Are you an entrepreneur who is trying to start his or her own business? Maybe you have already started and are wondering how to handle your business finances. Either way, this guide will help you understand the importance of good accounting, how to do good accounting, and why your personal finances matter.
I wrote this guide because business finance articles tend to be complex and not to the point. This is my attempt to simplify this topic to help you avoid easy mistakes that could cost you thousands of fees to correct or, worse, cost you millions in funding.
Start Tracking Now, and with Accrual-Based Accounting
When it comes to finance and accounting, most people don’t even create a personal budget for themselves. To be a successful business owner, your budget is the minimum thing you need to have. This is because you can't run a business if you don’t have money to “keep the lights on.” The only way to create a budget is to track your spending and the money you are making/using to run the business. Regardless of what you find, you need to keep your spending under your revenue/funding.
Sometimes this will mean moving away from the tools you are currently using to free alternatives, or going to a more manual process until you can afford the tool. You will be surprised by what you can find by googling “[tool you are using] free alternatives”, or taking a look at our startup-friendly tools on our partner page or our coming soon resource area for our members.
If you are just getting started and don't want to sign up for a software tool, here is a great google sheet template that auto-fills your profit and losses, and your balance sheet from your expense and revenue tracking.
PRO-TIP: Now that you are tracking your expenses and revenue, a huge tip if you will be fundraising, is to use accrual-based accounting instead of cash-based accounting. Almost all investors will want your finances this way and are required for companies with average revenues of $25 million or more over three years. The reason to start with accrual accounting is that it can cost you thousands of dollars to make the switch later.
To put simply, accrual-based accounting provides a more complete view of your business health and smooths out your revenue and expenses as you are recording things as soon as you make a sale or get a bill for expenses, not when you get paid or pay a bill. This is typically handled by using Account Receivable and Account Payables to help track what has and hasn’t been paid for. You can use the free-to-start accounting software Wave to help with this.
Track your Cost of Goods (COGs) Correctly
The biggest piece of financial knowledge you have as a founder is your Unit Economics. Your Unit Economics is how much it costs to create a single unit of your product or service, and how much profit you make by selling a single unit of your product or service. An example of this would be making a cake for $10 and profiting $5 because you sell it for $15. Things can get more complex if you provide discounts for buying more cakes at once, or if you can decrease your costs for making the cake by buying and making more cakes at once.
A key part of your unit economics is how much it costs for you to make your product or perform your service, otherwise called your Cost of Goods or COGs for short. The reason it is important to track your COGs correctly is that it affects your taxes, how you calculate your profit, and how you prioritize what expenses are core to your business.
This might seem straightforward, but for some businesses like software startups, things that you wouldn’t consider like your engineer payroll are technically a COG expense. Things can definitely get complex even for businesses that seem straightforward, so definitely put in the time to research how others in your industry are tracking their COGs, and consult with an Accountant with experience in your industry if you still have questions.
Personal Finances Hygiene
The last thing I wanted to mention, is the importance of having your personal finances organized and in a good place. The reason for this is that if you do need a business loan, the loan company or bank will look at your personal credit score and other areas of your personal finance as part of the qualifying process. They will even look at the personal finances of your business partners as well. In addition to this, showing that you are capable of managing your personal finances correctly can only build credibility in the eyes of investors who are about to give you their money to manage.
If you are looking for help in this area, I would recommend reaching out to Damondrick “DJ” Jack who runs a non-profit as a credit coach, providing pro-bono services. You can book a meeting with him here https://calendly.com/call-with-dj
Business finance is not as hard as people make it out to be, and not doing it will always set you on a course for failure. Luckily software makes it easy to do most of the tedious work of tracking and reporting. The important thing is to start tracking as soon as possible, and knowing how to track and report your finances when you start, so you don't waste time and money trying to fix things later.
Google template for expense and revenue tracking
Article further explaining Accrual Accounting vs Cash Accounting
Article further explaining Accrual Accounting
Free accounting software that has accrual-based reports