Accounting is central to any business, and needs to be organized. You can’t deny the need for accounting, or try to push it under a rug. In fact, that’s probably the worst thing you could do when starting your business. While Phidgets didn’t make this mistake, there were plenty of other lessons that we had to learn in the accounting realm.
We thought it might be helpful to share some of our accounting lessons with you, from warning signs, to setting up a system that models your business accurately. These tips will be useful for anyone who’s thinking about starting a business, or beginning to set one up.
But first, let’s go over some definitions for people who’ve had little experience with accounting.
- Assets: what the company owns.
- Liabilities: what the company owes.
- Balance sheet: a report on assets, liabilities and other capital at a particular point in time.
- Equity: The value of the company, determined by the assets minus the liabilities.
- Revenue: the money that the company makes in sales.
- Expense: the money the company spends or the costs the company incurs.
- Profit and loss statement: a report on revenues and expenses incurred during a specific period of time.
- Profit: the revenues minus the expenses.
Fairly painless so far.
The First Steps When Starting a Business
The first task is to model your business. This model should resemble your business and make sense. How will you model inventory? Will you need an account for each customer, or can customers be “anonymous”? While you can’t possibly predict everything that’s going to happen (see the next step), taking the time to set up a good model will make everything run smoother down the road.
Now, you can choose an accounting system. This doesn’t have to be complicated. Phidgets chose to use Quickbooks right off the bat. It’s a strong brand and incredibly inexpensive for all that it does. Whatever software you use, the next step is to find someone who’s set up an accounting system before and have them walk you through everything. If you find someone who knows what they’re doing and has a similar enough business to yours, they can also provide suggestions on the business model you created. They might even be able to share some of the problems they encountered. Do not wait, thinking that you’ll figure it out. Not only is this a waste of time, but some mistakes can end up costing a lot of money.
The Red Flags of a Bad Accounting System
Now that you’ve got your accounting system up and running, and you know how you’re going to be using it, this is a good time to tell you about some red flags to watch for:
- you can’t reconcile the accounts at the end of the month
- you can’t just hand off the books to an accountant at tax time
- the accounting system doesn’t make sense to you
- you are wasting time on organizing or you are constantly fixing problems in the accounting system
If you run into any of these, stop and look at what you’re doing, pinpoint the errors, get rid of what’s causing the problem and rework the system from the roots up. Do not create workarounds and hacks!! For Phidgets, this is what created some of our accounting problems in the first place. Workarounds and hacks are signs that the accounting system is not modelling the business correctly and needs to be looked at again.
Top Three Mistakes to Avoid
While we did do some things right, there were plenty of things we didn’t do so right. Here are some of the top three mistakes our CEO, Chester Fitchett, recognized:
1. Worrying about Foreign Currency
The accountant we hired hadn’t dealt with foreign exchange before and did some clever, but inappropriate, “hacks” to make the accounts balance. The problem was that customers would owe us in USD, but the exchange rate from the time they purchased to the time we did our books had changed. The accountant tried to correct the difference in our books by adding additional “purchases”, but when the person paid, the exchange rate had changed again. The lesson: you need a bookkeeper who understands foreign currency.
2. Seeing Assets as Expenses
Another mistake we made was in modelling our inventory and materials. For years, our accountant modelled our business as though we were a small service industry business. Every component that we bought for making Phidgets was written off as an expense. At the end of the year, we’d calculate profits as revenue less expenses and the profit would be small. The problem is that inventory is an asset, it’s something the company still owns. This was easy enough to fix, but we still had to make up some bad taxes.
3. Forgetting what we did Last Year
You only have to do end of year reports once a year, which means you’re likely to forget what exactly you did the year before. Having someone who knows what they’re doing helps (i.e. not leaving it up to the CEO who has a lot of other things on his or her mind), as does keeping everything well organized. And even though you, as the business owner or CEO, shouldn’t be doing the bookkeeping, you still need to be involved and know what’s going on to catch anything that may go wrong.
If we can leave you with any wisdom, it would be set up your accounting system right away (and make sure it’s ready for the growth of your business), find someone who’s done it before to show you how it’s done, keep the books organized, and maintain an understanding of your accounting system.
One final takeaway, accounting systems don’t magically solve problems. You still need to spend time coming up with a good business model and learning the accounting system. As the business owner, you need to keep tabs on what’s going on, so you need to understand the system. But hopefully, with this initial time investment and a good bookkeeper, the rest will be smooth sailing.