MODULE 12 | ACCOUNTING AND FINANCIALS

ACCOUNTING AND FINANCIALS

A. Accounting for Startups

 Finance is one of the most basic skills that any business must embrace to be successful, yet,
financial know-how, issues, and analysis are often the entrepreneur’s Achilles’ heels.
 Finance function is much more strategic than just financial accounting, both bookkeeping and
accounting are vital to every business’s success.

ACCOUNTING
 The language of business – a means to summarize the financial picture of a company which
then helps us understand future prospects.
 Answers questions such as what do you own, what do you owe, and how well did you perform
last year.

Accounting Methods - Before you start your accounting, you’ll need to make a few decisions about
the structure of your business, like choosing your business entity-type, developing a detailed financial
roadmap, choosing an accounting method, and deciding on the initial shape of your accounting system.
 Cash basis: most common and where most startups will start. Cash coming in less cash
coming out -and that’s your net cash.
 Accrual Basis: used by most accountants around the world. You recognize revenues
and expenses when they actually occur, not when the cash comes in or goes out.
 Tax Basis: the ‘tax return’, booking different depreciation methods, expenses not
deductible – the goal is to minimize tax liability – so you choose methods, and follow the
tax law to report the minimum of income in each year.

Good Accounting Starts with Great Systems

 Bookkeeping: bookkeeping and accounting are not the same thing. Bookkeeping is
the process of tracking all financial records, like income and expenses. While
accounting is about interpreting those financial records and making sure you pay the
right amount of taxes or make strategic business decisions based on your business’s
numbers.
 Chart of Accounts: it is effectively your account listing, it’s all the different buckets
that you’re going to classify the accounts into (income, expenses, assets and
liabilities).
 Trial Balance: it’s the chart of accounts with actual amounts assigned to each account
at a specific point in time.
 General Ledger: basic document where a bookkeeper records the amounts from sales
and expenses. The recording act is referred to as ‘posting entries’ to the ledger.
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Maintaining a general ledger is one of the main components of bookkeeping, others are:
 Categorizing expenses
 Recording financial transactions
 Posting debits and credits – making journal entries in the proper place
 Producing invoices
 Maintaining other historical accounts
 Completing payroll
 Accountant: Accountant turns the information from the ledger into the financial
statements that reveal the bigger picture of the business. Business owners will often rely
on accountants to help with strategic tax planning, financial analysis & forecasting, and
actual tax filing.
The process of accounting provides reports that bring key financial indicators
together, and includes:
 Reviewing the bookkeeper’s work
 Preparing adjusting entries
 Preparing financial statements and other reports
 Preparing other reports that bring key financial indicators together
 Prepare your tax filings – income tax returns
 Aiding the company management with analysis of the impact of financial
decisions
 Financial Statements: Accounting numbers are summarized into three main financial
statements: the balance sheet, income statement and cash flow statement.

 The Balance Sheet: basically summarizes a company’s net worth, at

any single point in time. There is only one equation in accounting: Assets
= Liabilities + Equity.
 The Income Statement: the profit and loss statement, describes the
company’s financial performance for any current year: whether they
created value or they destroyed it.
The “bottom line” as it’s known (since net income is the last line
item on the income statement) is a single “yes/no” answer to whether you
succeeded or not.
An important line item in the income statement is the gross profit
figure. Gross profit indicates the intake per each product sold, without
factoring selling and other support costs.
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 The Cash flow Statement: shows a firm’s cash transactions, and how
much cash was generated/disbursed from various activities: operations,
investments, and financing.
Since the income statement does not indicate how much cash a
firm makes during a period in time, the cash flow statement is
constructed to indicate the cash related balances for the fiscal year.
 Payroll: The main thing about payroll is, if you hire an employee, you
need to calculate payroll correctly – not just randomly pay them an
amount. It’s recommended to hire a payroll company if you have more
than a couple of employees, or if you don’t think you will make payroll
payments timely, because the company you hire will make sure to
process things on time.
 The bottom line: Not having a strong finance team is like flying an
airplane with no windows and no navigation system–you are in the air but
not knowing exactly where you’re going. And this applies to companies at
any stage in their life cycle.

B. Financial Projections for Ventures

FINANCIAL PROJECTIONS
 What your business expects to happen, based off hypothetical situations using the facts
and data you have available.
 Often prepared to present a course of action for evaluation.
 Type of pro forma statement: examples of pro forma financial statements include
projected income statements, balance sheets and cash flow statements.
 Projections are based on financial modeling techniques and provide the answers to
questions that may come from lenders, investors or other business stakeholders.
 Essentially, these statements are an answer to the questions, “If we lend you this
money, what will you do with it? And how will you pay it back?”

Why Are Financial Projections So Important for Startups and Small Businesses?
 help you see when you may have financing needs and the best times to make capital
expenditures
 help you monitor cash flow, change pricing or alter production plans
 Projections provide all the minutia that lenders might be looking for to better understand your
business: how it obtains revenue and where it spends money. Additionally, if your business is
ever the target of an acquisition, the financial statements help potential buyers evaluate its
worth.
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 There are subtle differences between For example:

the terms projection and forecast. But Linda’s Linens is growing its sales volume 10%
both describe predictions of future each year, and that growth has been steady for the last
financial performance using financial 18 months. After examining the financial forecast, it’s
reasonable for Linda to assume that growth will
models. continue, and she should plan accordingly. This helps
 A financial forecast presents predicted her with inventory planning, hiring decisions and how
much to allocate for marketing.
outcomes based on the conditions you
Linda is considering opening a second location.
expect to exist for your business.
So she prepares a financial projection to show her bank
 Projections are financial statements that a “what if” scenario to see how much growth she might
present an expected financial position expect if she received a loan to open another store on
the other side of town. The hypothetical situation of
given one or more hypothetical opening a new location in the financial projection is
assumptions. what makes it different from the sustained growth she
might reasonably suspect in the financial forecast.

What Are Financial Projections Used For?

Financial projections help you realize possible potential in your business. What might happen
if you receive outside funding? Or purchase additional equipment? This is where you get to be creative
and explore what the future of your business might look like.

Business Plan: Financial projections and business plans go hand-in-hand. It’s a way to show that your
company is stable and is financially successful. It’s a good practice to provide quarterly or monthly
projections for the first year and annual projections for the four years after that.

Investors: potential investors want to know if the business will make money and when they can expect
a return on their investment

Loans and Lines of Credit: These are the most common sources of external funding for small
businesses. To secure a Small Business Association (SBA) loan, you’ll need a thorough
understanding of your finances so you can show the lender how your funds will be used and when the
loan will be paid back.

Know your Business: Financial projections show discipline in financial management – and better
financial management leads to a much higher chance of business success. By using a financial model
to make financial projections, you can see if, when and whether your business will make a profit. You’ll
have a better understanding of your cash position to make better decisions about when to hire more
people, buy more inventory or make capital investments.
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7 Steps to Building a Financial Projection for Your Startup or Small Business

1. Create a sales forecast.
What’s driving your sales? That’s where you should start with your projections.
2. Create an expense budget.
Expenses will include the costs associated with sales, as well as operating expenses. To
forecast cost of sales or cost of goods sold (COGS), take all of the current information on the
income statement about product cost, fulfillment expense, customer service and merchant fees.
Express assumptions about how that will change as a percentage of revenue. Apply the same idea
to operating expenses.
3. Create the income statement projection.
Link those assumptions to formulas built in the income statement. The financial model will
forecast revenue, net revenue, COGS, gross profit, gross margin, operating expense, operating
profit and operating margin. The output of the financial model is the projected income statement.
4. Create the cash flow projection.
The cash flow projection shows your cash position and provides a more detailed view of
monthly inflows and outflows of cash for a specific period of time — 3 months, 6 months, 12
months, etc.
5. Create the balance sheet projection.
The balance sheet shows or projects the worth of your company at any given time. Cash flow
projections appear on your balance sheet as assets. On the liabilities side of the balance sheet,
you’ll list things like accounts payable and debt.
6. Use projections for planning.
Projections are important when seeking new funding. And they help you know when to make
capital expenditures. For planning, projections help with analyzing the impact of different
business strategies.
7. Monitor.
By comparing projections against actual results you can see if you’re on target or need to
adjust to reach them. Consider purchasing accounting and planning software for financial
projections. Tracking performance is much easier and quicker with dashboards and charts that can
show you at-a-glance information.

Benefits of Using Accounting and Planning Software for Financial Projections

There are advantages to automating financial modeling. You can handle more complex
datasets and certain visualization capabilities, as well as streamline financial projections.
 All lines of businesses are connected to the same data, improving control, visibility and trust in
the numbers.
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 Drill-through capability means you can spend more time drilling into the data to understand the
source of the numbers. Finance then has more time to understand the "why" and can better
help the business owners understand how their decisions affect the rest of the company.
 You can easily run what-if-scenario analysis to explore different business opportunities.
 Pre-built reports and dashboards make it easy to compare projected vs. actual results.

Automation can increase accuracy save time, and help you compare actual and forecasted
results in charts and dashboards. With so much potential, automation is a growing trend. In fact, a
survey by Robert Half, a global human resources consulting firm, found that nearly one quarter of
respondents expect to automate processes behind financial forecasting.

C. Legal Structure of Ventures

Choosing the right legal structure for your business starts with analyzing your company’s
goals and considering local, state and federal laws. By defining your goals, you can pick the legal
structure that best fits your company’s culture. As your business grows, you can change your legal
structure to meet your business's new needs.
What Legal Structure Is Best For Your Business?
 One of the first decisions you’ll need to make
when you start a business is to determine the
correct legal structure for your company.
 You will need professional legal guidance to
make this decision, but the first step is learning
what the different structures are, depending on
your situation, your long-term goals, and your preferences.

4 Types of Legal Structures for Business

Legal Structures Taxation/ Liability/ Formation Pros and Cons

1. Sole Proprietorship Taxation: A sole Proprietorship has Pros:

pass-through taxation. The  Easy and fairly cheap to
- A type of business entity business itself does not file a tax establish.
that is owned and run by return. Instead, the income (or loss)  Owner has absolute
one individual – there is passes through and is reported on control over the
no legal distinction between the owner’s personal tax return. business.
the owner and the Cons:
business. Liability: The Owner of the sole  Owner has unlimited
proprietorship has unlimited personal exposure to
- the most common form personal liability for any liabilities the risk, as the owner is
of legal structure for small business incurs. You can mitigate responsible for all
businesses this risk with insurance and sound liabilities incurred by the
contracts. business.
 Investors typically would
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Formation: The sole proprietorship not invest in a business

is the simplest way of doing organized as a sole
business. The costs to create a proprietorship.
sole proprietorship are very low and
very little formality is required.

2. General Partnership Taxation: A partnership is a tax- Pros:

reporting entity, not a tax paying  Fairly easy to create and
- An association between entity. A partnership must file an maintain.
two or more people in annual information return with the  Profits and losses are
business seeking a profit. BIR to report income and losses passed through to the
from operations, but it does not pay owner’s personal tax
- Partnerships can be federal income tax. Profits and returns.
created with little Losses are passed through to the Cons:
formality, but because owners based on their profit sharing  Partners are personally
more than one person is percentages outlined in the liable for business debt
involved, a partnership Partnership Agreement. Each and liabilities.
agreement should be partner pays taxes on their share of  Can lead to management
created. the profit/loss. and oversight issues
absent a partnership
- A partnership agreement Liability: Owners typically have agreement.
stipulates the terms of the unlimited personal liability. Each
partnership by formalizing partner is jointly liable for the
rules for profit/loss sharing, partnerships obligations.
ownership percentages,
dissolution terms, and Formation: Usually easy to create,
management rights among but it is important to have an
many other things. attorney create the partnership
agreement. Partnership agreements
establish the terms of the
partnership and typically cover
topics such as:
 Capital Contributions
 Distributions of profits/losses
 Management
Responsibilities
 Bookkeeping
 Banking
 Dissolution

3. Limited Liability Company Taxation: An LLC is considered a Pros:

(LLC) “pass through entity” for tax  Owners have limited
purposes. This means, business liability, meaning that the
-A hybrid between a income passes through the entity is responsible for
corporation, general business to LLC members who all liabilities the company
partnership, and sole report their share of profits or losses incurs.
proprietorship. on their individual income tax  Profits and losses of
returns. The LLC entity is only company are passed on
-Owners of an LLC are required to file an informational tax to the member and are
called members. Members return, similar in character to the only taxed at the
may include individuals, general partnership. individual level.
corporations, other LLCs  Allows an unlimited
and foreign entities. Most Liability: LLC members are number of members
states permit an LLC with protected from personal liability for Cons:
only one owner, called a business debts and claims, a  Often subject to
“single member LLC.” feature known as “limited liability.” If additional taxes at the
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a business with limited liability owes state level.

money or faces a lawsuit, only the  Each member’s share of
assets of the business itself are at profit represents taxable
risk. income, even if the profit
wasn’t distributed.
Creditors can’t reach personal
assets of the LLC members, except
in cases of fraud or illegality. LLC
members should exercise caution
so that they don’t “pierce the
corporate veil,” which would expose
members to personal liability.

Formation: To form an LLC, you

must pay a filing fee and must have
articles of organization when at the
time the entity is established.
Operating agreements are highly
recommended, but not required by
all states. Much like a partnership
agreement or corporate bylaws, the
LLC operating agreement sets out
rules for ownership and operation of
business. A standard operating
agreement includes:

 Ownership interest for each

member
 Member rights and
responsibilities
 Member voting power
 Profit & Loss allocation
 Management Structure
 Buy-Sell provision

4. Corporations (C-Corp and The two types of corporations are Pros:

S-Corp) C-Corps and S-Corps. The major  Corporate shareholders
difference among the two types of have limited liability,
-Corporations are the most corporations is the tax treatment of meaning the entity is
complex business the two entities: responsible for all
structure. liabilities the company
Taxation: incurs.
-A corporation is a legal C-Corp: For federal income tax  Usually a favorable
entity that is separate and purposes, a C-Corp is recognized formation for investors.
independent from the as a separate taxpaying entity, thus Cons:
people who own or run the the entity files its own tax return. A  The process to establish
corporation, namely c-corporation is subject to corporate the business is more
shareholders. income tax on any corporate profits rigorous and costly.
(entity pays taxes). Shareholders  Earnings are subject to
-A corporation has the pay personal income tax on the “double taxation”,
ability to enter into contracts corporate profits distributed by the meaning that earnings
separate from that of the corporation to the owners. As a are taxed at the entity
shareholders, but it also result, C-corps are subject to level and the individual
has certain responsibilities “double taxation.” level upon distribution to
such as the payment of shareholders.
taxes. S-Corp: S-Corps elect to pass  High level of governance
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corporate income, losses, and oversight by the

-Corporations are generally deductions and credit through to board of directors.
more appropriate for larger their shareholders for federal tax
established companies with purposes. However, the entity is
multiple employees or when required to report income, losses,
other factors apply (i.e. gains, deductions, credit, etc.
corporation sells a product Shareholders of S corporations
or provides a service that report the corporation’s income and
could expose the business losses on their personal tax returns
to sizable liability). pay federal income tax at their
individual tax rates. Thus, S- Corps
-Ownership is designated avoid double taxation.
by issuing shares of stock.
Liability: A corporation is a legal
entity that is “immortal,” meaning it
does not terminate upon the
shareholders death. Corporation
shareholders have limited liability as
they are not personally liable for
debts and obligations incurred by
the company. Shareholders cannot
lose more money than the amount
they invested in the corporation.
Similar to the provisions of an LLC,
shareholders should be careful not
to “pierce the corporate veil.”

Formation: Corporations are more

complex entities to create, have
more legal and accounting
requirements and are more complex
to operate than sole proprietorships,
partnerships, or LLCs. One of the
major disadvantages of a
corporation is the high level of
governance and oversight by the
board of directors. Often times, this
prolongs the decision making when
multiple shareholders or investors
are involved.