Why Startups Need to Start Bookkeeping ASAP
Like any startup, yours probably began as a great idea that grew into a passion and, eventually, a business plan. In Toronto’s favourable startup ecosystem, which boasts double the amount of startups in Vancouver and Montreal, there’s plenty of opportunity, but there’s more to success than simply being in the right place at the right time. A component often overlooked by businesses in their fledgling years is bookkeeping, the day-to-day recording of a business’s financial transactions.
Bookkeeping is exactly as it sounds: the keeping of the company books, or ledger, which records every incoming and outgoing sale, purchase, payment, and expense. And, it sounds simple, right? Precisely for this reason, many entrepreneurs neglect the task. Doing so can have serious implications. For example, without proper bookkeeping, you can’t generate a financial statement, and a proper financial statement is vital for proving CRA compliance, securing investments and making operational business decisions. Let’s take a look at these a bit more closely.
Three Things You Can’t do Without a Financial Statement
1. Demonstrate Compliance. Without a proper financial statement, you can’t provide an accurate account of your financial transactions to the CRA. This means you can’t prove compliance with CRA regulations. What’s more, if you don’t file properly, you will lose out on potential tax refunds. Now, you might think that because you’re a startup and don’t have any prior year’s earnings, you can’t receive an income tax refund. This is true. But, it overlooks other potential refunds that you may qualify for, such as a GST/HST refund. If you’re in the startup phase and haven’t generated any revenue, you probably haven’t collected much or any GST. But, you’ve undoubtedly paid GST on business expenses.
This is key, because the GST long method works is: total GST collected minus Total GST paid. If you get a negative answer out of that equation, you get that money back. Additional tax refunds, such as media tax credit programs, SR&ED, the CMF, ITC and provincial training grants, may require you to structure the money you’re spending in certain ways. Without a financial statement, you won’t be able to illustrate how you’ve structured your spending period, nor will you know how to adapt that structure to meet these requirements.
2. Secure Investor Financing. From an investor’s point of view, whether that investor is an individual, a bank or other creditor, it’s important they be able to see what’s being done with their investment. Makes sense, right? Unfortunately, without an up-to-date and accurate financial statement, you won’t be able to give your investors this detailed feedback.
This can be problematic, as some debt financing comes with specific requirements related to cash flow, sales, and the management of other debts and liabilities, and these often need to be met in order to secure additional funding. If you’re working with several investors, they may all have covenants they expect you to uphold, which makes accounting for these all the more complicated. It’s important that you be able to demonstrate how your company is meeting these requirements. If you’re not, it could result in your loan being called and further funds withheld.
3. Make Operational Business Decisions. Even in a startup-friendly place like Toronto, startups need to pivot and adapt relatively quickly in order to succeed. Flying by the seat of your pants won’t cut it. When you’re making a decision about whether to add or drop a product line or service, that decision needs to be based on real, tangible numbers. You need to know your gross margins by product in order to understand each product’s profitability. That’s done through cost accounting, one of the most important elements of business analysis, and it requires a financial statement.
When determining your most successful product, the sales numbers are not the most telling indicator. You need to dig into that financial statement and look not only at the sales revenue, but also the cost of production. For example, let’s say your highest selling product brings in $1 million in sales, beating out the next product that sells half that. On the surface, that $1 million product seems to be your best, right? Not necessarily.
What if you dig deeper and see that the cost of making this product is $900,000, whereas the cost of making that next product is only $200,000? That means that in actual fact, $1 million baby makes you $100,000, while your runner-up brings in $300,000. Knowing this, where are you going to spend your resources?
The tricky aspect of cost accounting is the breakdown – what costs are fixed, what costs are variable, which costs apply to which products and so forth. This is where a good CPA or bookkeeper can really come in handy.
While not all business can afford to engage a bookkeeper or accountant right away, it’s important that startup owners, at the very least, understand the importance of keeping accurate financials. If you can’t hire a bookkeeper right away, then consult one, and implement as many basic bookkeeping standards as possible. Starting with even the basics will put you in a better position, and in time you can engage a bookkeeper to help you develop a more robust bookkeeping environment.