Fatal Mistakes Made by
Start-Ups |
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Written by Olivia Pun, CPA
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Page 1 of 2  | | business start-up |
For a Smooth Launch, Address These Critical Financial and Accounting Issues
According to the latest information released by the Small Business Administration, the failure rate of start-ups in the first four years is 66%. If you don’t want your new business to be included among the failures, you should carefully check your existing business plans using the financial and accounting advice offered in this article. Before you launch your business, make sure it is set up to avoid the mistakes and oversights of so many entrepreneurs, which very often lead to the demise of their otherwise viable businesses.
Don’t Use the Wrong Business Entities
One of the first mistakes made by entrepreneurs is that they set up business entities for their businesses without truly understanding how such entities can affect their businesses in terms of tax consequences. Contrary to the common beliefs that one form of business entity is better than another in minimizing income taxes and protecting personal assets, it is the specific characteristics of your business and your financial interest that determine what form of legal business structure is the most advantageous. Even though the success of small businesses is heavily dependent on the owners’ financial interests and resources, many entrepreneurs fail to select a business entity based on its merit to maximize the financial bottom-line for the owners and the business as a whole.
Without understanding the unique nature of their business and their own personal financial goals, many small business owners unknowingly select a business entity that subjects them to higher tax rates. Besides losing out the ability to retain the most amount of income for their business growth, these entrepreneurs very often have to involuntarily forego the many deductions that are otherwise allowable if only they have picked the right form of entity.
To find out what business entity can provide you with maximum tax benefits and legal protection, you should ask your CPA and legal advisor to perform a situational analysis based on your understanding of the following:
· The number of owners or investors your business will have.
· The amount of asset you have that you want to protect.
· Your plan for a near-term transfer of business interest.
· The revenue and profit expected to be generated by the business.
· The nature of your business and the risk factors it is subjected to.
· The plan on whether or not there will be employees.
· The amount of income you earn regardless of the business.
· The amount of start-up loss expected to be incurred.
· The amount of income and fringe benefits you intend to draw out from your business.
· The future need for owners to borrow against their retirement accounts.
· The plan deciding if earnings be used to finance business expansion and capital projects.
Don’t Buy the Wrong Accounting Software
Accounting software isn’t made the same. Each has its unique features that can produce different reports, maintain different databases, and perform different levels of accounting and financial management functions depending on your industry, your business needs, and how sophisticated you want your internal reporting to be. It’s not uncommon that business owners pick the kind of accounting software that is cheaper, but costs more in the long term because it fails to provide useful and timely reports to make business decisions. These business owners will also have to pay for higher accounting fees if their accounting software is incompatible with the ones used by their CPAs to process their tax returns or financial statements reviews.
A good accounting software is not just there to keep tabs of your receipts and disbursements. It is there to help you understand every aspect of your business so you can produce the kind of reports that: are in compliance with government reporting standards; get immediate information to control cost; respond to competition; and manage your financial resources with an appropriate control.
Selecting the right accounting software for your business is never an easy task, but knowing what data you need to run your business most efficiently and most competitively can narrow your choices. Before investing in your accounting software, you should solicit help from someone who is familiar with the type of business and the kind of activities involved. That someone should also possess experience with various accounting software and understand accounting principles.
Have Good Accounting Practice
Without a professionally staffed in-house accounting department, a lot of small businesses are practicing accounting without realizing that they have to use the accounting method that correctly reflects the incurrence of their income and expenses. Corporations may as well beg for an audit from IRS — if they use cash method of accounting on their tax return when they are under the IRS’s defined category of “accrual method” only filers. The cost to prepare for an IRS audit and the potential damage as a result are something all small businesses should try to avoid.
Unless your business is conducted under a cash-in cash-out basis, the accrual method of accounting is probably the most ideal for both business and tax purposes. Under the method of accrual accounting, income and expenses are accounted for when all events that determine the right to receive the income; or the obligation to pay for the expenses have occurred. Therefore, if you don’t record your product sales at end of the year until the following year when you will collect the money, you are practicing bad accounting.
Good accounting practice includes accounting methods consistency, accounting principles compliance, proper documentation and record retention for your business transactions. If your business is unlucky enough to be randomly picked by the government as an audit target, it will have to rely on good accounting practice to defend any income or deduction challenged by the tax auditor.
Don’t Operate with a Poor Accounting Policy
To a lot of small businesses, a poor accounting policy is actually the non-existence of any accounting policy. An accounting policy is a guide map on how a business should account for its various business activities and to whom the business should assign the various accounting functions and control. Without a sound accounting policy, the business will be unable to apply accounting principles consistently. The accounting system will become chaotic, because errors and misstatements will not be detected until it’s too late. The accounting system will become unreliable because there is no guideline on periodic maintenance and update of the accounting data.
When there is no policy to tell everybody what to do or to define how each department should register their activities with the accounting system, the accounting system will also become a vulnerable system that is open for asset misappropriation. Your business will soon find that it’s losing its direction and it’s losing control over its assets, income, and expenses.
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