Financial management is the backbone of any successful startup. It involves planning, organizing, directing, and controlling all of your financial activities.
You're in a race against time to turn your bold vision into a sustainable venture, and understanding your company's financials is one of the most important steps.
Understanding Financial Statements
First up, your financial statements: the Profit and Loss Statement (P&L) and the Balance Sheet.
- Profit and Loss Statement (Income Statement): Think of your P&L as the story of your company's earnings and spending over a certain period. It answers the question "Did we make money or lose money?".
- Balance Sheet: Provides a snapshot of a company’s financial condition at a specific moment in time. It shows what the company owns (assets), what it owes (liabilities), and the shareholders' equity.
You book your transactions to one or both of these financial statements.
The Importance of Categorization
Categorization is a way to make sure your finances are accurate. Your expenses and revenue should always be correctly recorded under the appropriate accounts. E.g. a contractor expense vs. marketing expense.
Accurate categorization of transactions will keep your financial narrative clear and help you make informed decisions for your company's growth.
Chart of Accounts
A chart of accounts is a list of categories you can choose for each transaction. Whether it’s a contractor expense, marketing costs, or hardware investments, this helps you track every aspect of your finances accurately. Following this method gives you an organized, consistent categorization of all transactions.
Some category examples:
- Travel & Meals Expense
- Contractors expense
- Computers & Hardware
- Cash & Equivalents
Categorization example:
Payment for Figma - Categorized as Software expense on P&L.
A more detailed approach to the same example:
Payment for Figma:
Debit: Software expense (on the P&L)
Credit: Cash (on the Balance sheet)
The simplest way is to look at your Figma subscription as just a software expense. But, in accounting, it's actually a double-entry account and you will have a debit and a credit category option. Debit: Software expense is your category but you are also crediting cash because you are paying for Figma - your cash is going down as your expenses are rising.
Double-Entry Bookkeeping
Every transaction impacts two accounts: a debit to one account and an equivalent credit to another. For every financial action, there’s an equal and opposite reaction.
This system ensures the balance sheet always balances, reflecting every transaction's impact on the company's assets, liabilities, and equity.
- Accounts Payable: This represent the money you owe
- Accounts Receivable: The money owed to you.
This will help you master the flow of cash in and out of your business.
Categorization Complexities
Cash vs. Accrual Accounting
Cash basis is straightforward—money in, money out. But accrual basis offers a more nuanced view of your financial health. It's about choosing the perspective that best supports your strategic decision-making.
- Cash Basis Accounting: Records revenue and expenses when cash is exchanged. It's simpler but can provide a less accurate picture of a company’s financial health.
- Accrual Basis Accounting: Records revenue when earned and expenses when incurred, providing a more accurate financial picture, especially in terms of earnings and expenses within a specific period.
Tax Categorization
When you send your bookkeeping to a tax preparer, you might notice they changed some categories. The financial accounting that you did for your bookkeeping usually won't match your tax returns. Tax rules are different from financial accounting rules.
Bank Reconciliations (Bank Recs)
Bank reconciliations are a method that ensures your company’s records (usually the ledger) match your company's bank statements. This process helps identify any discrepancies between the two and ensures that the financial records are complete and accurate.
Essentially, this is what Puzzle and other accounting software does- it tracks and automates all of your transactions for you, and compares it to your bank statements. The numbers in your bank statement need to match what is in your accounting software. If not, you are missing a puzzle piece. You won't have a complete set of financial statements.
Reviewing Financials
Regularly reviewing financial statements is crucial for identifying errors, understanding financial health, and making informed decisions. Look for large or unexpected changes month-over-month and verify that all transactions are categorized correctly.
Key things to look out for when reviewing your finances:
- Negatives ($1,000): Income or revenue that got booked to an expense account, or an expense item that wrongly got booked to a revenue line.
- Big numbers ($1,000,000): Important to review and make sure they are categorized correctly.
- Small numbers ($5): Same as big numbers, simply make sure they are categorized correctly.
- Changes month over month: Pay attention to both ends of the spectrum, no changes are just as important to review as significant changes month over month.
Accrual Adjustments
Imagine this: You are closing a round of funding and are expecting $100,000 over 2-3 months. You should be creating an accrual entry estimating how much that legal bill you are accruing will be each month. Once the bill for it comes, you can adjust or correct the entry.
The process looks like this:
- Creating an accrual entry
- Adjusting entries
- Correcting entries
- Reversing entries.
This will give you an accurate representation of your cash, burn rate and runway.
As a startup founder, understanding these concepts thoroughly or seeking professional accounting help can provide a strong foundation for your company's financial health.
Streamline your finances and get real-time insights into your startup metrics with Puzzle!
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