What is one accounting basic that every startup leader should know?
To help you identify the accounting basics you need to run your startup successfully, we asked startup founders and business owners this question for their best insights. From reading balance sheets to understanding accruals and deferrals, there are several basics of accounting that every startup leader should know to help them manage their businesses effectively.
Here are seven accounting basics these entrepreneurs use in the day-to-day running of their startups:
- How to Read a Balance Sheet
- The Difference Between Accounting Profit and Tax Profit
- Cash Flow Forecasting
- Tracking Every Transaction
- Cash Flow Statements
- The Difference Between Profit and Cash Flow
- Accruals and Deferrals
How to Read a Balance Sheet
Every startup leader should know how to read a balance sheet. The balance sheet is a snapshot of the company’s assets, liabilities, and equity at a given point in time. The two most important pieces of information on the balance sheet are the total equity (also known as shareholder’s equity) and the total liabilities (also known as net liabilities).
The total equity is the market value of the company’s assets minus the total liabilities. The total liabilities are the total amount of money that the company owes. When you add the total liabilities to the total equity you get the total value of the company. Knowing how to read a balance sheet will help a startup leader understand the financial health of the company and plan for the future.
The Difference Between Accounting Profit and Tax Profit
One of the most important things to know is the difference between accounting profit and tax profit. Accounting profit is the total revenue minus the total expenses. Tax profit, on the other hand, is the taxable income minus taxes paid. In other words, tax profit is what’s left after you’ve paid all your taxes. Understanding the difference between these two types of profit can help you make better decisions for your business. For example, you may decide to reinvest your accounting profit back into the business, but if your tax profit is low, you may need to use it to pay off debts or investors. With a little bit of accounting knowledge, you can make informed decisions that will help your business succeed.
Cash Flow Forecasting
Cash flow forecasting is one of the basic accounting skills that every startup leader should know. It’s a process of analyzing historical and projected data to predict how much money your company will have to pay bills, make investments, and fund operations for a given period. It’s an important part of developing a business plan, as it helps you determine whether you have enough resources available to meet your goals. You can use cash flow forecasting in various ways—for example, it can help you set pricing strategies that ensure you’ll have enough money coming in to cover expenses and other costs related to running your business. You can also use it when deciding which projects are worth investing in or deciding how much capital you need to begin operations. So I believe this is something startup leaders must understand and use to their advantage.
Tracking Every Transaction
When you are trying to be lean and agile, it is easy to dismiss some financial transactions as too minor to bother keeping track of. But, as the old adage goes, small things add up and become big things.
I’ve seen it again and again through the years in my own business, with customers, and with companies I’ve worked with. A financial problem pops up, people start digging, and you realize that if you had kept track, the situation would have been obvious before it became a problem. You never want to have to say, “I didn’t think it was important enough to track.”
Cash Flow Statements
The cash flow statement is an accounting report that tells you how much money has come into or gone out of a company. You need this information because it will tell if they have enough for their expenses and purchases, but also what happened with any profits made along the way! It keeps track of all these things differently than other statements such as income reports.
“A cash flow statement shows changes over time rather than absolute dollar amounts at a point in time. It uses and reorders the information from a company’s balance sheet and income statement.” (Beginners’ Guide to Financial Statements – SEC.gov)
The bottom line on this kind of report usually consists mainly of data from financing activities (such as loans granted) but it also includes information about what type(s) of investing or operating activity was involved given those were partaken during past periods too; e.g: buying property value increasing by 20% while rent increases.
The Difference Between Profit and Cash Flow
As a startup leader, one of the most important things to keep in mind is that profits are not equal to cash flows. Just because your company is generating a profit doesn’t mean that you have the cash on hand to cover expenses. This is because profits are typically reported on an accrual basis, while cash flows reflect the actual movement of cash into and out of the business. For example, if you sell a product on credit, you will record the sale as part of your profits even though you have not yet received payment. As a result, it’s essential to keep track of both your profits and your cash flows in order to get an accurate picture of your financial health.
Accruals and Deferrals
In order to maintain the matching principle, businesses need to practice accruals and deferrals. The accrual approach ensures that all revenue and expenses are reported in the period when they actually occur, regardless of when the cash is exchanged. For example, if you send out 100 invoices in December but don’t receive payment until January, you would still report that revenue in December. You would then have an accounts receivable balance for those customers at the end of December.
The deferral approach pertains to prepaid expenses. These are costs paid in advance, such as insurance or office supplies. They need to be allocated over time so that only the portion used in a given accounting period is reported as an expense. Otherwise, you would be distorting your current financial picture by including a cost that hasn’t yet been used.