Setting Up Your Accounting System
When we were last with Dick and Jane on Finance Fridays, our fearless entrepreneurs were figuring out how to split up their founders equity and account for an investment from Jane. While they’ve been hard at work on their product, they’ve also incorporated the company, now named SayAhh (thanks Mac!) as a C-Corp in Delaware. They’ve done a bunch of other mundane things, such as establishing a business checking account and depositing Jane’s $50k in seed capital, but like all good early stage entrepreneurs, they’ve spent most of their time obsessing about their product, talking to a few potential early customers about what they needed, and coding away on their MVP.
Dick and Jane had limited formal business accounting experience, but they both knew how to balance a checkbook. They reached out to their friend John, a CFO at a late-stage VC-backed company in Boston that was about to file an S-1 to go public. John took an hour out of his day to do a conference call with Dick and gave them advice on how to set up their accounting system. His advice included the following,
- Set up a double-entry accounting system and use it to track all financial transactions.
- Build a financial model that forecasts the P&L. Revenues and costs should both be based off of a robust set of assumptions. This should tie to your GL for “Actuals” (i.e. historical data).
- Be sure to use accrual accounting, not cash accounting.
- Tie the P&L forecast to the Balance Sheet and Cash Flow Statement and generate snapshots of what the Financial Statements will look like each year for the next 5 years. Create monthly snapshots on a rolling 12 month basis.
- Anytime the financial model indicates that SayAhh will run out of cash, determine how you will raise capital to ensure liquidity and be sure to properly account for the debt or equity transaction on the balance sheet and Cap Table.
- Tie each round of funding to a set of key milestones in the development of your product/business.
John also mentioned a bunch of other stuff that Dick didn’t write down because they weren’t really sure what it meant, but it included phrases like 409a and VSOE. Feeling overwhelmed, Dick emailed his friend Josh, the CEO of an early-stage startup in Boulder, to see how they figured out all of this stuff. He summarized Dick’s advice and Josh replied: “That’s great advice and you should do all of that stuff – eventually. But, for now, focus on the following:”
- Make sure you both have business credit/debit cards and that you use them (or checks) for all transactions.
- Setup a simple accounting system like QuickBooks and sync it with your bank account. At the end of each week, make sure you’ve properly labeled each transaction using the QuickBooks Chart of Accounts. This takes a little getting used to, but you’ll pick it up. Ask me if you have questions.
- QuickBooks allows you to forecast expenses. Think through all of the expenses that you anticipate over the next 12 months and enter them. Update this every time you become aware of new transactions and maintain this on a rolling basis. QuickBooks will show you if/when you will run out of cash within the next 12 months.
- Build a plan as to how you will inject more cash into the business any time QuickBooks shows you running out of cash, and be sure to start raising any needed cash well in advance.
Dick and Jane followed Josh’s advice. It required a small investment of time and money to get QuickBooks up and running, but it was a manageable distraction from building SayAhh’s core product.
To be successful, you need to know about a wide range of issues affecting your business. However, you do not have to become an expert on each and the degree to which you need to understand various issues evolves along with your business. It is easy to get caught up in all the administrivia of of forming a company, building a business plan, and developing financial forecasts that you fail to spend time building your product.
How do you know what matters most when? This is where developing a network of trusted and qualified mentors comes in handy. While John was trying to be helpful, his advice missed the mark because he didn’t have a lot of experience at the early stages. In contrast, Josh was an experienced entrepreneur who had started several companies and likely learned his lessons through experience. As you build your business, surround yourself with as many Josh’s as you can. And, as you grow, make sure you find mentors like John to help you at at the appropriate stages.
As Josh suggested, when you first start your business you should focus on building systems and processes that allow you to accurately capture as much data as possible from the start. QuickBooks and other accounting software programs will do this for your finances, but you should also implement tools for tracking other key metrics (e.g. customer behavior, support inquiries, marketing analytics). You can and will become increasingly sophisticated in analyzing and interpreting that data over time, but you cannot analyze it if you do not have it.
Additionally, at all points in the development of your startup – including on Day 1 – you should focus intently on forecasting your cash flows as accurately as you possibly can. Running out of cash will either kill your company or force you into a very painful financing round. Know exactly when you run out of money, well before the time you hit a wall and go splat.