Cash is king, even more for a start-up which tends to survive on limited resources until revenues really pick-up. While looking at a bank account online is the fastest way to know a company’s cash position, it does not provide any idea of the future expectation of cash which is contingent on upcoming revenues and expenses.
Proper financial reporting can help plan for a start-up cash needs, but it can also help for:
Planning for short and mid-term operational needs
Tracking results against budget
Calculating taxes to be paid (if any)
Solid financial reporting is also essential if you are planning on raising money from investors.
So, how is reporting typically done for start-ups and what are the steps to set-up financials for a new venture in the e-commerce or specialty retail sales channel?
The basics: how reporting is done
The typical financial documents produced by a company are:
Balance sheet: details the accumulated assets, liabilities and shareholder’s equity of a company at a specific point in time.
Profit & Loss statement (often abbreviated “P&L” but also called income statement – terms used interchangeably in this post): reports the revenue and cost over a specific period of time.
Cash flow statement : breaks down the use of cash across three activities: operating, investing and financing activities.
Out of the three statements, the most used is typically the income statement which will be the main focus of the rest of this post.
All financial reporting happens across two dimensions:
Across class of items (revenues and expenses for P&L - assets, liabilities and equity for the balance sheet)
Over time (for P&L) or at specific point in time (for balance sheet)
Finally, and specifically for the income statement, the reporting of the actual numbers is typically done against a budget. Before building out a budget, the founder of a new venture will have to make several decisions in regard to the method of recording accounting transactions, the classes of items to be reported against, the beginning and ending of the reporting period, and the frequency of reporting. Each of those decisions will be discussed in the next sections and specifically for companies operating in the CPG or/and specialty retail sales channel.
Steps to set up financial reporting for a start-up
The basic steps to set up financial reporting for a new venture are the following:
1. Bringing a bookkeeper and accountant on board
2. Choosing the method of recording accounting transactions
3. Building the chart of accounts
4. Choosing the reporting period and its frequency
5. Building the budget
Each step is detailed below.
1. Choosing a bookkeeper and accountant
Most bookkeepers and accountants are found via word-of-mouth and recommendations. Like for any new hire, the founder should always collect and call references before making a final choice. Some firms or professionals might offer an all-in-one solution (bookkeeping and accountant services); however, to maintain checks and balances, it is not recommended to get both services from the same source. The accountant should ensure that the information booked by the bookkeeper is entered accurately and properly. In some instances, the bookkeeper can consult the accountant when the bookkeeper is unsure of how to appropriately book an unusual transaction. Finally, the accountant will typically be the one using the financial statements to calculate and submit taxes.
Along the rest of the process, the bookkeeper and accountant can assist the founder in making decisions.
2. Method of recording accounting transactions
The founder of a new venture must choose between two methods to record accounting transactions: cash basis accounting or accrual basis accounting, it is best to consult a CPA to determine which method is best for the business.
In cash basis accounting, each transaction - whether revenue or expense – is reported in the books when the cash related to the transaction is received by the bank (for a revenue) or paid out by the bank (for an expenditure). The date of the cash flow determines when the transaction is booked for reporting purposes.
In accrual basis accounting, each transaction is reported when the money is earned or when the expenditure is incurred. The date of the transaction determines when it is booked for reporting purposes.
For example, assume an entrepreneur did a photo shoot in the summer and receives an invoice in September dated as of August. The company pays the invoice in October. In cash basis accounting, the transaction would be booked in October. However, in the accrual method, the transaction would be booked in August (according to the date on the invoice). Generally speaking, the date on an invoice or a ticket (for retail transactions) dictates when the transaction is booked for reporting purposes.
While cash basis accounting is simple and reflects the flow of cash in and out of the business, the accrual method provides a better view of the firm’s performance and is sometimes required by the IRS depending on the business.
3. The foundation for reporting in the books: the chart of accounts
The chart of accounts (COA) outlines the list of all accounts necessary to build the balance sheet and the income statement. For the balance sheet, accounts fall into three categories: assets, liabilities, and shareholder’s equity. For the income statement, the categories are income accounts and expense accounts. Typically, a code is associated with each account and used to reference it. For a small company, these codes are usually 3 to 5 digits. You can see a sample chart of accounts here.
At this stage, the founder reviews the chart of accounts with their accounting advisors (bookkeeper and CPA) to ensure that all the necessary accounts for the new business are listed. The chart of accounts is an evolving document and is updated over time.
In practice, whenever revenue or an expense is recorded, the person responsible for booking the transaction will associate a code from the chart of accounts with the corresponding document's identifying reference number (or data).
4. Reporting over time: beginning and end of fiscal year
The most basic and mandatory financial reporting period is dictated by the fiscal year, which typically matches the calendar year (January 1st to December 31st). In some cases, companies in retail and/or e-commerce choose to close their books at the end of the first quarter (end of March). For retailers and B2C e-commerce, 30% of their yearly business can be concentrated in the last two months of the calendar year. To focus all their attention and resources on supporting this significant increase in business, they prefer not to close their books during this period and instead move the fiscal year-end to the following quarter, which is typically less busy. For an operating company, this change requires a one-time adjustment to the current books and a specific filing with the IRS.
While this yearly reporting is mandatory for tax filing purposes, it is not frequent enough to effectively manage a business.
"companies working in retail and/or e-commerce might choose to use a 4-4-5 calendar"
The most common reporting period is monthly, with most companies reporting from the first day to the last day of the month. However, to facilitate comparisons of historical data and align financials with other business functions, such as operations and marketing, companies in retail and/or e-commerce may choose to use a 4-4-5 calendar. In this system, each quarter is divided into 2 months of 4 weeks and 1 month of 5 weeks.
In other words:
1 quarter = 4 weeks + 4 weeks + 5 weeks for a total of 13 weeks
1 year = 4 quarters of 13 weeks each = 52 weeks
The week becomes the standard building block of the financials. This makes it easier to compare the same month year-over-year or compare a 4-week month to a 5-week month (by simply dividing the results by 4 or 5, respectively). These comparisons are more difficult with a standard monthly reporting period.
To improve efficiency and reporting across the company, the 4-4-5 calendar should also be used by the marketing team to build the marketing calendar and by the operations team to build retail schedules. Payroll payouts should also be done every other week rather than twice a month.
5. Budgeting
Running financials without a budget is like running a venture without a business plan. The company doesn’t know where it is going and cannot benchmark its actual results against internal assumptions. Ideally, the budget captures all revenues and costs associated with executing the business plan.
1. The easy part: Projecting costs, bottom-up approach
Sadly, costs are much easier to predict than income. For a start-up with no historical data, the easiest way to project overall costs is to list all individual costs by activity for each vendor, by month. Costs fall into three categories:
Recurring: weekly, monthly, quarterly, etc. (example: monthly electrical bill)
Proportional or closely correlated to revenues or specific costs (examples: credit card fees are correlated to revenue, payroll taxes are proportional to gross salaries)
Isolated costs (example: cost of a photo shoot)
Building your budget in a spreadsheet generator such as Microsoft Excel or Google Sheets is essential; it simplifies projecting recurring and proportional costs.
Although predicting costs is relatively straightforward, predicting revenues is much harder.
2. The big guess: Projecting revenues using comparable data and marketing investment
For a new venture with no historical sales data, predicting revenues can feel almost useless. Revenue projections are best used to determine the company’s potential cash position under various scenarios. One should “play with the numbers” to answer key questions:
How long can my company survive with very little revenue?
What is my burn rate?
Over the next 4 to 6 months, if revenues are mediocre, how should I adjust expenditures? What adjustments should be made if revenues exceed expectations?
When will my company reach the break-even point?
Revenue projections should be based on personal experience, comparable business data, any available historical data, and marketing investment. A return on investment is expected from dollars allocated to branding and promotional activities.
Conclusion
Setting up good financial reporting helps the founder plan business activities, track results, and make better decisions that shape the company's future. Based on your company’s needs, the team at Olari Consulting can help you set up the most optimal infrastructure and processes.
Thanks to Mark Gilbert for reviewing the content of this post.
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