So you have a great idea for a new product or service, or you have a novel way to revolutionize an industry, great, but remember not every great idea always succeeds just on it’s novelty or uniqueness. Some of the best businesses have gone under during their first iteration, and often it’s solely based on not understanding some simple accounting principles. This blog will help you understand how to think about your burgeoning business from an accounting standpoint to help you succeed.
First, before you actually incorporate and start selling, no matter if it’s a product or service, take the time to write a complete business plan. Not only will this help to organize your thoughts and ideas, but a business plan should include a start up budget and a break-even analysis. Emphasis here is on the break-even analysis, this is because most entrepreneurs have a great idea, know their demographic and the price point, but sometimes they do not fully know their cost structure. A break even analysis will help determine your fixed, costs that do not change based on production levels, and variable costs that are increased or decreased by level of production. For example, if you have to travel to every client you meet with, gas is a variable cost, it will fluctuate with the number of clients you meet with. Understanding these costs and your break-even analysis will give you an idea of how much of product X you need to produce in order to cover costs before you start making a profit.
Another potential pitfall of entrepreneurs is not maintaining set of books. A lot of people make the mistake of thinking everything is going just fine because they paid X number of dollars for something to be produced and sold it for a profit, but often this leads them to be surprised when they aren’t making as much money as they expected, or they are unsure of their tax position at the end of the year. Maintaining your companies books, or ledgers, can be somewhat tedious (if you’re not in the business of accounting and don’t love it) but it is a great source of information that should help drive the decision making going forward with your business.
Lastly, and probably one of the most difficult principles to get entrepreneurs and small businesses to understand is an old saying “you gotta spend money to make money.” For this point let me give you an analogy to help drive home the point. At two different times in my life I worked for the consumer electronics store Circuit City, each stint 4 years apart. The first time was in 2003 when the company had an emphasis on coverage, meaning their was a number of well trained, knowledgeable staff dedicated to their department to cover large flows of consumers. It worked well, the company made a great deal of profit despite their enormous personnel costs, and they had highly successful customer service scores. In 2007 I worked as a supervisor and it was drastically different, the company was focused on cutting costs every opportunity, they began by cross-training every employee to be able to sell in each department, which seems like a phenomenal idea until you understand that consumer electronics covers a spectrum of products that is a daunting task for almost anyone to be an expert in, instead everyone was an expert in one thing and just barely able to understand the technologies on everything else slightly better than the consumer. Secondly, now that everyone was cross-trained, less staff was needed, or so corporate thought. But instead of maintaining sales while cutting costs, Circuit City’s sales plummeted, and going back to the break-even analysis we discussed earlier, this meant that fixed overhead costs were no longer being covered. BAM! Bankruptcy. Cutting costs sounds like a great idea to increase your profit, but remember the most successful companies in the world don’t cut costs to make more money, they increase expenditures in the areas that correlate the most to increased revenue.
Hopefully this has been helpful for those entertaining the idea of going into business but have little to know understanding of accounting. If you are really in the dark and still need more info my recommendation is to take the opportunity to sit down with a CPA, often it is worth the investment to get some quality consultation from someone with expertise.
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