When starting a business, it’s easy to get wrapped up in fun things like coming up with a name, creating a logo, designing a product or service, and just getting stuff done in general.
While each of these is valuable and deserves your time and attention, entrepreneurs often wear multiple hats. This requires devoting at least some of your time to the seemingly less attractive aspects of business management, such as finance and accounting.
Knowing how to move money around to purchase goods, pay creditors, and attract investors is just as important as creating and executing your business plan.
To put it in other words, if you’re a business owner or you’re considering becoming one, you also need to familiarize yourself with the account aspects involved.
Why should entrepreneurs learn accounting basics?
Managing costs, cash flow, invoicing, vendors, and payroll is most likely not what you had in mind when you decided to start your own company. However, these are key components of any successful business, particularly during the early phases when you are both the captain and the showrunner.
Accounting affects practically every aspect of running a business. Actually, accounting will be at the basis of everything you do, from applying for company loans or grants and finding investors to handling payroll and employee benefits, paying bills like rent and utilities and invoicing your suppliers.
If you can’t afford an accountant, you will have to do it yourself. But even if you do have an accountant, it’s better to learn enough to be able to talk about these aspects with investors, potential partners, and employees.
There are a lot of different reports that your accountant can generate for you, but in this section, we’ll focus on three important ones that you should familiarize yourself with: the income statement, the balance sheet and the cash flow statement.
While some companies prefer to produce these reports quarterly or even annually, as a small business, you can benefit from reviewing them every month. This will provide you with the insight you need to make adjustments to your marketing strategy, sales goals, and budget.
The income statement summarizes all of your revenue and expenses during a specified time period. Usually, the last thing on the statement is a number that shows how much money you made after subtracting the money you spent. At the end of the reporting period, the accounts on the income statement will be resent, but the data will not be erased from the system. Most accounting software systems allow you to print income statements for a quarter, a year or whatever period you’d prefer.
Balance sheets are used to record the assets and liabilities of a company. Your property includes the funds in your bank account, your receivables, and your inventory. If you buy or own your building, vehicles, equipment, or furniture, they will also be included as assets. Liabilities are sums owed. For example, if you financed your cars, the balance you owe would be listed as a liability. Expenditures you have accrued will be recorded as liabilities until they are paid. Your equity is typically the last line on the balance sheet, and it is what remains after subtracting all of your assets.
Cash flow statements are considered the most difficult reports to produce, but they are also the most useful for new businesses because they show how money moves in and out of your company. Your earnings and balance sheet accounts are broken down into three categories: funding, operating expenses, and investments. Since the cash flow statement shows your business’s solvency and ability to meet its financial obligations, most lenders and creditors will consider it when deciding whether to grant you a loan.
Adopting consistent bookkeeping practices will help you keep your financial records in order. This means you need to track all your business transactions – all the money that goes in and out. Here are some approaches that will help you:
- DIY Bookkeeping – DIY bookkeeping can be useful in the early stages but not in the long run.
- Cloud-Based Solutions – To automate transactions, you can use a cloud-based accounting service such as Quickbooks and manage your bookkeeping online.
- Part-Time Bookkeeper – If you are on a tight budget but still want professional accounting services, consider hiring a part-time bookkeeper or accountant.
- In-House Bookkeeper – Once your company grows, you should think about hiring someone full-time.
Debits & credits
The double entry system is the most widely used accounting system. In simple terms, this means that each transaction affects at least two accounts. When you write a check to pay the rent for your offices, for instance, you affect both your bank balance and the account linked with your property rental expenses.
In general, debits can either increase expenses and asset accounts or decrease liability accounts. Credits can either decrease expenses and asset accounts or increase liability accounts. In our example, your bank account would be credited, while the lease expenditure account would be debited. The total of all debts and all credits must match but with opposite signs.
Finding ways to increase profitability
Profitability is defined as the amount of money remaining after all expenses are deducted from each dollar of sales. Even though this may seem obvious, it can easily be overlooked in the early stages.
To reach a target market and attract customers, businesses often have to take a loss in the beginning. But this can only work for so long. To attract investors and prosper in the long run, entrepreneurs must have a clear understanding of what profitability involves.
Seeing your company’s future
Growth is a major motivator for most entrepreneurs. Even if you’re content with running your business as a solopreneur, you still seek to maximize your revenue. Others may want to hire more people so they can delegate. And some want to take things to a whole other level.
An entrepreneur must be capable of making forecasts about the future of their company, no matter what their goals are. To attract investors, secure funding, recruit employees and gain customers, they need to estimate future revenues and operating costs.
Without reasonably accurate predictions, you can make the wrong decisions. You’ll grow your company too quickly or not quickly enough, and both can be harmful to your company’s long-term survival.