A founder doesn’t have to be an accountant and doesn’t have to know all the ins and outs of balance sheets and P&Ls. They do need to understand enough accounting basics to make informed decisions about their business, especially when starting out.
As a founder, a basic understanding of accounting allows you to take better control of your finances. You’ll maintain a better overview of where your money goes as well as what’s working and isn’t working, which will help you grow and prevent costly mistakes early on.
How much do founders need to know about accounting? The short answer: it depends on your business and the complexity of your financial transactions.
Accounting Basics Every Founder Needs to Know
Effectively running your business requires some basic accounting skills. You don’t need to know how to set up T-accounts or an amortization schedule, but you need to understand the information your accountant provides and how to ask for it in a way that makes sense to both of you.
Here are some accounting basics every founder needs to know.
The Importance of Cash Flow
Cash flow is the movement of money into and out of a business. It’s crucial for startups because it lets you know how much money you have at any given moment — and how much you’ll have in the future.
Businesses depend on cash flow to survive. Enough cash means you can pay your employees and suppliers on time, invest in new equipment and inventory, and grow your business.
Your startup cash flow statement tells you and your investors how well the business is performing. Plus, a startup that’s consistently generating positive cash flow is more attractive to potential investors, often making them willing to invest more money upfront.
The Meaning of Burn Rate and Cash Runway
As a founder, it’s essential to understand the meaning of burn rate and cash runway. Burn rate is a term used to describe how quickly a company uses its cash reserves. You need to be aware of the factors affecting your burn rate.
Burn rate is how much money your business is consuming each month and can indicate how long a startup will last. A high burn rate and limited funds mean you need to reduce your startup burn rate (or generate cash quickly) to extend your business’s life span.
Cash runway is the length of time a company can continue to operate without an additional injection of funds. It’s calculated by taking your cash on hand and dividing it by your current monthly burn rate.
Both metrics are crucial because they give insight into how well you manage cash and how long your business can survive without additional funding or revenue.
How to Build a Budget
Every business needs a budget. It helps you determine your target income each month or quarter and how much you’ll have left over after expenses. An accurate idea of what will be coming in is essential for accurately planning expenditures.
There are three basic steps to building a startup budget:
- Establish your baseline income and expenses for the next few months.
- Make adjustments for seasonal changes or other factors that might skew your numbers.
- Project future income and expenses by coupling historical trends with realistic expectations.
Understanding accounting basics and how to build a budget can help prevent you from having to raise money too soon.
Setting your goals at the beginning of the year will enable you to track progress, use budget variance to achieve goals, and make smarter decisions.
Taxes are a fundamental part of running a business because they can be such a massive expense. And what you pay in taxes isn’t available to reinvest in your company.
Like with most accounting topics, as a founder, you don’t need to be an expert, but you do need to learn how to handle startup taxes with confidence.
Here are some critical components of taxes that every founder should know:
- Business structure – Is your company a corporation or a partnership? This determines how much you pay in taxes, what kind of tax returns you file, and what deductions you’re eligible for.
- Planning for quarterly payments – If your business is profitable, it’s vital to make quarterly estimated tax payments to avoid owing too much money at the end of the year. These payments consume lots of cash.
- Tracking expenses for credits and deductions – You may deduct business expenses if they are “ordinary and necessary.” Document everything and keep all receipts related to the purchase or use of an asset for your business.
- Timing income and expenses – If you own more than one business, it’s important to pay attention to when you book income in each one — this will affect when you pay taxes on them.
- Sales tax – If you operate in multiple states, each can require you to collect sales tax if they deem your company has a nexus (a physical presence). If you ship products or have customers, they could be subject to sales tax.
These components are important because they affect how much tax you owe each year, which can affect your cash burn rate and runway.
Leveraging Data From Financial Reports
As a founder, accounting is one of the most fundamental skills you need. It’s the language of business and integral to measuring your company’s financial health.
But it’s not just about knowing your profit and loss statement or balance sheet — it’s also about understanding how data can help make better business decisions and grow your company. Basic knowledge can also help you prepare annual financial reports for investors.
When to Turn to an Expert
If things go well for your business, your startup’s needs will quickly outgrow your basic accounting knowledge; when that happens, it’s time to turn to an expert.
At Founder’s, our outsourced accounting experts can guide you through the accounting basics while handling the most complex topics.
Have the feeling you need an expert? Contact us today!