Five Accounting Mistakes that Make Startups Stumble
The startup phase is full of energy and excitement. That being said, taking the time to think about accounting and bookkeeping is a bit like asking which neighborhood wants to sit out the pickup ballgame to serve as scorekeeper.
No matter how tempting it can be to overlook the finer details of your finances, you need to get everything squared away if you’re going to make it past the startup phase. According to SBA estimates, 90% of small businesses fail in the startup phase. The right accounting can help keep your startup from becoming a statistic.
Commingling of Funds
When you’re first starting out, it seems like the line between your wallet and your business is blurred. After all, it’s your business so it must be your money, right? The truth is more complicated than that.
Even though you’re the sole owner of the company and it may be taxed as a pass-through entity on your personal tax returns, you need to separate your personal and business finances. This can help protect you from liability issues, maximize your tax-saving opportunities, and make it much easier to keep track of your cash flow and profitability.
Imagine, for example, that you want to review your financial reports to see how profitable last month was. This should be a simple task but if you’re using the same bank and credit card accounts for business and personal expenses, it’s going to be much less clear. You’ll have to identify every personal expense first to make sure you don’t factor them into your profit calculations. Then you’ll have to perform profit calculations instead of just letting your bookkeeping and accounting software show you the profit numbers.
At tax time, having your business and personal money commingled can be a huge red flag for the IRS. They see it as a sign that you’re running your business as more of a hobby than a properly run enterprise and may disallow many tax deductions, especially any losses you need to claim or carry forward.
Confusing Cash and Accrual Basis
Do you track your business on a cash basis or an accrual basis? If you’re not sure what that means or what method you’re using, you could be getting into a big mess.
Put simply, cash basis accounting records expenses as they’re paid and revenue as the actual cash is collected. Accrual records revenue as it’s earned and expenses as they’re incurred. For instance, a bill may be recorded on May 1st, even though you won’t actually send the cash to pay the bill until May 30th.
While cash basis accounting is simpler and can be used by many small companies, it doesn’t give the complete picture. Accrual accounting shows what’s really being earned or spent in a given month, regardless of any delays in collection or payment. It does this by matching expenses to the revenues they helped generate within the same month. Make sure you know which method is allowed for your entity and that you’re following the right system.
Entering Everything Manually
One of the major complaints of small business owners is that bookkeeping and accounting just take too much time. For this reason, many avoid the task and leave it undone for far too long.
While it’s true that manual data entry and bookkeeping can be very time-consuming, recent advances in accounting automation can save you hours every week while also protecting your financial records from human error. Cloud-based accounting software allows you to connect directly to your bank, as well as integrate a variety of apps to track and record different aspects of your business.
Along with direct bank feeds, optical character recognition technology (OCR) can read the information directly off of scanned receipts and invoices while digital receipts can be emailed directly to your AP software tool. This is just one more way you can automate your processes to save time and improve accuracy.
Today’s tech can help you automate everything from monthly reconciliations, to payroll, to invoicing.
Putting the Books on the Back Burner
One of the biggest issues new businesses face is simply not keeping track of their financial health. As mentioned above, they often put off the bookkeeping and accounting because it’s a difficult or unfamiliar process. This is a big mistake because it can lead to fraud or errors going undetected or to you simply not knowing what’s really going on in your business.
Those companies that don’t avoid accounting often relegate it to a very low spot on the priority list, rushing through it at the end of the month or handing the task to whoever has extra time, whether or not they know what they’re doing.
Treat your bookkeeping and accounting the way you would treat your own health (in a perfect world). Make sure you give it the high priority it deserves and it will serve you well as you grow your business.
Forgetting To Review Your Financials Regularly
Now that you’ve got your books accurate and up to date, make sure you’re using that information. Accounting isn’t just about doing paperwork for tax season. You need to regularly review your income statement, balance sheet, and cash flow statement to make sure everything is going as it should be inside your business. If you’re not familiar enough with these reports to know exactly what they mean, schedule time to review them regularly with your accountant.
To see your business thrive in the startup phase and live beyond it, you need to pay attention to your finances. Accounting is the language of business and your books will show you exactly what’s going on under the hood. But to get the best results, you need to stay on top of your accounting and make sure everything is set up correctly.