Don’t Get Stuck in an Accounting Quagmire
Accounting is an established discipline, which, over centuries has developed tools and techniques for tracking and analyzing the money matters of even the most complex multi-national corporations. Yet it all boils down to income and expenses, profits and losses. What follows are some tips on how not to go overboard by adopting practices that are more complex than you need and don’t add value to your business’s bottom line.
Stay Conservative When Estimating First-Year Income
Writing a good budget is arguably the most important accounting exercise for emerging businesses. However, estimating your first-year income is notoriously difficult, and some advisors make it sound like it can be done with a high level of precision.
For example, some advisors recommend deciding how much you’d like to make and working back from there. In other words, start with bottom-line profit and work back to top-line revenue. Alternatively, you are directed to research other, similar businesses near you and model your income expectations on theirs.
The response is the same in both cases: These may be good planning strategies for seasoned businesses, but not for a start-up right out of the gate. It usually takes time to refine business processes and solidify your customer base. Unrealistic first-year income projections could result in excessive spending—and unnecessary pressure on you. Better to stay conservative and give yourself a reasonable amount of time to reach profitability goals.
In general, entrepreneurs don’t start companies in industries they know nothing about. No one will ever know more about your business than you do. So don’t be afraid to use your judgment when you have specific information that you trust.
Is Double-Entry Bookkeeping for You?
The real complexity of accounting rears its head in the system of journals and financial statements described above. These were developed for double-entry bookkeeping, which requires every credit to have an offsetting debit and vice versa. That’s not too tough. But knowing which journal to use for each type of transaction requires a fair amount of experience.
For example, some assets known as “intangible assets” are not recorded as assets; things like R&D or market research are deducted against net worth, while purchased patents may be amortized. In other words, it’s not exactly intuitive how to keep records on this level.
Here’s a simpler example: A bank has deposits and loans on its books. Which are the assets and which the liabilities? Hint: If you’re not a banker, it’s the opposite of what you’d expect.
If you’ve already mastered the system or see it as a key core competency that you need to learn, then double-entry bookkeeping will provide you with a powerful tool that will help keep your finances well accounted for. That said, most emerging business owners will probably find it simpler to use an off-the-shelf accounting program or hire an accountant.
The Bottom Line: What’s Essential?
The real questions for owners of emerging businesses are what kind of accounting system do you really need—and how much should you try to do yourself? For sole proprietorships and businesses that don’t need to solicit bank loans or other formal investments from outsiders, it’s arguable that you can do fine with a simpler process. A budget is essential, and keeping it up to date with actuals on a monthly or quarterly basis will provide many of the same insights as a balance sheet. Making sure your checkbook always has a comfortable balance is a quick-and-easy way to track cash flow. And running some kind of net worth report twice a year is a handy substitute for a P&L.
The next step up would be to run a formal cash flow report. The existing templates are good, the required inputs are fairly intuitive, and the information is of immediate value. It’s something you can do yourself with relatively little investment of time or money.
If your business plan calls for rapid growth, you’ll probably require loans from banks or other types of capital infusions. In this case, you will have to learn how to conform to lenders’ and investors’ requirements. Here, it’s questionable whether an entrepreneur should try to go it alone. Business accounting is regulated by the Federal Accounting Standards Board (FASB), which produces a voluminous set of guidelines called the FASB Accounting Standards Codification (PDF).
What’s a better use of your time, developing products and promoting your business—or boning up on the latest statements, interpretations, technical bulletins, and countless other modifications to the Codification? As the old saying goes, “Don’t let the accounting tail wag the business dog.”