In my last post, I discussed a few tactics for identifying bad accounting. Here I’d like to take a little stroll on the sunny side of the street and talk about how to create useful accounting infrastructure once you’ve got the basics down. When starting a company, it’s easy to think about accounting as just another necessary evil like setting up payroll, maintaining a C-Corp entity and registering with all of the relevant authorities. However, putting your financial data to work can be a major source of insight for how you’re running your business. Also, doing things right early on will save a ton of headache down the road. Here are a few tips to get the most out of your accounting from a business strategy perspective:
Generate Summary Level Financials
Zoom out, then zoom back in. The Profit & Loss statement that you can download from Quickbooks is not the P&L that you should be sending to investors, bankers and other third parties. It’s also not the P&L that your management team should be reviewing on a monthly basis. This downloadable P&L (what I call the “System P&L”), is going to show all of your active accounts and is too detailed for third parties and high level management review. Ditto on the Balance Sheet.
Instead, set up a summary template that groups multiple accounts into summary categories to make the view more useful for somebody who might be unfamiliar with your business. I’ll likely write an entire post about this topic at some point, but you want to see a summarization like this:
Note: the summarized P&L shown above is not technically a GAAP format Income Statement (again, a topic for another blog post)
As you can see, the P&L on the right is much easier to read, even if we were to blow up the one on the left to a reasonable font size. Certainly there is more information in the detailed statement, but starting with the summary level is a better way to identify significant trends, inefficiencies and opportunities. Once issues have surfaced, then it’s time to roll up sleeves and dive into the details.
Keep a clean Chart of Accounts
The “Chart of Accounts” is the listing of accounts that make up a company’s detailed income statement (the P&L on the left in the image above) and balance sheet. When you’re setting up your accounting system, think about how you want to run your business and organize your COA accordingly. In order to do this effectively, you need to expand a little and simplify a lot.
Expand - What are the major cost drivers in your business? If technological innovation is a major part of your business, you may have a ton of IP related legal bills. In that case, one account for “Legal” may not do the trick. You may need “Legal - Patent”, “Legal - Corporate”, “Legal - Litigation”, etc.
Simplify - One example: at some point you will probably incur charges for rental cars, ridesharing apps, and employee mileage. Are these specific types of auto expenses important for running your business? If not, you can combine these types of charges into a single account called “Auto expenses”. The COA is the top-level reporting in your accounting system, so you want to be able to analyze it at a glance. It’s best to keep this pretty streamlined where possible. Which brings me to...
Make use of Departments and other Fields
If we think back to history class, in order to tell a complete story, we need to know “who, what, where, when and why?” The chart of accounts is your first level of reporting, and generally provides an answer to the “what” question when it comes to transactions (ie. is it a sale? An expense? What type of expense?). As for the other “w” questions, I’ve seen companies attempt to use the COA to answer these and it can get out of hand very quickly. One classic example of this would be creating a separate account for each customer. So the sales section of your P&L would look like this:
4010 - Sales Customer 1
4011 - Sales Customer 2
4012 - Sales Customer 3
And on into infinity. DO NOT DO THIS.
Instead, make proper use of your fields when entering transactions. Different accounting systems will offer different default fields, but the list below covers most of the bases:
Date (when) - When did the transaction occur? Some accounting systems will have an additional field for “accounting period” in the event that the date of the transaction and the date of the recognition of the transaction are different.
Account (what) - Here you select an account from your COA.
Name (who-external) (“Customer” if revenue, “Vendor” if expense) - See above. If you are using your fields properly, it would be redundant to maintain an account for each customer if you are recording the customer in this field as well.
Department (who-internal) - This field is generally used to assign expenses to one of your teams (product, engineering, legal, finance, etc.)
Location (where) - Not all accounting systems will have this field available, but unless you are managing the business out of multiple locations, you may not need this field.
Description/Memo (why-free form) - You can leave notes or explanations about the transaction in this field
Class (why-structured) - This one is a bit of a wild card. You can use it to track projects, functional teams, products, or whatever. Just be sure that you commit to a path here so that the field data doesn’t get too messy.
Item (what) - You may not see this one in every accounting system either. For companies with inventory, this will be the specific product that you are selling or purchasing (as opposed to Class which would be the product family). Your finance and supply chain teams should be attached at the hip when it comes to the maintenance of your item list.
Setting up some of these processes may seem like a low priority headache to many founders. But in my experience, once a company is able to organize the financial data properly, this allows for easier insights and becomes a thread that founders are eager to pull. Additionally, establishing a strategic view over your accounting operations at an early stage will make life so much easier for your future finance contributors as your team grows.
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