Proper management of a business’s finances, and having someone dedicated to that process, is a crucial component of success for small businesses and startups alike.
According to the Bureau of Labor Statistics, 20% of businesses don’t make it past year one, and only 30% of small businesses will remain in business 10 years after their launch. Adherence to accounting best practices and hiring or outsourcing a person dedicated to this function, can help prevent the cash flow issues that are to blame for many business failures. Further, these best practices can also point the way to insights that can lead to small business growth.
Top 15 Small Business and Startup Accounting Tips
Every small business needs to follow basic accounting processes to ensure strong financial management practices. These include:
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Separate business and personal expenses. One of the first steps a small business should take is opening a business bank account, which it can do after obtaining its Employer Identification Number, or EIN (sole proprietors can use social security numbers). Business bank accounts offer several advantages over personal ones, including:
- Making it easier to track and substantiate business expenses to take advantage of tax deductions.
- Offering personal liability protection by keeping business funds separate from personal funds.
- Providing the option of a line of credit that the company can use to cover cash gaps.
Businesses should open a checking account, savings account, credit card account and merchant services account, which allows the company to accept credit and debit card transactions from customers.
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Get bookkeeping software (and a bookkeeper). Bookkeeping is the organised process of tracking all income and expenses. It’s a critical component of financial management that ensures business owners have the information they need to make sound business decisions. For many small business owners, accounting is not among their skill set. Hiring a person dedicated to the task or, for smaller businesses, outsourcing the function is often a wise investment.
Accounting software automates bookkeeping processes that are time-consuming and error-prone if completed manually, and makes it easier to find all of that information to complete financial statements. Small businesses are finding a lot of success with cloud-based accounting software, in particular, with more than half of U.S. respondents surveyed by Robert Half reporting their companies use either some or only cloud-based solutions for accounting and finance. Although most businesses start with basic accounting software, as they grow and become more complex, they may need to invest in an enterprise resource planning (ERP) system. Once a company has an ERP system, it can add modules for other business functions, with everything tied to a single database.
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Develop a budget. One of the first steps in creating a business plan is coming up with revenue projections and a list of anticipated expenditures, and then comparing that budget to actual expenses and revenue. A study by The Federal Reserve Banks of Chicago and San Francisco reported that more than 60% of businesses with excellent financial health always built a budget and, subsequently started a separate bank account for payroll. Less than 5% of businesses with poor financial health engaged in these two financial planning and management practices.
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Keep accurate business records. Recordkeeping is one of the most important responsibilities for a small business owner. Accounting software can automate much of the recordkeeping process and digitally store financial records. That makes it easy to document the amount, time, place and business purpose of a transaction when you claim expenses as tax deductions. IRS requirements mandate keeping the records, in general, for at least three years—accountants recommend keeping them for seven years. Records a business needs to maintain are listed in detail in IRS Publication 583. But a few worth calling out for small businesses and startups include:
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Gross receipts are the income you receive from your business, and records include: Cash register tapes, deposit information (cash and credit sales), receipt books, invoices and Forms 1099-MISC.
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Expenses are the costs you incur to operate your business, and records include: canceled checks or other documents reflecting proof of payment/electronic funds transferred, cash register tape receipts, account statements, credit card receipts and statements and invoices.
Receipt scanners make it simple to digitise receipts and invoices for easy tracking by automatically mapping the contents to defined fields in the accounting software. Accounting software may either offer its own mobile app or support a third-party app that enables an employee or business owner to scan receipts with their smartphone camera. These apps use optical character recognition (OCR) technology to translate text into machine-readable code.
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Fixed assets need to be recorded to compute the annual depreciation and their gain or loss when you sell them. Asset documents include purchase and sales invoices; real estate closing statements; canceled checks or other documents that identify payee, amount and proof of payment/electronic funds transferred; credit card receipts and statements and invoices. Costs related to the purchase of limited life intangible assets are amortised. Other asset categories, such as current or indefinite-life intangible, are neither depreciated nor amortised.
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Choose an accounting method. Every small business and startup must pick a set of rules for determining when to report income and expenses. This provides a consistent accounting method for tax purposes. In general, under changes put in place by the Tax Cuts and Jobs Act, small businesses with $25 million or less in annual gross receipts for the three prior tax years can choose between accrual accounting and cash basis accounting. However, because Generally Accepted Accounting Principles (GAAP) require accrual accounting, many companies prefer this method.
Cash basis accounting can be more straightforward and easier to manage for small businesses because revenue is recorded when payment is received. Similarly, expenses are deducted when the money actually comes out of the company’s account. Accrual accounting records the sales when a product ships or a service is delivered. In a retail setting, a sale is recognised at the time of purchase, and in other industries revenue may not be recorded for several weeks or even months after the sale. It requires double-entry bookkeeping. Since accrual accounting takes a long-term view of the business, it generally provides a better picture of a company’s financial health.
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Keep the books up to date. Without keeping the books current, owners and employees don’t have a clear picture of the company’s financial state. Automating receipt and invoice capture is one way to ensure the books are always up to date. Another important step is to link bank accounts with your accounting software. Businesses can download credit card and bank statements and manually import them as CSV (Excel), but some accounting systems offer a plug-in that will pull information from your bank account and automatically retrieve daily bank transactions and statement files. The business can define the matching rules in their system to reconcile the statements, which makes the reconciliation process much easier. Some accounting software offers a direct integration to banks, so the business owner can manage and complete all banking tasks in the accounting system without also logging into their bank account portal.
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Optimise AP terms and invoicing. To hold on to cash longer, take advantage of credit terms from key suppliers. Pay bills on a schedule that maximises your cash flow, and when possible, pay early with vendors that offer a discount for doing so. To ensure steady cash flow, do everything possible to encourage on-time payment from customers. That could include offering discounts for early payment, running credit checks on potential customers before doing business with them and, when necessary, revoking credit terms. Accounting software that can automate invoicing processes by automatically sending out bills and follow-up reminders could also help prevent outstanding invoices from piling up.
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Separate accounting functions. Public companies must follow regulations that require controls to ensure segregation of duties. Small businesses are more likely to have a single person handling many accounting functions, but this creates an environment that introduces risk of accounting fraud. However, owners can minimise this risk by putting some simple controls in place. One effective control is to ensure the same person who cuts the checks doesn’t sign the checks and reconcile the bank statements.
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Keep an eye on certain high-cost expenses. Labour costs are the largest expense for most small businesses, and inventory is often another. To reduce labour expenses, many small businesses outsource work to contractors that bill at an hourly rate. This can be cheaper because the contractors may not need 40 hours/week to complete your work and they don’t require benefits. Time-tracking software can help leaders understand how much certain tasks are costing the business, enabling the business to better budget and find ways to control these expenses. Companies can lower inventory costs by tracking inventory carrying costs, inventory turnover ratio, amount lost to obsolete inventory and other key metrics.
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Plan for major investments. By consistently tracking expenses and revenue, the business can identify the best time for large investments and establish the credit it may need to cover the cost. Business credit cards can help an organisation establish a credit history so it has a better chance at qualifying for financing (and optimal financing terms), including lines of credit and loans, when it needs more capital. Securing these funding sources are important to a company’s overall financial health—45% of businesses with excellent financial health received loans or credit cards from a bank, compared to just 3% of companies with poor or below-average financial health, per the Federal Reserve study. Additionally, credit cards offer perks for the business such as business rewards or travel rewards.
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Carefully monitor tax preparation. The IRS generally requires that sole proprietors, partners and S corporation shareholders make estimated tax payments if they expect to owe taxes of $1,000 or more when their return is filed. There are specific employment tax records you must keep (detailed in IRS resources on Recordkeeping for Employers and Employer’s Tax Guide). The IRS provides worksheets in Form 1040-ES, Estimated Tax for Individuals, or Form 1120-W, Estimated Tax for Corporations that help calculate estimated tax. Businesses should also check the IRS tax calendar. The tax calendar includes due dates and actions for every month. A business can sign up for email reminders, or even import reminders into Outlook.
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Seek professional tax preparation guidance. The NSBA says that one in three small businesses report spending more than 40 hours each year on federal taxes. It’s not surprising then that roughly two-thirds of small businesses pay an external tax professional/accountant to handle their taxes. There are even more benefits here for a sole proprietor, as the cost of hiring someone to prepare your business’s tax return is deductible.
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Ensure inventory data is accurate. To prepare financial statements, the business needs accurate inventory data. It must calculate the cost of goods sold (COGS) for the income statement, and the value of inventory on hand for the balance sheet. Physical inventory is tracked either by manually counting items on a regular basis or pairing counts with an inventory management system that can automatically adjust the numbers as sales happen if it’s integrated with the point-of-sale system and accounting software. Inventory management software not only makes it much easier to track inventory, but the information will be more accurate.
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Use financial statements to evaluate business performance. Logging expenses and income are the basis for generating these three key financial statements. Income statements help the business determine its profit (or lack thereof), a balance sheet shows assets, liabilities and shareholders’ equities for a snapshot of its financial position at a certain point in time, and the cash flow statement shows whether the company has enough money flowed into and out of a business in a given period and how much cash remains. When combined with the balance sheet, however, the cash flow statement can show whether a company has sufficient cash to meet its current obligations. All three statements are required by banks and investors to secure financing or funding.
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Generate financial projections. Financial projections help businesses estimate future income and expenses to anticipate if they need financing or should make capital expenditures. Financial forecasts help business leaders estimate cash flow and determine when to change pricing or production plans.
Forecasts provide important financial information to external stakeholders when the business seeks a loan or funding, or if the business is the target of an acquisition. A company can also use these forecasts to create pro-forma financial statements, which are projected income statements, balance sheets and cash flow statements. Projections are based on financial modeling techniques and provide the answers to questions that may come from lenders, investors or other business stakeholders. At their basic level, they provide the answer to a question like: if we lend you this money, what will you do with it and how will you pay it back?
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By taking steps to establish strong accounting processes from the beginning, small businesses and startups increase their likelihood of success. Studies show that the more often a small business reviews its financial numbers, the better its financial health, which should ultimately drive long-term success. Although bookkeeping is not the passion of most small business owners, they must frequently review these critical financial metrics to capitalise on opportunities to grow and ensure their company is not on a path to insolvency.
