Bookkeeping is an essential part of running a business – particularly in uncertain times, when it’s more important than ever to have an accurate picture of your company’s financial health. Bookkeeping is also time consuming, detail-oriented, and easy for new businesses to mess up. Here’s the top 5 bookkeeping mistakes that trip up startups – and how to make sure they don’t trip up yours.
This one can’t be overstated. When you’re first getting your business off the ground – and especially if you’re funding it out of your savings – it can be tempting to just use your own accounts for the business’s expenses. Don’t.
There’s a number of reasons that mixing your personal and business money (also called “commingling”) is a bad idea. The most well known is taxes. You’ll probably want to deduct business expenses from your business taxes; if all of your expenses come from a single account you’ll need to be extremely meticulous in tracking which are for the business.
Sometimes this might be easy – you probably didn’t buy all those servers for personal use – but other times it won’t be. Which day did you meet prospective clients at your favorite restaurant, and which day did you go with friends? Which of these dozen Amazon expenses were for office supplies? If you haven’t been keeping up with classifying them throughout the year, then tax time is going to be a major headache.
Besides just the tax issues, commingling makes it hard to tell the actual health of your business. You can’t easily see how much money is going where, because it’s all mixed in with your personal spending. This can make it hard to get an accurate picture of your burn rate, which in turn can lead to less-than-optimal spending decisions.
How to Avoid It:
It’s never too early to get your business its own credit card and bank account. Use these accounts exclusively for your business expenses. If you accidentally use the business card for a personal expense (or vice versa), make sure to flag it right away.
When you set up your business’s bookkeeping system, you have two options: single-entry and double-entry. Single entry is much simpler, and familiar to most of us from our bank statements. It’s also much more vulnerable to errors and fraud, which is why using the single-entry method for business is usually a mistake.
A quick overview: in single-entry bookkeeping, all records are made in a single account:
Month start: $5000
Product sales $10000
Month end: $9000
The problem is, if you make a mistake and enter the wrong amount for something, there’s no real way to tell until you eventually get a bank statement that doesn’t look like you expect. For that same reason, it’s much easier for fraud to go undetected in single-entry systems.
Double-entry bookkeeping, on the other hand, requires that each transaction be recorded twice in two separate accounts, as a debit and as a credit. For example, if you buy a new desk that costs $200, you’ll record $200 leaving the cash account, just like you would in single-entry. However, you’ll also show $200 entering an asset account, showing that you now own $200 worth of desk.
The most important thing is that the totals have to match. With double-entry, if you enter the wrong amount for something, the totals won’t match, and you’ll be able to track down what went wrong. As a result, you’ll get more accurate books, and a more reliable view of your finances. There’s a reason double-entry bookkeeping is the industry standard as part of GAAP principles.
How to Avoid It:
Start things off right by using double-entry bookkeeping from Day 1. Regardless of which system you choose, you’ll have to switch to double-entry at some point – your investors will want to see proper double-entry books, and publicly-owned companies are required to follow GAAP (and thus have double-entry books). Like the company bank account, this will be easier to manage the earlier you implement it. Don’t wait until you have to switch.
It’s not just your bookkeeping method – when you start a business, you’ll also have to decide on an accounting method. As with bookkeeping, the choice between cash-basis and accrual accounting may seem esoteric, but can actually have a big effect on your business. And, as with bookkeeping, one of the options is much more growth-oriented than the other.
Cash-basis accounting is more straightforward: you record when money comes in or out. If you make a sale in June, but the client doesn’t pay until July, you record the transaction in July. At first glance this might seem like a good idea – after all, you didn’t actually have the money until July.
Accrual-basis accounting, however, offers a fuller view of the state of your business’s finances. Under the accrual system, transactions are recorded when they take place, regardless of when the money changes hands. Under this system, when you make the sale in June, you record it in June as income.
For a single transaction, this might not seem like a significant change. But imagine you made three sales each in June, July, and August, and all the clients paid in August. From a cash-basis perspective, it looks like your business had no activity for most of the quarter, before a giant sum came in at the end. From an accrual perspective, however, you can see that your business is making a steady, regular amount of sales.
This helps you – and potential investors or lenders – get a better idea of how well your business is doing. And since you record expenses as well as income when transactions occur, there aren’t any surprises when a bill comes due. You’ll be better able to plan for the future.
How to Avoid It:
LIke double-entry bookkeeping, accrual-based accounting is an industry standard, and one that you’ll have to adopt eventually: once you reach a certain size, the IRS requires it. You can save yourself later headaches by using the accrual system right from the beginning.
Startup founders are pulled in a million directions. Next to pitching investors, building a team, developing a product, planning go-to-market, and everything in between, bookkeeping can feel like an afterthought. This is especially true if you don’t have a lot of transactions at this point, and your company’s finances are fairly straightforward. Do you even really need to think about the books at this point?
The answer is yes, you do.
Besides the importance of having quality books in the first place (i.e., it’s hard to make solid financial decisions without them), waiting to get serious about your bookkeeping is essentially setting a time bomb in your operations. At some point, you’re going to need your books, and it’s going to go off. When it does, you’re going to be faced with the giant mess of trying to sort out your records, potentially for a much more complex financial operation than you currently have.
How to Avoid It:
Like many of the things on this list, the key is to start early. Don’t ignore your books just because they’re currently simple – in fact, that’s the ideal time to put a process in place that will scale as you grow. Starting off a strong foundation means you’re less likely to have a bookkeeping crisis steal your momentum later on.
This is closely related to the previous mistake (and in fact, #5 is a leading cause of #4). A leading bookkeeping mistake for startups is trying to DIY, long after the point of diminishing returns.
As an early-stage founder, your time is your most valuable resource. And as your company grows, demand for that resource will only increase. You could learn to be an expert bookkeeper, and conscientiously manage your company’s books without help. But if you’re running the books, who’s running the company?
It may make sense to handle the books yourself when you’re first starting out, your company’s only employees are you and your co-founder, and your only real expenses are a few software licenses. As your business grows, however, digging through the nitty-gritty in your monthly books probably won’t be the best use of your time. At best, it’s distracting you from growing your company; at worst, it’s setting up a future mess.
How to Avoid It:
Recognize when DIY is no longer working. How much of your time are you spending on books? How often are they being updated? Are you able to get quality financial statements? If the answers to these questions aren’t “very little, often, yes,” it’s time to bring in help.
Founding a company is hard enough, without having to worry about problems in your bookkeeping. Avoid these 5 mistakes, and you’ll already be better positioned for growth.
At Pilot, we are a team of startup finance enthusiasts, not lawyers, financial advisors, CPAs, or tax preparers. This article is provided for informational purposes only, and it is not legal advice, accounting advice, or tax advice. You should always consult a licensed accountant, lawyer or other appropriate professional for advice on your specific situation.