You've done the hard work. You have a new business idea or you've found an existing business to purchase. Want to help ensure your business success? Pay attention to correctly setting up your business' accounting system. Here's how:
- Consider business entity. Choosing the right legal and tax entity for your business is important. Consult experts to discuss your options. On the tax side, sole proprietors use a Form 1040 Schedule C to report their activity, while other business entities such as S-Corporations and Partnerships file informational returns and pass-through profits to your individual tax return. C-Corporations require separate tax returns without pass-through of profits onto your personal tax return.
- Determine if you'll use cash versus accrual basis. There are different approved methods of accounting. You will need to determine which is best for you. Sometimes your business dictates a required method, but not always. The basic difference lies in when you can book revenue and expense. One method (cash) is based upon when you actually receive or make payment. While the accrual method allows capturing this same information when there is an established obligation.
- Separate your books. If starting a business from scratch, remember to set up separate bank accounts and recordkeeping. IRS auditors are quick to disallow expenses when your business expenses are mingled together with personal expenses. The same is true with credit cards. Use a separate credit card for your business transactions.
- Use sub-ledgers. Well-run businesses understand the need to organize elements of their business into accounting categories. These categories often use their own reporting system called sub-ledgers. Common areas are sales, accounts receivable, accounts payable, fixed assets, and inventory.
- Honor cash flow. Often success or failure of your business is predicated on whether you have enough cash to pay your bills. Determining your cash needs means understanding the cash situation of your business. To do this requires a good set of records. This includes recording your current situation on a timely basis and establishing a forecast of cash needs throughout the year.
- Create a fortress balance sheet. Banks love a strong balance sheet. If you think your business may need money for expansion, you will want to focus on developing a strong balance sheet that is low in debt and high in liquid assets like cash and accounts receivable. The irony here is that it's easy to borrow money when your records show you don't need it and it's hard to borrow money when you do need the funds.
- Identify financial pressure points. Every business has a few financial items that drive profitability. Do you know yours? It might be payroll in a labor-intensive business. It might be rent in a retail establishment. Perhaps your margins are low because of heavy promotional costs. A strong accounting system will help you stay focused on the more important financial elements of your business.
- Understand seasonality. By setting up a good accounting system AND forecasting performance over a twelve-month period, you will understand the true needs of your business. This is especially important if your business is seasonal in nature.
Remember, by spending time setting up the accounting system that is right for you, you are increasing your business' chance for success.