Accounting is a critical element when launching a successful business venture. Unfortunately, it’s also an area where startups tend to make mistakes. Here are some common (and avoidable) errors that entrepreneurs should watch out for.

Failing to track expenses

Starting a new business is exciting — and it’s natural to focus on generating revenue and building business relationships. But it’s essential to keep detailed records of expenses, including receipts and invoices. This will help you properly allocate costs, price products and services, assess and improve financial performance, and claim tax deductions.

Forgetting to reconcile accounts

Reconciling accounts involves comparing your records to your bank and credit card statements to identify and correct any discrepancies. Account reconciliation ensures that your business pays close attention to its expenses and available cash. It can also help to prevent and detect fraud by third parties and employees.
Commingling personal and business expenses

When you own a business, you need to keep personal and business matters separate for financial reporting, tax and legal purposes. In addition to maintaining a distinct workspace for your business, you should have different bank and credit card accounts. This will avoid confusion and make it easier to track business expenses. It also will facilitate budgeting and forecasting.

Incorrectly classifying workers

How much control do you exercise over the people who work for your business? Are your workers an integral part of your operations? Misclassifying employees as independent contractors can have serious legal and financial consequences. Make sure you understand the differences between employees vs. contractors and categorize them appropriately. If you don’t follow the rules, the IRS, the U.S. Department of Labor and a state tax agency might challenge the status of your workers.

Not budgeting for taxes

Since many startups run at a loss, at least initially, some owners forget to set aside money for taxes. This can lead to cash shortages and other financial difficulties when tax time rolls around. Failure to make timely federal and state tax payments can result in penalty and interest charges. And don’t forget about payroll, sales and property tax obligations, too.

Failing to set up a formal accounting system

Entrepreneurs must select and consistently follow an accounting method based on their business needs. Many fledgling businesses start off using cash- or tax-basis accounting, then graduate to accrual-basis reporting as they mature. But lenders, franchisors and investors sometimes require accrual-basis financial reporting from the get-go.

It also pays to invest upfront in simple internal controls — such as locks on file cabinets, regular software updates, network backups and antivirus programs — to help prevent theft and fraud. Startups with valuable intellectual property, such as patents, secret recipes and proprietary software, should consider protecting these assets by requiring employees and contractors to sign noncompete agreements, implementing network security policies and filing appropriate legal protections. Additional internal control measures can be implemented as your business matures.

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When companies report financial results, they often rely on estimates made by management. Examples include the allowance for doubtful accounts, warranty obligations, costs of pending litigation, goodwill impairment and the fair values of acquired intangible assets. How do auditors evaluate whether amounts reported on the financial statements for these items seem reasonable?

Inquiry and testing

Accounting estimates may be based on subjective or objective information (or both) and involve a level of measurement uncertainty. External auditors evaluate accounting estimates as part of their standard audit procedures.

For instance, they may inquire about the underlying assumptions (or inputs) that were used to make estimates to determine whether the inputs seem complete, accurate and relevant. Estimates based on objective inputs, such as published interest rates or percentages observed in previous reporting periods, are generally less susceptible to bias than those based on speculative, unobservable inputs. This is especially true if management lacks experience making similar estimates in the past.

Whenever possible, auditors try to recreate management’s estimate using the same assumptions (or their own). If an auditor’s estimate differs substantially from what’s reported on the financial statements, the auditor will ask management to explain the discrepancy. In some cases, an independent specialist, such an appraiser or engineer, may be called in to estimate complex items.

Auditors also may compare past estimates to what happened after the financial statement date. The outcome of an estimate is often different from management’s preliminary estimate. Possible explanations include errors, unforeseeable subsequent events and management bias. If management’s estimates are consistently similar to what happened later, it adds credibility to management’s prior estimates. But if significant differences are found, the auditor may be more skeptical of management’s current estimates, necessitating the use of additional audit procedures.

Gray area in accounting

Accounting estimates and fair value measurements involve a high degree of subjectivity and judgment and may be susceptible to misstatement. In today’s uncertain market conditions, predicting metrics that underlie accounting estimates can be particularly challenging. Therefore, they require more auditor focus today than in more-stable prior accounting periods. Be prepared to provide comprehensive documentation to support your estimates during the upcoming audit season.

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CPA firms do more than audits and tax returns. They can also help you with everyday accounting-related tasks, such as bookkeeping, budgeting, payroll and sales tax filings. Should your organization outsource its accounting needs? Here are five potential advantages to consider when evaluating this decision.

1. Professional advice. Outsourcing to an experienced CPA firm provides access to professional guidance related to tax, legal and financial matters. This makes it easier to remain compliant with rules and regulations and avoid costly mistakes due to a lack of knowledge or errors in interpreting complex regulations.

By engaging a third-party firm, there’s a second set of eyes on your company’s books. This can provide peace of mind that your books accurately reflect the performance of your business. Additionally, a CPA can help streamline your accounting processes and help record complex transactions correctly.

2. Scalability. As your financial situation evolves, you can dial up (or down) the services provided by your CPA. For example, a start-up that outsources its accounting needs wouldn’t need to worry about outgrowing its bookkeeper over time — or training that individual to take on more advanced accounting and tax needs. Likewise, if you embark on a major financial project — such as a launching a new product, building a new factory or merging with a strategic buyer — your CPA has the expertise on-hand to help you achieve the best possible outcome from a financial and tax perspective.

Outsourcing can also be a viable temporary solution if you unexpectedly lose your CFO. This can provide breathing room while you search for a qualified replacement in today’s tight labor market.

3. Cost savings. Outsourcing can save you money on payroll taxes and insurance costs associated with hiring an in-house accountant. Further, CPAs enjoy economies of scale regarding software usage and purchases, so they likely can provide accounting services cheaper than your firm can by working alone or relying on independent service providers for each task.

4. Efficiency. When you transfer accounting functions to your CPA, your management team has more time for core marketing, product development and other activities. It also frees up resources for higher-value tasks that can increase cash flow and optimize efficiency within the organization, such as negotiating with prospects or building deeper relationships with existing clients.

5. Enhanced confidence with stakeholders. A CPA firm’s involvement can instill confidence in lenders and investors if you intend to borrow money or solicit investment capital. It shows that your firm is committed to maintaining accurate business records and has access to the expertise needed to address complex issues.

Contact us if you’re considering outsourcing your daily accounting tasks, either permanently or temporarily. We can tailor a cost-effective service plan that works for your current and future business needs.

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