The basics of your startup finances
Having a startup comes with a variety of responsibilities, and keeping your finances in order is one of them. Yes, we understand that you’re more excited about working on your business ideas instead of worrying about bookkeeping. However, since this is a vital part of your startup, we would like to make your life a bit easier. Here we’ll give you some helpful tips on how to keep track of your startup’s finances and make it as simple as possible. Need some more tips on how to keep your finances in order after reading this blog post? Keep on reading and feel free to ask your questions at the end of this post!
An important part of your finances is complying with the administrative obligations. Bookkeeping is a big part of those, and is basically keeping up to date with your expenses, revenues, and the financial situation of your company.
Bookkeeping is usually conducted in an accounting program. Herein purchase and sales invoices are processed, bank statements are booked, and many other entries (like payroll or asset registration) are recorded.
A booking is done by making journal entries. The classical representation of an entry booking looks like this:
Using this technique, the debit and credit side should always result in the same amount, thus balancing your entry. There are some basic rules that will make sure you’ll always be in balance:
- Increasing of asset: Debiting account of asset
- Decreasing of asset: Crediting account of asset
- Increasing of debt: Crediting account of debt
- Decreasing of debt: Debiting account of debt
- Increasing of equity: Crediting account of equity
- Decreasing of equity: Debiting account of equity
This way you can monitor exactly what you spend and what you earn. Now that you’ve mastered this part of bookkeeping, there are of course also some footnotes to be made. You have to keep these differences in mind as well when bookkeeping:
1) Earnings – Issued invoice is booked, but not yet received (on the accounts receivable)
2) Income – Issued invoice is booked and received (on the bank)
3) Costs – Received invoice is booked but not yet paid (on the accounts payable)
4) Expenses – Received invoice is booked and paid (from the bank)
It is important to know the differences mentioned above as you need to allocate your costs to the period in which the earnings, associated with these costs, are made. This is also known as the matching principle.
Costs and investments
Now that you’re able to manage this part of bookkeeping for your startup, there’s another distinction to be made, namely between costs and investments. Costs can immediately be deducted from your revenues, this way your taxes will be lower. An investment will be activated on your balance as an asset. Every year you’ll deduct a part of your investment, the depreciation, from your revenues. Hereby you can lower your taxes for more than just one year. However, the deduction by depreciation will of course be lower than deducting the costs at once all together.
Let’s say you have an investment in your company of €4,000 and you buy a machine to build your product for €3,025, including €525 in a 21% tax. The €525 tax you can reclaim either way. During this year you make a revenue by selling your product for €10,000. Let’s say the costs allocated to the sales are €6,000, this means you have a gross margin of €4,000.
The machine is activated for €2,500 and at the end of the year valued at €2,000 (minus the €500 depreciation). On the asset side of the balance your cash will increase with the gross margin, on the liability side your debt of taxes rise to €700 and the equity will increase with the net profit of €2,800.
Profit & Loss statement:
The depreciation will be deducted of the gross margin, thus leaving a result of €3,500. Over the profit the taxes will be calculated at €700, leaving you with a net profit of €2,800.
If you labelled it as a cost, your balance sheet and profit & loss statement would look like this:
On the asset side the cash increases with the gross margin, where at the liability side the equity increases with the net profit and the taxes debt rises to the amount of € 300.
Profit & Loss statement:
The costs of the machine will be deducted from the gross margin, than the taxes will be valued at € 300. Thus leaving you with a net profit of € 1,200.
So by labeling the expense as an investment the net profit will be higher but you pay more taxes. When labeling it as a cost it’s reversed, your net profit is lower, but you pay less taxes. The choice is dependent on a variety of factors, like your liquidity needs.
To keep your startup financially healthy, it’s not only important to follow your spendings and earnings, but also to set up and keep track of the budget. The budget can be seen as a financial translation of the strategy and business plan for revenues, costs, investments, cash flow, and possibly capital requirements.
Depending on the size of the organization there are, in addition to the company budget, also shared budgets for the various divisions, business units, departments or cost units. They usually are created by the board, based on the market position and expected future developments. The board proposes a long-term plan, as well as, for example, a derivative investment planning.
Based on the long-term plan and investment planning, the board proposes (together with all the department heads, and taking into account the current and short-term developments) a one-year plan for the sales, purchases, and expenses. The administration translates this into an annual budget and, for example, in sales prices. There are several methods for budget creation:
1) Fixed cost budgeting
With fixed budgeting (input budgeting), a department is allocated a fixed amount for a certain period.
2) Variable cost budgeting
With variable budgeting (output budgeting), there is a clear correlation between performance and the allocated budget.
3) Joint cost budgeting
This is a hybrid of the two above. Here a division is given a fixed total amount of costs, as a fixed amount per unit of output.
4) Flexible cost budgeting
Here the level of the budget is determined for the necessary costs, at a certain associated occupancy rate. This method explicitly takes into account the fact that costs can react in several ways to changes in occupancy rate (e.g. digressive and progressive variable costs).
5) Zero-base budgeting
In the first phase it’s required from each department head, to supply his budget and to provide it with a motivation of the cost to be incurred.
In the second phase, the top management will prioritize the various motivated budgets; they are arranged in order of importance. After that, the budgets will be allocated.
6) Beyond budgeting
This model advocates abolition of the current budgeting process and replacing it with a range of integrated management techniques such as the Balanced Scorecard, rolling forecasts and dynamic standards.
Take some time to get your financial foundation right
These basics about bookkeeping, costs, and investments and budgeting will help with getting your startup’s finances under control. Make sure to take some time to organize your finances. This prevents a lot of sleepless nights because of uncertainties. It will also give you a good overview of the state of your company and what you can or need to improve. Be aware that bookkeeping lies at the foundation of reporting your finances and making informed decisions.
Do you still have questions about your startup’s finances? Feel free to shoot an email to firstname.lastname@example.org to get your answers!
Milan Fonds studied Accountancy at the Institute for Economic Studies in Amsterdam and has been working at Rockstart since 2016 at the finance department. He is responsible for the bookkeeping, credit control and the administrative organization. Before working at Rockstart, Milan founded his own company in 2015, and worked on helping individuals and companies with their sales and income taxes and was mainly focused on startups.
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