Accounting is unlikely to be your favourite part of running a business but it is crucial to your survival.
Running out of money is the reason 29 per cent of startups fail, according to a survey run by CB Insights. So, how can you prevent yourself becoming one of them? Make sure you get to grips with some accounting fundamentals as soon as possible.
Don’t assume you can simply delegate your accounts to your bookkeeper or accountant. Understanding your finances will help you assess your performance and spot potential problems quickly, so you can act to prevent them.
It shouldn’t be something you pay attention to once in awhile either. You should always be able to answer crucial questions like are you borrowing too much, or is your revenue covering your expenses?
Here are a few key steps you can take to feel in control of your finances and make a success of your business.
Make sure you get to grips with key terminology
It can be daunting to get to grips with all the terminology associated with accounting but you can’t afford not to. Terms like your deductibles, liabilities and accruals should become part of your vocabulary, especially if you want to have a meaningful conversation with your accountant or investors.
Record absolutely everything
Don’t make the mistake of thinking it’s too early to start recording your finances. Record absolutely everything from day one. Keeping a hawk eye on every penny going in and out of your business is fundamental but easy to overlook.
Always keep your business records separate from your personal expenses to give you a clear picture of what’s going on.
Keep on top of compliance requirements
Keeping accurate records of everything you do will help you fulfil your legal obligations, so don’t treat it as optional. HMRC requires you to keep documentation to backup your tax returns for six years. Invoices, receipts and bank statements are just some of the documents you need to keep.
In addition, make sure you keep track of your VAT liabilities, so you don’t inadvertently go over the threshold.
Make sure you have clear accounting policies and procedures in place and that everyone who needs to know these is familiar with them.
Calculate your break even number
This is one of the most fundamental numbers you need to keep an eye on. To begin with, you’ll need to calculate your monthly expenses – taking into account both your variable and fixed costs.
Then you’ll need to work out your gross profit percentage – which is your gross profit divided by your sales and expressed as a percentage. You’ll then need to divide your expenses by your gross profit percentage. To take this one step further, work out how many units you’ll need to sell to break even. Do this by dividing the break even number by the cost per unit. To keep it accurate, you’ll need to recalculate it regularly as your business changes.
Know your burn rate
Your gross burn rate is the amount it takes to operate your business each month. Take away any revenues and you have your net burn rate.
This figure is particularly crucial for startups who may take a while before they earn a profit. It gives a clear idea of how sustainable your business really is. Your investors will also want to know this figure because they will use it to work out if you are worth investing in. They’ll check how it compares to your forecast and how quickly your revenue is growing.
A good rule of thumb is to make sure you always have six months’ worth of operating capital in reserve.
Calculate your customer acquisition cost (CAC)
This the figure you typically need to spend on convincing a customer to buy from you, so it needs to take into account your marketing and sales efforts.
It’s calculated by dividing the total amount you spent on acquisition by the total number of new customers. To put this figure into perspective, you then need to consider the customer’s lifetime value. If the customer gives you repeat business over several years, then the CAC might be worthwhile, compared to if they only make a one-off purchase. Tracking such metrics is a lot easier nowadays, thanks to the fact many businesses are digital.
Embrace the digital age
HMRC anticipates that by 2020 most small businesses will be using apps and software for their record keeping and to report information to them. They are therefore transitioning to a more digital way of working with small businesses. They are already piloting changes in the way they handle taxes with a view to phasing this in from next year.
They recognise that operating finances digitally means you are less prone to making errors, or missing deadlines. Business accounting software offers numerous benefits to small business owners. It allows you to automatically keep accurate records in real-time, so you always know where you stand financially.
Using cloud-based accounting software allows you to securely share such information with other parties who may need access to it, like your accountant. If your business still relies on spreadsheets, then you are making your life harder than it needs to be.