Startups: Accounting Best Practices
You worked day and night to get your small business off the ground. As the sales and expenses grow, you have finally got the hang of bookkeeping, in addition to your main business tasks. While keeping your company’s books correct is a great start, there are several best practices that can not only keep your company financially successful, but also increase its bottom line.
Choose a software package
In beginning your company, you may use a simple spreadsheet to keep track of your business income and expenses. At some point, however, you may wish to consider using a small-business accounting software package such as Sage Peachtree or QuickBooks to keep track of the company’s financial transactions. As a new start-up grows, the paperwork involved between collecting income from customers and paying expenses from your suppliers can prove too overwhelming without the help of a reliable and accurate financial database. A good small business software package will also ease your income tax compliance, inventory recordkeeping, and payroll records.
It is important to consider your business model as you choose your accounting software. If you sell goods, almost any basic software business software program will suffice. However, should your business provide primary contracting services, you may want to consider a software package that focuses on project accounting. Should your business manage real property, you may want to consider a package that focuses on fixed income accounting. Even though these specializations may immediately cost more, they will prove vital to your long term financial management.
Choose an accounting method
As a small business, you have some leeway in how you record your financial transactions. Since you are not a large corporation, you do not have to produce financial statements according to Generally Accepted Accounting Principles (GAAP). For example, you may prefer to record your income whenever you deposit payment for a job into your bank account and report the expenses whenever you write a check to cover an expense. Accountants refer to this accounting method as the cash method of accounting. While this does not follow GAAP, it is more than adequate for a small start-up.
As your business grows, however, you may choose to adopt a more sophisticated financial recordkeeping process. At this point, you may wish to consider the accrual method of accounting. Under this method, you record your income when you have an invoice for services provided, rather than waiting to get paid for that service. You recognize a business expense when you receive a bill from a supplier, rather than waiting until you pay the supplies. This method of accounting is preferable because it allows you to more closely match the income your business generates to the expenses you incurred to earn it. For example, you may have received an advanced cash payment before you provided services to a customer. You may want to wait and record that amount as revenue during the year you actually provided the services, rather than the year in which you received the cash.
From an income tax perspective, the IRS is very flexible in allowing you to choose an accounting method. According to its rules, you may use any method as long as it clearly reflects income and expenses and you treat all items of income and expenses in the same manner from year to year. However, if you produce, purchase, or sell merchandise, special rules apply on when you must use the accrual method. If your business handles inventory in any way, you should consult our accountants to determine when to use the accrual method.
Create a Budget
Successful small business owners, while deeply focused on servicing customers, also keep good financial records. However, your financial situation can quickly spiral out of control despite this diligence if you are not also managing your money.
Many small business accounting software packages allow you to create a budget, either based on a previous year’s records or from scratch. Creating a budget is important because it will create standards of performance for your business. After an interim period, you should compare your company’s actual performance to the budgeted amounts and then explain the differences. This process will tell you whether you are on track to meet your sales goals for the year. It can also keep your business profitable.
Compare your performance
Finally, most small business accounting software packages also allow you to compare your business’s current-year financial statements to those from previous years. This process allows you to see trends in your business. It also provides insight on how you can add to its success.
For example, if your revenue increased by 10-percent in 2011 over that from 2010, but, to do so, your expenses increased by 30-percent, this suggests some inefficiency in your business model. Are you investing in assets with the greatest return on investment? Or, did you forget to provide invoices for some services provided during the year? Conversely, if your revenue increased by 30-percent for 2011 over that from 2010, but your expenses only increased by 10 percent, this suggests that your business model could be hyper-efficient. Were all expenses recorded? Were some revenue items duplicated? Or did you truly manage to increase your return on investment? It is important to get to the bottom of these trends in order to have an accurate picture of your business’s performance and to make important financial decisions.
Visit the Startups and Self Employed Tax Guide For more tax advice for running your startup and small business.