MBA Mondays: Accounting From The Archives
We have five weeks (including today) before we start the sustainability course. It's not enough time to start a new series. So I've decided to rerun five posts on accounting and financial statements that I did early on in MBA Mondays. This is core stuff. If you want to start a business, run a business, and/or operate a business, you need to know the basics of accounting and finance.
So today we will rerun the post on accounting. The next three weeks we will go through the three main financial statements. And we will end with a post on understanding financial statements.
Accounting is keeping track of the money in a company. It's critical to keep good books and records for a business, no matter how small it is. I'm not going to lay out exactly how to do that, but I am going to discuss a few important principles.
The first important principal is every financial transaction of a company needs to be recorded. This process has been made much easier with the advent of accounting software. For most startups, Quickbooks will do in the beginning. As the company grows, the choice of accounting software will become more complicated, but by then you will have hired a financial team that can make those choices.
The recording of financial transactions is not an art. It is a science and a well understood science. It revolves around the twin concepts of a "chart of accounts" and "double entry accounting." Let's start with the chart of accounts.
The accounting books of a company start with a chart of accounts. There are two kinds of accounts; income/expense accounts and asset/liability accounts. The chart of accounts includes all of them. Income and expense accounts represent money coming into and out of a business. Asset and liability accounts represent money that is contained in the business or owed by the business.
Advertising revenue that you receive from Google Adsense would be an income account. The salary expense of a developer you hire would be an expense account. Your cash in your bank account would be an asset account. The money you owe on your company credit card would be called "accounts payable" and would be a liability.
When you initially set up your chart of accounts, the balance in each and every account is zero. As you start entering financial transactions in your accounting software, the balances of the accounts goes up or possibly down.
The concept of double entry accounting is important to understand. Each financial transaction has two sides to it and you need both of them to record the transaction. Let's go back to that Adsense revenue example. You receive a check in the mail from Google. You deposit the check at the bank. The accounting double entry is you record an increase in the cash asset account on the balance sheet and a corresponding equal increase in the advertising revenue account. When you pay the credit card bill, you would record a decrease in the cash asset account on the balance sheet and a decrease in the "accounts payable" account on the balance sheet.
These accounting entries can get very complicated with many accounts involved in a single recorded transaction, but no matter how complicated the entries get the two sides of the financial transaction always have to add up to the same amount. The entry must balance out. That is the science of accounting.
Since the objective of MBA Mondays is not to turn you all into accountants, I'll stop there, but I hope everyone understands what a chart of accounts and an accounting entry is now.
Once you have a chart of accounts and have recorded financial transactions in it, you can produce reports. These reports are simply the balances in various accounts or alternatively the changes in the balances over a period of time.
The next three posts are going to be about the three most common reports;
• the profit and loss statement which is a report of the changes in the income and expense accounts over a certain period of time (month and year being the most common)
• the balance sheet which is a report of the balances all all asset and liability accounts at a certain point in time
• the cash flow statement which is report of the changes in all of the accounts (income/expense and asset/liability) in order to determine how much cash the business is producing or consuming over a certain period of time (month and year being the most common)
If you have a company, you must have financial records for it. And they must be accurate and up to date. I do not recommend doing this yourself. I recommend hiring a part-time bookkeeper to maintain your financial records at the start. A good one will save you all sorts of headaches. As your company grows, eventually you will need a full time accounting person, then several, and at some point your finance organization could be quite large.
There is always a temptation to skimp on this part of the business. It's not a core part of most startup businesses and is often not valued by tech entrepreneurs. But please don't skimp on this. Do it right and well. And hire good people to do the accounting work for your company. It will pay huge dividends in the long run.
Accounting protip: The person doing your bookkeeping should have zero access to the checkbook. Zero.
unless they are your partner in the business
Ya still a lot of caveats though….I don’t even like to do my own bookkeeping….I like having to explain things to someone else.
that’s a good rule
double signature requirements above certain amounts is a rule that can help. we do that. also helps guard against temporary insanity, checkwriting while intoxicated, etc (it can happen!)
You mean separate bookkeeping from accounting?
Does this exclude doing your own accounting?
I think it should….there is a lot of value in having to explain cold numbers to cold hearts.
See also: Mad Men, and Lane Pryce’s story archttp://www.vulture.com/2012…
“Zero access to check book”.I am assuming you mean as signer – typically you want your book keeper to write the checks, but have an owner be the main signer on the bank account, same with electronic – wire transfers.Another simple control is to have someone independent of writing checks or reconciling cash – to open the bank statements.
What do you think of some of these fancy accounting software Apps like http://waveaccounting.com/? They facilitate the bookkeeping aspects mostly.
i like them. we looked at Wave closely for an investment last year
Uncharacteristic of you to publicly disclose passing on an investment, no?
I didn’t say we passed. In fact they took money from another investor before we could make up our minds
Bad assumption on my part.
I will take a look…..Quickbooks is the standard in the market place, you can typically find people who have used it before, and if not very little learning curve.Exports to xls if you want to do additional analysis – or customize reports before sending out.A good friend once told me – that the incremental cost to produce software is zero, and that you are typically best off using a product or platform that is widely used;- Cost for enhancements can be spread over wider installed base- Broader user base – will lead to more features- Rich ecosystem of 3rd party add -onsQB also has an online version – if you want your data in the cloud
Remember that almost all accountants and bookkeepers are familiar with QB, which makes getting data to the right people easy fir taxes, etc.Given that, I hate the product. It is a relic of 1989 software design and development, Intuit is pompous (when reporting a bug the support person told me there was no bugs in the software) and expensive for the web version.
I agreeWhen I see them using it my eyes roll but it worksThe one I mentioned is self-service for the user
“expensive for the web version”Cheap when compared to NetSuite – granted not apples to apples
Expensive compared to the Windows version, is what I meant. (The Mac version isn’t worth the money last I looked a year ago.) Costs a lot more to pay the monthly subscription then the one-time cost. (I don’t know anyone who buys the desktop version every year, either, making it even more expensive.)
YUP agree Cloud vs Windows…Other reasons to think about cloud is – if you are not always working at the same location – I do some part-time CFO work…and it is a real pain in the ass as far as trying to keep every thing in sync.- Other issue may be as you point out – Mac version not being that good, I assume??? that the cloud version – works reasonably well from a browser.I have quickly tested the online version – seems OK, I mostly use the windows PC version – one other issue – is that QB has three different version ( good, better, best) and they issue a new version each year – so I may have QB premier 2011 on my PC, and one of my clients might use the 2010 version – it is a real pain. It has to be a real pain for accounting/tax firms.
Agreed Elia. None of the old software can handle multi-currency, Paypal and the sheer volume of transactions in an elegant and inexpensive way. Drove me crazy trying to shoehorn new ways of business into an outdated model.
Actually, QB doesn’t handle most everything to do with a software/web service business very well at all. Opportunity/headpin there, if can build the trust factor.
Hence why we see new approaches in Wave and also Xero (based in New Zealand of all places!). Working from an earlier comment these systems really put cashflow front and centre in the way they handle accounting and my accountant couldn’t be happier!!
Hi Fred,I cannot thank you enough for the experience and wisdom you shared with us. It’s been many years since I stumbled upon your blog, and I keep reading it with the same joy and delight.That being said, and coming back to the HR series, I would like to read more about evaluating your employees (and more specifically about a CEO’s evaluation on his / her management team).Can you pinpoint me to some articles, or maybe, if I don’t ask too much, a new blog entry on this topic?Thanks again.
Wilkins Micawber is a fictional character from Charles Dickens’s 1850 novel, David Copperfield. He was modelled on Dickens’s father, John Dickens, who like Micawber was incarcerated in debtors’ prison (the King’s Bench Prison) after failing to meet his creditors’ demands.Micawber is known for asserting his faith that “something will turn up”. His name has become synonymous with someone who lives in hopeful expectation. This has formed the basis for the Micawber Principle, based upon his observation:”Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”http://en.wikipedia.org/wik…
“On “The “Head “Of “WILKINS MICAWBER.”
If I’m not careful, I’m going to hijack this thread with David Copperfield quotes.
“The most important thing in life is to stop saying ‘I wish’ and start saying ‘I will.’ Consider nothing impossible, then treat possiblities as probabilities.”
If you can’t see your business from a numbers perspective you can’t manage it.Basic fact of business life.Simple and right guidance from Fred to get this part of your house in order from the beginning.
My rule: if you can’t measure it, it didn’t happen. This of course applies to analytics more than accounting, but it does put emphasis on the hard data, the bread and butter of good decision making.
Yes….data points lead to more comfortable decision making.Early stage though if you depended on data you would have little action.That’s why I really love early community stages where every customer is a market highlight and every gesture and interaction the beginnings of a language to discover your next action.
Early stage is fun but the ‘comfortable decision making’ stage is probably welcomed by most people 🙂
‘comfortable’ of course has little to do with being ‘correct’.But…and this is the rub…every decision is important but almost everything in business from a market building perspective happens in the execution.In fact, strategic execution is what I adhere to.From awhile back on this topic:The best marketing strategy is dynamic execution http://awe.sm/k3FiC
Absolutely. There are different takeaways from data depending on where you are in the stages of a company. 1) Small and growing user base: cohort analysis to see whether your users are coming back.2) Small with a solid user base: A/B testing to see what features are useful. Anyone doing some sort of gamification would fall into this bucket.Once you get to a solid user base, it’s up to the product managers to decide what features to look for, and the “idea guys” (internal or external) to find direction of the product and company, but always keeping a close eye on the data.The payoff for large companies is introduced here: http://www.nytimes.com/2011…If on the other hand you are a data-centric company like Google, Bitly, Foursquare, etc, data analysis is at the forefront of your business.PS: your link doesn’t work in Canada 🙁
Doesn’t work in Canada…new to me. Too weird. Have a bunch of Canadian blog readers and never heard that.
Good points – I am in Canada and the link worked fine for me
It must be my router or ISP that forwards me to a Canadian spam site.Thanks for verifying Abdallah.
Completely agree about your point about execution. Also, thanks for providing the link to your post. It is packed with tremendous advice and I like how you linked up discovery, communities and dynamic execution in one package. It is definitely worth a re-read a few times
Thanks!I reread it when I linked it actually. Been awhile.Think I should start writing a series on all the ‘holes’ between talking the talk and walking the walk between theory and reality that I’m discovering every day with launching a community project.
@awaldstein:disqus I enjoyed your post Arnold. Thanks for the link.
how do you know what numbers to look at? (non accounting numbers, of course)
Early stage this is easy of course Shana. Running your business is not that different from running your life, add employees of course.
early stage companies often measure the wrong things, especially if they are pre-revenue
Really sharp oilpatch CEO – Gwyn Morgan – ‘if it matters measure it.’Nothing beats numbers to stat a feedback discussion.
Nice twist biut maybe sound more than sense.On a business side, community matters for certain. How do you measure it?On a personal side, monetizing popularity seems to be the avocation of the social web and the market itself. The leap beyond influence. Measuring both seem like a wrong turn to me.There are many aspects of business that matter that you can aggregate data but can’t really measure. I’m a staunch reactionary that ROI applied to anything but the balance sheet is a dead end activity.
Not so much ROI but quantity.If you have some numbers that show community activity, then you have trending info & A/B testing results, etc.
The biggest issue w/ the three statements Fred outlined above – BS, PL, CF – is that they are reporting on historical events/activity – the past.I agree w/ Fred that a lot of accounting is a Science….the Art partly comes with being able to plan and project the future. This is not done solely by the accounting team – most important to include other members from the management team – depending on where the company is in the business cycle re: pre revenue – building the product / team – expense heavy, or post revenue.
I think of that as financial planning and management but not accounting. Great point!
Agreed. The primary benefit a good accounting executive provides is to be looking forward and asking hard questions of the rest of management. It’s easy for a sales manager to predict astronomical growth. It’s significantly more difficult to justify that growth to a finance/accounting exec. asking the right questions.
When setting up your financial statements, one thing to think about is how you will use them to forecast and change direction in the future. That means creating a meaningful chart accounts that is organized in such a way that your management team can process the information and act on what they learn. For example, are all of your staff created equal? If so, then one account for salaries may be fine. But maybe you have a large sales staff that can be trimmed in lean times. If so, you may want to break them out, since that’s something you’ll want to keep an eye on. I recommend looking at an Jeremy Hope’s books on Beyond Budgeting for more info.Another great resource for thinking about the future is Future Ready [Steve Morlidge,Steve Player ] They talk a lot about how to make forecasts, using a mix of Statistical, Mathematical and Judgmental models. They also discuss a lot about how often to make forecasts, how far out into the future to look, how to measure your forecasts to improve your forecasting abilities, and much more.
Hi Rex, how technical are Beyond Budgeting and Future Ready? I work in Sales and am trying to improve my knowledge of accounts and forecasting, but starting from a pretty low level.
Great point John. I work with a number of tech start ups and multinationals in Australia to get them tax credits / government grants, and one of the key issues I see is the disconnect between accounting and the strategic side of the business.The thing to remember is cash is king (both to keep the company solvent, but also to fund expansion / future projects and through to base R&D), and further to Fred’s other MBA posts on burn rate etc, it is critical that major stakeholders understand the P&L, BS and CF statements and more importantly how they interrelate. The majority of staff don’t need to know how a certain expense is technically treated under sAASB 112, but should know capex from opex for example. This becomes critical when the board needs to start understanding what’s happening numbers wise.
For any entrepreneurs looking to outsource their accounting, can I highly recommend the brilliant team at BGSServices who handle accounting for IfWeRanTheWorld and MakeLoveNotPorn: http://bgsservices.com/ They are fantastically supportive, go over and above the call of duty, and I don’t know what we (as a tiny, bootstrapping, keep-close-track-of-every-cent-and-stretch-our-seed-funds-as-far-as-possible team) would do without them.
Edit note: s/principal/principle/(I wish disqus would let me delete comments later)
Best advice I can give anyone starting up: hire a bookkeeper. They are usually very flexible, can come in once per month for a half hour to help out, and usually reasonably priced. I have a lot of accounting experience but still chose to higher a bookkeeper. A second set of eyes is important on finances, helping you categorize expenses appropriately and thus minimizing the tax preparer fees. Plus, there is a certain amount of minutia that we embed ourselves in as a start-up and debits and credits does not need to be one of them.If you can’t afford the $25-50 or so per month it would cost early on, it would be very good to hire one once you start with payroll. Even I’d never touch that myself.
I hired a bookkeeper 20 years ago. He is one of the greatest things I do monthly to stay on track. He comes once a month and verifies all the data and makes sure it all goes in the right category. Between the two of us, we create the best looking, audit proof books around, according to my two accountants. And you should know I despise having to do this kind of [email protected]:disqus need not worry about turning me into an accountant – my two accountants already tried that and failed, along with a failed attempt to send me to get an MBA. Besides, how many years on AVC counts as a better than MBA equivalent??
At what point in revenue do you think it’s important to hire your first full time accountant?
Sorry to be “that guy”, but since the typo is in the first line, and it refers to the upcoming course topic, “sustainability” is misspelled in the link. The second “t” is missing.
And “principle” vs. “principal” while we’re on the subject.
Keepin’ the standards high for the A VC archives. 😉
Charlie has already mentioned this. Take an active part in setting up your chart of accounts, its your business, you should know what areas are likely to make up the largest expenditure so make sure that those areas have plenty of sub accounts so that you can get a decent analysis. Don’t just let a book keeper set up a standard template.Make sure you look at your accounts and reports at least monthly and understand all the numbers in it. If there is something you don’t understand ask. If you take vc investment from a vc as a ceo you will need to ensure that you know and understand the monthly figures not just your finance person.On hiring, a decent controller who is willing to do grunt work at the beginning is a great hire because they will get to understand your business and more value than a bookkeeper. You don’t need a cfo just like you don’t a chief revenue officer until you are way down the track.
Thanks for breaking it down.I’ve worked directly with an Accountant where I had to handle all the money that came in from Donors. I think it takes focus, communication and integrity to be able to enter all financial data. There are pro’s and con’s to having more than two people handling funds.In my situation there were three people handling the funds. In the beginning I was always the second person to enter the funds in. Towards the end I became the first person to handle the funds. It’s sometimes a moral issue. I think the person who handles the funds first has the most important position.Funds can go missing or never reported. When you enter funds the minute you receive them, there are fewer disputes when other people do not report those funds. At the time I was using razor edge software which is use by non-profit organizations.I don’t know if it’s still being used. This was around 2004-2005.
I work with over 200 small businesses people a year, and the most common problem is the lack of good managerial finance tools. They simply don’t have good enough financial records, laid out in a “Management Dashboard” that they can use to make decisions.To that end, we teach a course for small businesses called Profit Mastery. http://www.brs-seattle.com/I refer to the course as “Everything I need to know about finances, and should have learned sooner.” We walk small business owners through Gross Margins, Break Even, Cash Flow Projections, Forecasting working capital needs, and Planning for transition.This might not be the best program for a tech start up – it is geared more to retail or manufacturing. Please feel free to reach out if you need more info, or just to bounce ideas.
We just got an amazing financial person on our advisory board. His comment to me was that i track the $$$’s like most start-ups — all around cash flow. He’s giving me templates etc. that look at it from a more holistic perspective moving forward.
“It’s not a core part of most startup businesses and is often not valued by tech entrepreneurs.”Lived it.
General comment or thought about BS, PL & CF…..Balance sheet – is at a snap shot at a point in time usually specific dates ( think last day of month, qtr, or fiscal/calendar year).Income Statement and Statement of Cash flows – showing activity for a period of time ( think month, quarter or year).You can always tell by the heading on each of these statements – Balance sheets will be ” as of a certain date” whereas PLs and CFs will state “for the Month of, quarter ending, year ending”).
My tip would be this: Ask the accountant how you can make things as simple as possible, and not sacrifice anything. I’ll give three examples. If you are billing subscription, you can pro-rate the first period and then bill the same on each period afterwords. Simplifies billing and collection. You can pay monthly or if you have to bi-monthly and not have to accrue pay across periods. Same for expenses.
I love these tips. Value added commenting!
The most important thing.Accounting For Business
I wish more companies would involve finance in sales/forecasting – I am still often appalled at just how amateur/chaotic and unaccountable forecasting is. Such a vital metric yet one so often overlooked or simply addressed in a token manner with an Excel of platitudes!
“The first important principal is every financialtransaction of a company needs to be recorded.” – Keeping things documented isone of the most important things to take note in your business’ accounting. Bybeing precise with data ensures that your business’ books are well-kept, andaccurate.http://bestcpareno.com/irs-…
At my current company we actually reformatted the entire chart of accounts to align with our model/budget. This drastically simplified reporting and as periodic management reviews occur we’ve been able to streamline unused accounts and improve the model accordingly.
I had the most detailed chart of accounts in the dreadful Quickbooks I so despised.Then, as @facebook-17829973:disqus did, I drastically simplified the 15 year old system to reflect having sold a major asset. I am so much happier now. We have actually gotten Mint to mirror the revised CA in QB, and saved a lot of time which I now use for projections.