So What’s Accrual Accounting and Why Does it Matter?

So you make a sale. When you deliver the goods, you record it as a sale. If the customer didn't pay you immediately, you record the accrued amount as Accounts Receivable.

You order some goods. When you receive them, you don't pay for them. Instead, you record the accrued amount as Accounts Payable.

At the end of the tax year you have some expenses outstanding, like professional services you know you'll be billed for but you haven't been billed yet. You accrue those expenses into the current tax year. They are deductible against income.

In so-called cash basis accounting, the opposite of accrual accounting, you don't put the sale or the purchase onto your books until the money changes hands. With business-to-business sales, the norm is the money changes hands later. So accrual accounting is better. It gives your books a more accurate picture of your financial flow and financial position.

Why does this matter here? Because timing of sales, costs, and expenses makes a difference. Start your forecasts correctly so the can be part of a more formal financial forecast when you finally need one.

If You’re Planning a New Business, Budget Your Startup Costs

There's a lot of potential confusion about startup costs. You tend to jump right into one of those accounting vocabulary problems that often trip people up, because they want to make things mean what they ought to mean, instead of what standard accounting and financial analysis make them mean.

Not a startup? Go on. Jump to somewhere else in this book. This is one thing you don't have to worry about.

Startup costs include two kinds of spending. You might not care about the distinction, but standard accounting and finance do, and, more important, the government does. It affects taxes. So take a couple minutes to understand the distinction.

1. Expenses. These will be deductible against future profits, so they will eventually reduce taxes; at least they will if you ever make a profit. So keep track of expenses as expenses. These include spending on rent, payroll, travel, meals, consulting, most (but not all) legal expenses, and so on.

2. Assets. Money you spend on assets isn't deductible against taxable income, so the bookkeeping is different, like it or not. Assets are things like signs, furniture, fixtures, cars, trucks, buildings, land, and -- harder to deal with -- cash on hand and inventory on hand.

A word about words: Is it start up costs, start-up costs, or startup costs? I think spelling matters so I apologize for the confusion there. I've decided to simplify my world and use startup. If that bothers you, I don't blame you. I like things in writing to go according to predictable rules. But sometimes the language just has to change. Sorry.

It seems like the toughest estimate to make is what you will need as cash on hand when you start the business. On the one hand, you have people telling you that you need working capital, and on the other, you have to raise it somehow or take it from your own savings and invest it in the business to make it cash on hand.

For expenses, timing is very important. Expenses like rent and payroll are startup expenses until your business is up and running; after that, they are just running expenses, that come out of your profits as deductible against income, so they reduce your taxable income. The only difference between rent paid before the company starts (which is a startup expense) and rent paid during the normal course of the business is timing. When it happens before day one, it's a startup expense. Afterwards, it's a regular business expense.

If you are a startup, then your basic business numbers should include startup costs. Make two simple lists, one of expenses and the other one of assets. You'll need this information to set up initial business balances and to estimate start-up expenses, such as legal fees, stationery design, brochures. Don't underestimate costs.

The following illustration is a typical start-up table for a homebased office, service business -- in this case a resume writing service. The assumptions used in this illustration show how even simple, service-based businesses need some start-up money.

You can see in the illustration how you have two simple lists, one for expenses, and one for assets.

Startup Costs Table

Use the start-up requirements worksheet to plan your initial financing

These are estimates. Where do they come from? Part of the planning for a startup is figuring these numbers out. Either you already have a pretty good idea, because you've worked in this area before, or you have somebody in the know, as partner, team member, advisor, or friend, who is helping you. You can also find some industry-specific startup information on the Web and in bookstores. Sometimes a carefully selected sample business plan will help, but if you try that, be careful, because sample business plans are just about one case for one business at one specific location some time in the past. They are not intended to stand for all businesses; you have to know your own case.

You might also make a separate list of the assets instead of just this summary. Other current assets, for example, are things that you need to buy but don't last long enough to be depreciated. That might be coffeemaking equipment, packaging equipment, some printing and layout materials, maybe chairs and tables as well.

If you're looking at starting a company that has significant long-term assets, such as manufacturing equipment, vehicles, or land and buildings, you can also make a list of those.

You don't want to start a company without having a pretty good idea of what you have to spend to get it started.