.
Whether we made or lost money the IRS and local tax authorities want to know where the company stands. We need to file corporate tax returns annually, and if we made a profit (yay!) pay the requisite taxes (womp womp womp).
We'll want to keep track of our bank statement receipts and credit cards statements — most of which can be found online anymore - so that we can keep accurate records for our tax returns.
Depending on our business we may be required to collect and remit sales tax. This isn't something we want to do manually therefore we'll likely employ some sort of accounting software as a bookkeeping system to track and pay sales taxes.
Most businesses will handle this through either their e-commerce provider (as far as calculating collections) or offline using a consultant for finance services related to this. It's definitely not something we want to let linger for too long.
A word of caution – The IRS and other taxing authorities aren’t responsible for “sending us a bill.” The only bill they are likely to send us is one that reads “You forgot to pay your taxes for the last 3 years – here’s what you owed with a criminally-high set of penalties and interest as well.” We’d recommend at least making sure these 4 categories are considered if nothing else.
When managing our finances we have to choose between two methods of recording transactions: Cash and Accrual accounting. This is just a decision as to when we determine a transaction should be recorded in a particular month. It’s a small nuance, but an important one.
Let’s assume we hired a designer to work on our company logo. She performed $500 worth of work in January and then sent us a bill that we paid in February. Do we record the transaction in January when we incurred (accrued) the expense, or in February when we paid it (in cash)?
For this we must make a choice – but it’s an important one because however we choose to record this transaction should work the same for all of our transactions. There’s no wrong or right here, it’s more a matter of how we would prefer to manage our finances.
We only record the transaction once we’ve paid for it in cash. In this example, we would have posted the transaction in February when the money left our account. The benefit to this is that we can focus exclusively on what transactions moved in and out of bank account. Whatever the time stamp is on those transactions, that’s the month it’s accounted for.
We record the transaction when we incur it, even if we pay for it in cash later. The benefit here is that we have a monthly statement that more accurately reflects the decisions we made in this specific month versus when those decisions happened to be paid for in cash. If Johnny makes $1,000 in salary for January but the withdrawal doesn’t post in our bank account until February 2nd, we can still show that his payment was for January.
If we’re totally lost on which one to pick – choose “Cash Accounting” simply because no matter what we can always defer to the timestamps of what posted to our bank account, even if they don’t directly reflect when and how we made those decisions.
Much like the assembly line of dishes at Thanksgiving time – rinse, wash, dry – every month we will enjoy the ritual that is “monthly close”. Here we will tally up all of our activity, drop it into our Income Statement, and analyze the hell out of the results.
We’re about to walk through each step, but here’s a quick overview of what we’re about to do:
We will download and retrieve all of our income and expense activity for the month including credit card processing statements, bank statements, credit card bills and paper invoices. Every one of the financial transactions that we will need to populate our financial statements will get collected.
Initially, this may seem complex or tedious, but once you've run through it once or twice the next few times become incredibly quick. We're collecting the same business transaction every month from the same sources, so it becomes easy to streamline.
With all of our info in hand, we’ll begin recording these financial transactions in the appropriate spots of our financial statements. Hey look — we're doing accounting for startups!
Our accounting system stays simple here, where we run through the same accounting process every month and input the same financial transactions into the same fields. Exciting? No. Well, unless there's some net income at the end of it!
We’ll double-check that our math is right and then do a little bit of analysis to figure out what worked, what didn’t, and how to revise our assumptions and forecasts for the future.
So long as we follow the steps in order, we shouldn’t have a very difficult time accounting just like the big kids.
From when we launch through the first couple of years this "rinse and repeat" system should get by just fine. It's basic bookkeeping but it's also getting into some good habits around setting up a business structure on the finance side that we can follow.
At which time we're ready to graduate to some more complicated business accounting needs, all of the infrastructure and financial records will be nicely kept to make that upgrade. We'll also get used to looking at these business transactions often enough that the larger systems make sense.
No one likes accounting! (Just kidding, accountants). It's often not the most glamorous part of the business but having a keen understanding of the financial health of our startups makes a huge difference in how we manage the business.
Said differently, having zero understanding of how our finances work, even if we're not out creating fancy financial reports for our new business — matters.
If we go on to raise funds from investors, they are absolutely going to want to know that any business owner they invest in understands accounting basics. Wouldn't you?
We can outsource all of it if we want to, but at Startups.com we really recommend at least learning a simple accounting method that you can use to understand your financial model or projections.
If later on, you decide that it's totally boring (which it is) then by all means you can roll someone in to pick things up from there. But again, it's a really valuable lesson.
We need to run through the process of collecting, processing, and analyzing all of our business transactions on a regular basis.
The first few times we do this, it will need some refinement, but as we get further into it, it is actually an easy process that shouldn't take more than an hour or two monthly.
Wil Schroter is the Founder + CEO @ Startups.com, a startup platform that includes Bizplan, Clarity, Fundable, Launchrock, and Zirtual. He started his first company at age 19 which grew to over $700 million in billings within 5 years (despite his involvement). After that he launched 8 more companies, the last 3 venture backed, to refine his learning of what not to do. He's a seasoned expert at starting companies and a total amateur at everything else.