Running a startup or small business can be exciting and exhilarating. You can innovate, implement your ideas and watch your passion project grow before your eyes. However, you need to make sure your venture sustains itself through a well-managed and optimized process that keeps the cash flowing in. This is easier said than done with most startups failing due to inflows of cash drying up. Startups often hurry to push sales and create a market niche while neglecting the lifeline of any business regardless of its scale – a fine tuned accounting system running on well-oiled wheels.
Accounting and bookkeeping are crucial to any business and it is necessary to hire CPAs who can take full charge of the business. This ensures all financial matters are meticulously dealt with so that cash flow is not affected in any manner.
Major reasons for startup failures
Studies have shown that there are a host of reasons for startup failures. Leading the pack is “no market need” (42%) followed by “run out of cash” (29%). The second is most important as “no market need” that tops the chart is something that could have been researched and settled before the venture was founded. Hence, with a little bit of caution, good accounting practices and steady inflow of cash, 29% of the startups that fail can easily be turned into a flourishing business.
How poor accounting practices account for startups running out of cash
If you want to insulate your startup from running out of cash, you should understand that poor accounting methodologies are the primary causes. Here are a few that play a pivotal role in pulling startups under.
- Focus on selling, not invoicing – While sales is the backbone of your business, you need to invoice and collect to get the cash flowing in. Error prone invoices, late invoicing, disputed amounts, and delayed approval and posting all lead to tardy collection against sales.
- High accounts receivable – Your sales are high, your invoicing is on time, but there is still no money to pay vendors and creditors. Examine your accounts receivable and regularly monitor accounts receivable. This will ensure collecting takes precedence over everything else.
- Not following market costs – When you determined pricing of your products, they were based on the prevailing market costs, overhead costs, and estimated gross margins. Over a period of time, these may have shot up but you have not made corrections to your sales price. The end result? Margins are down and cash in-flow is low. Your accountant should look at the monthly reports and advise you to make changes so that margins are maintained.
- Rampant rise in expenses – Your initial estimates of costs can become outdated over time. Suppliers will revise rates upwards and your expenses will increase. Get together with your accounts team, make sure your bookkeeping is up to date, and monitor expenses on a regular basis.
- Estimating available cash from bank balance records – This happens to startups only when their bank reconciliation is pending. Updated bookkeeping that includes posting of future expenditure booked ahead will give a better cash management balance and improved estimates of cash flow.
What are the common accounting issues faced by small businesses?
Without a foolproof accounting system, it’s tough to monitor the financial health of the business.
- Not following tested accounting practices – Many startups deviate from basic accounting practices. This provides inaccurate expenses and earning reports, two vital parameters that determine profitability for the business. Ultimately, it can give you a distorted picture of the company’s health.
- Not separating expense accounts – Small business owners often carry out business transactions through their personal accounts. This can lead to complications as it is difficult to separate personal expenses from professional ones.
- Unorganized receipts and documents – Receipts and documents that are not maintained in an orderly and organized manner can lead to unwarranted complications if they have to be produced during tax season.
- Not tracking expenses accurately – As an owner of a new business, it is difficult to understand the intricacies of different heads of expenses. Sometimes they can be posted under wrong heads, which leads to error-filled expense and income statements and wrong deductible claims.
- Delay in tax submissions – This can get any startup in big trouble. Timely submission of taxes is essential if notice from IRS has to be avoided.
- Loans being taken as share capital – There is a world of difference between the two, but startups often consider loans as share capital. Loans are returnable while share capital is not. Confusing the two can lead to the wrong assessment of liabilities and assets of the business.
- Not requesting professional help – Maintaining accurate bookkeeping records should not be entrusted to those who do not have a thorough knowledge of the subject. You may want to hire a CPA to ensure that records are accurately maintained and all reports generated are precise in all respects.
- Lack of basic accounting knowledge – Startup owners should have an understanding of accounting so that they can study reports and make necessary corrections. They should also be able to understand if any erroneous or fraudulent transactions have taken place.
How can startups get back on the right track with their accounting?
- Keeping invoices in order – Your invoices are cash blocked up and should be kept well organized for easy follow-up and monitoring of accounts receivable. You may want to organize the information on an Excel spreadsheet or use a software and record information like the date, invoice number, client name, amount, and tax payable.
- Closely monitoring bank reconciliation – There will always be a divergence between the books and bank balance as there will be a time gap between receipts and payments. Check the bank statement online every day and reconcile the items with your cash book. This will give you a more clear picture of the state of your finances, especially available cash on hand.
- Maintaining an organized expense file – Keep all original bills in a file and list out the details in a spreadsheet. When bills are paid, note the details of payment like check number on the bills for a better idea of what has been paid and what’s pending.
- Keeping a cashbook – Petty cash is important for a startup as small vendors and contractors might prefer to be paid in cash. Keep track of the expenses and at the end of the day, balance the cash on hand with the expenses made.
- Maintaining an asset register – Details of all assets including computers, software, printers, furniture and company vehicles should be maintained meticulously in a register. Store these records in accounts software and update them periodically.
- Outsource- Hiring a virtual accounting firm for your growing business can help with strategic financial data; as they have in-house experts and accounting tools to handle your cash flow optimally to survive in this competitive market.
Following good accounting practices can help startups avoid common accounting pitfalls, solve cash flow issues, and stay in business. The 29% of startups that fold within a year of opening their doors due to cash flow problems can be drastically reduced if these pointers are implemented.
Wardis Slovak is as a startup consulting manager at Cogneesol and specializes in structuring the business growth for startups. He has consulted multiple startups and helped them in achieving optimal levels of performance and accomplishment. As an eCommerce solution specialist, he provides consultation to ecommerce startups by helping them choosing the right technology platform, website architecture, website’s UI and UX & opting ROI focused marketing strategies.