How to Create your Accounting System
Before you begin doing much [tag]business[/tag], it will be of great benefit to get your [tag]accounting system[/tag] in order. Many businesses fail because of improper financial controls and reporting. As proper [tag]cash flow management[/tag] is such a key to building a successful business, it is imperative to always know how much cash you do have on hand, what your expenses are, and what liabilities and assets the company has at any point.
The basis of your accounting system will be your journal entries, [tag]income statement[/tag], [tag]balance sheet[/tag], and cash flow statement. Your income statement will keep track of your revenues and expenses, your balance sheet will be able to tell you the value of your assets, liabilities, and ownersâ€™ equity at any point in time, and your cash flow statement will allow you to monitor the in and outflow of money to and from your business over any set period.
You can use software such as [tag]QuickBooks[/tag], [tag]Quicken Business[/tag], or [tag]Money Small Business[/tag] to make managing your financials yourself much easier. I use QuickBooks and all I have to do is import my bank statement once per month for each of my companies and categorize each transaction. The software will automatically generate my balance sheet, income statement, and cash flow statement.
When you hire your first employee, youâ€™ll have to set up a [tag]payroll system[/tag]. Essentially, this allows you to keep track of what you pay your employees. While it is much easier to have your employees work as independent contractors and send them a 1099 at the end of the year, if someone is working for you full time, youâ€™ll have to add them as an employee.
Once you begin to have a few months of transactions in your accounting software, you can use the reporting features to view the ratios of your business. Essentially, these ratios are similar to a report card for your business. Theyâ€™ll quickly tell the experienced business person and investor how your company is doing. The most common ratios are the [tag]quick ratio[/tag], [tag]current ratio[/tag], and [tag]debt to equity ratio[/tag].
Quick Ratio (Acid Test) = Cash + Receivables / Total Current Liabilities
The higher your quick ratio is the better. The more available cash and receivables you have and the less liabilities, the better off you will be. You always want your liquid assets to be greater than your current liabilities. The higher this ratio is, the longer your company will be able to stay afloat if your sales revenue dries up. You want it be at least 1. The quick ratio is also known as the acid test, as it can give a quick look into the health of a company.
Current Ratio = Total Current Assets / Total Current Liabilities
Your current ratio will answer whether your business has enough current assets to meet the payment of its current debts with a safety net for possible losses in current assets, such as inventory reductions or collectable accounts? A ratio of 2 or higher is considered acceptable.
Debt to Equity Ratio = Debt / Equity
To find your debt to equity ratio, simply divide the amount of debt you have by the value of the ownersâ€™ equity in the company. Try to keep this number close to zero. While debt can be beneficial if used correctly, if your debt to equity goes above one, it may be a sign that you have too many liabilities for the amount of value in your company, creating the potential for bankruptcy.
Focusing on Building Your Business
As a business owner, youâ€™ll also want to look at your inventory turnover, gross margin ratio, net margin ratio, accounts receivable turnover, return on assets, return on equity, and return on investment. These ratios will be very helpful in managing your business. And always rememberâ€”cash flow is king. If things ever get too complex, thatâ€™s a good signâ€”because at that point youâ€™re likely making a good amount of money and can afford to hire a CFO.
As soon as you can afford it, hire a good bookkeeper and later on a Chief Financial Officer. You may also want to hire an accountant to help you set up your payroll system and file your tax return each year. Having these persons on your team will allow you to focus on building your business, instead of making journal entries.
Author: Ryan Allis, CEO of Broadwick Corporation