In the excitement of starting a business, many entrepreneurs tend to ignore the paperwork. Don't. "Lots of things can happen if you don't keep the right records," says Bruce Goldberg, a partner with the accounting firm of Coopers & Lybrand in Philadelphia, "and none of them are good."
The most ballyhooed reason for record-keeping is the fear of an IRS audit, where you would be asked to substantiate both your income and deductions. But, while less than five percent of sole proprietors are audited, poor records can still put your entire business at risk.
For example, are you sure that your fastest-selling product line is really making money? If you don't have a handle on how to price your product, and allocate overhead costs such as rent, electricity, and the depreciation on your new computer, you may find out too late that you're actually losing money with every sale. And then there are credit sales. Even with correctly priced products, a cash crunch could close your doors if your customers pay late--or not at all.
"Your tracking system doesn't have to be elaborate or expensive," says Goldberg, "but you must be able to get the management information you need, how and when you need it." At a minimum, you need to account for sales, expenses, assets and liabilities--in a word, your investment in the business--and taxes. These accounts will give you the information you need to compile a monthly income statement and balance sheet.
Most people are familiar with the income statement that totals your revenue, subtracts your expenses, and tells you if you've made or lost money. While an income statement covers a period of time, such as a month or a year, the balance sheet is a "snapshot" of your assets, liabilities and owner's equity on one given day--usually the last day of the month or, for a year-end balance sheet for a calendar-year taxpayer, December 31st. This is the statement your banker uses to analyze how much money you have invested in the business (the capital account), the debt you already have (what you owe to your banker), how many sales have yet to be collected (accounts receivable), and the bills you have yet to pay (accounts payable).
You can't wait a month, however, to find out if your sales are on track. You should be able to retrieve, within minutes, your bank balance and cash on hand, that day's sales and cash receipts, accounts receivable, all monies paid out by cash or check, and accounts payable.
If you have employees, you will also need access to weekly payroll records with the name and address of each employee, their social security number, the number of exemptions, the date the pay period ends, hours worked, the rate of pay, total wages, deductions, net pay and check number. You also need a weekly accounting of the income tax withholding and FICA taxes due to the federal and state governments.
On a monthly basis, your record-keeping system should also let you reconcile your bank statement to the cash account in your general ledger, reconcile your petty cash account, and produce statements showing costs and income attributable to each product or product line. Ideally, your system will also track, at least monthly, the "age" of your accounts receivable. Any receivable over 30 days old is a potential problem. Receivables that hit the 60- and 90-day marks should make both you and your banker nervous. If your inventory isn't moving--or you're constantly out of stock--you probably need a monthly inventory report. Your monthly income tax withholding and FICA reports should be tied to your weekly payroll reports.
You'll need quarterly reports showing gross sales and taxable income, and state and local sales taxes on gross receipts. At year's end, you'll need to create summary reports that itemize all information for your annual income statement and balance sheet, as well as for your federal and state income tax returns.
You can't run a business without records, says Dan Smogor, a partner with Kruggel Lawton Co. in South Bend, Indiana, but don't get lost in the numbers. "There's nothing wrong with paper-and-pencil records until you get up to speed," he says. "Eventually, you will want to use a computer. Just make sure you understand what you are doing before you automate your record-keeping."
In addition to your handwritten ledgers and computer reports, you need to keep original invoices documenting expenses paid, as well as copies of the invoices you send to customers. You also need to keep your bank statements, employee payroll records, and inventory records. Assets such as computers and office furniture should have a permanent file showing the cost of the assets and a depreciation schedule.
As long as you're doing everything right, open a separate checking account for your business; life--and record-keeping--will be simpler if you keep your business and personal accounts separate. The same holds true for telephone and gas credit card accounts used exclusively for business.
Accurate records are just the first step. You also need to develop a comfort level on how you--and your banker, attorney and accountant--will use your accounting records. Jenai Lane, president of Respect Inc., a designer of jewelry and accessories in San Francisco, recommends that start-up business owners take a formal course in the basics of financial statements. "When my banker first asked for my debt-to-net worth ratio," says Lane, "I thought she was speaking in a foreign language."
There is always, of course, the temptation to put everything in a shoebox and "let the accountant do it." Just remember, this business belongs to you, not the accountant.