Accounting for start-ups involves keeping precise records of financial transactions and analysing the financial data to identify opportunities for growth.
It is imperative for start-ups to build a solid accounting foundation to stay organised, increase efficiency, maintain and reduce expenses, and identify possible opportunities and risks for the business.
Therefore, getting the accounting right is critical for a start up to not only grow, but more importantly to survive during the initial introduction period.
What is accounting?
Accounting is the process of recording financial transactions pertaining to a business. The accounting process includes summarising, analysing, and reporting these transactions.
How does it help?
Accounting helps a business stay in full control of its finances, while minimising business tax and other overheads.
Also, good records help make smarter business decisions. Until you know how revenue comes in and expenses go out, it’s difficult to use your resources effectively.
Key stakeholders include:
Stakeholders are persons or groups that rely on financial information to make decisions.
Stakeholders include stockholders, creditors, governmental and regulatory agencies, customers, and managers and other employees.
Know the three main financial statements
Every start-up accounting system is built on the three main financial statements. These are the balance sheet, income statement and cash flow statement.
Each statement breaks down key components of your business such as revenue, expenses, assets, liabilities, and different types of cash flow.
The balance sheet shows your assets and liabilities, which lay the foundation for your company’s financial status.
The balance sheet formula:
Assets = Liabilities + Equity
Let’s break this down:
- Assets are items that your company owns that can produce future economic benefits, such as cash and inventory
- Liabilities are your company’s obligations and include short term debts along with taxes payable
- Equity is what you are worth from a cost perspective. Anything left over after subtracting liabilities from assets belongs to the owner(s) of the company. It represents the value of the owner’s investment into the business.
Income statement or Profit & Loss (P&L) Statement
The income statement, also referred to as the Profit & Loss or P&L statement is arguably the most important financial statement. Every business plan should include an income statement because it’s a key financial snapshot that helps to evaluate your company’s performance.
The income statement formula:
Net Income = Revenue – Expenses
Let’s simplify this:
- Revenue is the gross amount of money you earn from selling products or services. It is the total amount of income a business has earned before subtracting any expenses.
- Expenses are the outflow of cash or assets that your business spends for marketing, promotion, advertising, general administrative tasks, and so on.
Cash Flow Statement
The cash flow statement shows how much cash flows in and out of your business in a given time period. It is used as a tool to analyse how well a company manages its cash position and its overall operation. It is generally divided into three categories: operating, investing and financing activities.
Operating activities: These are activities that are essential for day to day operations. These include cash from inventory, net income, and accounts receivable. For example, the amount of money you bring in for selling goods or a service in a day or week would be categorised as operating activities.
Investing activities: These are activities used to grow the business, such as acquiring other companies and real estate. Start-ups often purchase many assets as they grow, therefore the cash flow from investing activities in your company may be high and produce a negative cash outflow. This is normal for the early stages of any business looking to grow.
Financing activities: Finally, these are activities the company undertakes to obtain investor financing. These are generally broken down between debt and equity financing. As mentioned earlier, debt financing occurs when companies issue debt, or bonds for investors to purchase.
This would be stated as an increase or (decrease) in debt on the cash flow statement. Equity financing occurs when a company issues its stock or equity to investors for sale. This event would be reflected as equity purchased or repurchased on the cash flow statement.
The cash flow statement is a valuable tool to analyse a company’s strength, long-term outlook and overall profitability.
How the financial statements affect a business
Knowing the fundamentals of each statement, how they interrelate with each other, along with key line items will help a business’s profitability. Through ratio analysis of the statements, a business can monitor their gross profit margin, operating profit margin and many more ratios to track the business’ progression.
Keeping a business’ finances in order is imperative for any start up business in order to track cashflow, financial growth and understand profitability. One of the biggest challenges for start-ups is finding the most compatible software that matches their needs as well as the legislative requirements.
Qualified accountants in London is an invaluable asset for any business as they can guide you through complex topics as well as monitor the movements in the finances allowing management to focus on growing the company.