Running a startup can be exciting. You can innovate and implement your ideas and see your project reach new heights. While it sounds great, you need to ensure your venture is sustainable. Moreover, activities should be carried out through a well-managed and optimized process that improves the cash flow.
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However, it is easier said than done. New ventures are often hurrying to push sales and create a market niche. They often neglect the lifeline of the business and the need for a fine-tuned accounting system.
However, with caution, good accounting practices, and steady cash inflow, & failed startups can easily be turned into flourishing businesses. Without further ado, let us understand how poor accounting practices affect startups and measures to solve them.
What is Accounting Practice?
Accounting practice refers to the ongoing process of documenting the financial transactions of a company entity daily. Maintaining accurate records to prepare a company’s mandatory yearly financial statements is crucial.
The accounting department implements a set of systematic procedures and controls to ensure the reliability of accounting records. As a result, the company’s accounts and transactions are more transparent.
"Businesses must prioritize accurate and timely record-keeping, regularly reconcile accounts, and stay up-to-date with tax laws and regulations changes. It's also important to invest in accounting software and seek the guidance of a professional accountant when necessary. By maintaining strong accounting practices, businesses can make informed financial decisions, track their progress toward goals, and ensure compliance with legal and regulatory requirements."
There are various accounting methods available for companies to adopt, but they must adhere to certain principles. The Financial Accounting Standards Board (FASB) has set a standard framework of accounting principles, procedures, and standards known as Generally Accepted Accounting Principles (GAAP). Publicly traded companies in the US are mandated to abide by GAAP while preparing their financial statements by their accountants.
Companies use different accounting methods to produce mandatory financial statements. There are two main approaches to accounting:
1. Cash Accounting
This method entails recording revenue and expenses during cash receipt or payment. For example, payment for sale is recorded as revenue, while expenses are recorded when bills are paid. Small businesses use this simple method. However, according to IRS, companies with over $2 million in sales must use accrual accounting.
2. Accrual Accounting
Accrual accounting matches revenues and expenses to accurately show a company’s financial position. Transactions are recorded when incurred, not when payment is made. For example, a purchase order is recorded as revenue even though funds are not received yet. Expenses are recorded when payment may not have been made yet. The accrual accounting method provides a more precise financial picture of a company.
Interesting read: Financial Accounting vs Managerial Accounting
What are Types of Accounting Practices?
Various organizations adopt different accounting practices, which can be classified based on function and purpose. There are different types of accounting practices, including:
1. Financial Accounting
The primary objective of financial accounting is to monitor, record, and report financial transactions using standardized guidelines known as Generally Accepted Accounting Principles. It accurately tracks past business performance through financial statements given to investors and financial institutions.
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2. Governmental Accounting
The Governmental Accounting Standards Board oversees the management of governmental accounting and has established reporting standards applicable to all tiers of government. The key distinction is that governmental entities use separate funds to track income and expenditures, such as a capital projects fund for road improvement projects. This method is essential to accurately report fund or program performance and public spending.
3. Public Accounting
Public accounting corporations serve diverse clients, including service industries, factories, retailers, non-profits, governments, and individuals. Public accounting firms offer various services, including auditing, tax preparation, financial statement preparation, investments, and more. These companies may also provide bookkeeping, accounting management, consulting, and payroll services and guide customers using accounting software applications.
4. Cost Accounting
Cost accounting is a specialized field that examines a company’s actual business costs. Cost accounting is commonly used in manufacturing but is also relevant to service-based industries. This type of accounting involves scrutinizing fixed and variable costs, such as materials, supervision, and production expenses, to furnish the administration with essential information, such as break-even points.
Most businesses use a standard costing system, but other methods are also available. Cost accounting is management accounting focused on the future, assisting decision-making rather than reporting past performance.
5. Forensic Accounting
Forensic accounting combines accounting, auditing, and investigative strategies to investigate the financial moves of individuals and corporations. It is commonly employed by banks, police departments, attorneys, and businesses to analyze financial transactions and provide a final report.
Forensic accountants play a crucial role in scam and embezzlement cases, using data analysis, and reporting techniques. They may also be tasked with reproducing or reconstructing financial information and could be summoned to court to elucidate their discoveries.
6. Management Accounting
Management accounting is used in companies worldwide to provide high-level data to decision-makers. This type of accounting is forward-looking, aiming to enhance efficiency and help the administration create sound policies.
Unlike financial accounting, management accounting information is exclusively shared within an organization. Three common types of management accounting are strategic, performance, and risk management, which may be used individually or in combination based on management’s needs.
7. Tax Accounting
Tax accounting ensures that individuals, companies, and non-profit associations comply with the Internal Revenue Code (IRC) regulations. Tax accountants help customers calculate their tax liabilities accurately, lower their tax liabilities, organize and file their tax returns promptly, and develop a tax strategy to minimize their taxes.
Tax accountants are required to stay abreast of evolving tax laws and regulations. Tax accounting is essential for individuals, businesses, and government entities to accurately report, plan for future taxes, and comply with the law.
8. Auditing
Auditing entails an unbiased review of activity to ensure adherence to established standards. Different types of audits include compliance, investigative, financial, and tax audits. A compliance audit software reviews company policies and procedures to ensure adherence to standards, while an investigative audit may uncover potential criminal activity.
A financial audit examines financial statements for accuracy, and the IRS conducts a tax audit to verify the accuracy of a tax return.
Interesting read: What is Managerial Accounting – Scope, Types, Importance
Examples of Accounting Practices
Modern accounting practices involve using software to document financial transactions for analysis, overview, and reporting for internal and external review. Having covered the accounting practice definition and types, let’s delve into some examples of accounting practices, which include the following:
- Easily maintain employee attendance records for accurate calculation of salary and overtime.
- Keep records of fixed assets, inventory, investments, canceled and issued cheques, shareholders, etc.
- Record bills for purchases, sales, expenses, and payments/receipts.
- Maintain records of payments to creditors and receipts from debtors.
- Perform manual calculations of depreciation on a test basis to ensure accurate results.
What are the Special Considerations for Accounting Practice
Modern accounting information systems have become predominantly computer-based, integrating both the physical and digital worlds. These systems assist in all accounting functions, including financial accounting, reporting, and tax management.
Financial reports generated by these systems aid in management decision-making and are utilized by external stakeholders like investors, creditors, and tax authorities. However, accounting practices and culture can sometimes create negative norms, leading to financial scandals.
12 Accounting Practices That Will Damage Your Business
Here are a few accounting practices that are key in pulling startups under.
1. Sole Focus on Selling
While sales are the backbone of your business, it is equally important to invoice and gets the cash flowing in. Late invoicing, error-prone invoices, and delayed approval can lead to a slower collection against sales.
2. Not Following Market Costs
When you determine the price of your products, you consider prevailing market costs, overhead costs, and estimated gross margins. However, these prices may shoot up over time, and you would not have corrected your sales price.
The result? Low cash-in flow and lowering margins
3. Rise in Expenses
Your initial estimates of costs can quickly become outdated. Suppliers will continue to revise rates, and expenses will increase in the short and long term. If these costs are not monitored, it can lead to a surge in your expenses and leave no profit-making margins.
4. Estimating Available Cash From Bank Records
In most startups, bank reconciliation is often neglected. On the other hand, updated bookkeeping software can give a better cash management balance and better cash flow estimates.
5. Not Following Tested Accounting Practices
It has been observed that startups deviate from basic accounting practices. This results in inaccurate expenses and earnings reports. Ultimately, it will only give you a distorted analysis of your company’s financial health.
6. Business Vs. Personal Account
Small business owners often carry out business transactions through their accounts. In the long run, it can lead to complications, as separating personal and business expenses will become tough.
7. Unorganized Receipts and Documents
Lack of accounting exposure can lead to receipts and documents that are not maintained orderly and organized. This, in turn, can lead to unnecessary complications if they have to be produced during the tax season.
8. Not Tracking Expenses Accurately
As a small business owner, it can be challenging to understand the various heads of expenses. They can be posted under the wrong heads, leading to incorrect financial statements and deductible claims.
9. Delay in Tax Submissions
A slight delay in tax submissions and notice from the Internal Revenue Service (IRS) can get your startup in big trouble.
While there is a lot of difference between the two, startups often consider loans as share capital. You can always return loans but not share capital. Confusing the two can lead to an incorrect assessment of liabilities and business assets.
11. Not Seeking Professional Help
While it is a great thought to do everything yourself, it seldom works when running a startup. You may need to hire a certified public accountant (CPA) to ensure that all the generated reports are accurate.
12. Lack of Basic Accounting Knowledge
Reaching out to investors, setting workflows, and hiring people can take a toll on startup owners. While some possess basic accounting skills, some are not well-versed in them. Not having a clear understanding can lead to undetected erroneous and fraudulent transactions.
Interesting read: What Is Cash Basis Accounting? A Comprehensive Guide
6 Important Accounting Best Practices for Your Small Business
Now that we are aware of the perils of poor accounting processes. Let us have a look at the accounting best practices and how to solve them.
1. Keep Invoices in Order
Your invoices are actually cash blocked up and must be stored in an organized manner. Thus, making it easy to follow up and monitor and improve accounts receivable. You can also organize the information in a spreadsheet and record information like date, invoice number, amount, client name, and tax payable.
2. Monitor Bank Reconciliation
There will always be a difference between books and bank balances. This is because there will be a time gap between receipts and payments. All you need to do is check your bank statements online daily and tally the items with your cash book. This will give you a clear picture of your business finances and available cash on hand.
3. Maintain An Organized Expense File
Keep all the original bills in a file and list the details in a spreadsheet. When you pay the bills, note the details of payments, like the cheque number, to better understand what has been paid and what’s pending.
4. Keep A Cash Book
Petty cash is essential for a startup, as small vendors and contractors prefer to be paid in cash. Keep track of the expenses and balance the cash on hand with the expenses made at the end of the day.
5. Maintain an Asset Register
You must maintain a register and record all the assets, including printers, furniture, computer, and company vehicles. Moreover, you can also keep track of these records in accounting software and update them periodically.
6. Outsource
Hiring a virtual accounting firm for your business can help you streamline your financial data. They will have in-house experts and accounting tools to optimally handle cash flow and help you survive in this competitive market.
Wrapping Up
Accounting practice refers to the methods, procedures, and systems established to collect, record, summarize, and report financial data. This depends on utilizing commonly recognized accounting principles, which offer a framework for accurately recording and disclosing financial data.
Interesting read: 13 Accounting Trends in 2024 and Beyond
Proper accounting methods and principles are crucial for businesses to have an accurate financial reporting system. When implemented correctly, they result in standardized financial statements that provide useful information to business owners, investors, creditors, and regulators to make informed decisions.
Following good accounting practices can help you avoid common accounting pitfalls and solve issues related to cash flow.
Did we miss out on any aspect? Let us know in the comments below.
Frequently Asked Questions
Accounting practice is not limited to businesses only. All organizations use it to systematically collect, analyze, and communicate financial information. Public and non-profit organizations, government agencies, and even individuals can benefit from using basic accounting methods to keep financial records, maintain budgets, file taxes, control spending, and achieve long-term financial goals.
Good accounting practice has several key attributes:
- It employs generally accepted accounting principles to ensure consistency, accuracy, and integrity of financial information.
- It has a well-designed accounting system with proper internal controls to safeguard assets and produce reliable financial statements.
- It is transparent, providing relevant and timely information to stakeholders.
- It is compliant with laws and regulations to avoid penalties.
- It is periodically reviewed and audited to identify weaknesses and make necessary improvements.
Accounting practice is essential because it allows organizations to analyze their financial performance, ensure compliance with laws and regulations, gain insights into business operations, and make informed decisions about future directions and improvements. In short, accounting provides crucial visibility and guidance for organizational success.
Yes, accounting practice can be outsourced overseas. Many companies outsource basic accounting functions like preparing MIS reports, financial analysis & planning, tax accounting, cost accounting, etc. Outsourcing these activities allows companies to tap into accounting expertise and resources not found internally, thereby improving efficiency, reducing costs, mitigating risk, and gaining valuable strategic insights - all critical components of an effective modern accounting practice.
Amaey Anand is a certified accountant with over 10 years of experience in the finance industry. He has worked with various organizations to streamline their petty cash management processes and reduce inefficiencies. He has also written several articles on financial management for leading publications such as Zensuggest and The Wall Street Journal.
