Here are a few ways in which the structuring of your startup’s financial statements can be improved.
First, you need to understand who exactly the readers of these financial statements are.
You want these readers to be able to look at your financial statements and easily understand what exactly is happening. For that reason, you want to use a descriptive set of general ledger accounts.
You want to make sure that you don't have duplicative accounts with the same information that can be condensed into one, and you'll want to make sure that each account that you use has a substantial amount of transactions and values in them. If not, they shouldn't be grouped with another account.
Let's go over an example of a poorly designed P&L. This is something common that I see whenever I start working with a startup. Here are a few mistakes in this statement.
First and foremost, we have a lot of duplicate names that aren’t descriptive enough as to what exactly the differences between these accounts are.
We have one for revenue, one for sales, and one for sale of product income.
To me as a reader of the financial statements, these all seem the same. To understand the difference, someone will have to explain to me via a call or an email, which is just redundant.
Next, we have several accounts in the wrong section. For instance, tech development. Tech development should not be a cost of goods sold; it is an operating expense.
Now maybe your business specifically is doing development for someone else, you're a dev shop, and because of that, it’s considered a cost of goods sold. But in this example, that's not the case.
It's the same thing with depreciation. So, ensuring that you have the correct accounts in the correct section is important for structuring your P&L properly.
Let's look at another account over here. 'Car & truck'. Now, aside from the fact that we've mentioned earlier about how this is just duplicative and can be bumped under travel, you'll notice that this is also a very insignificant amount, i.e. only $45 in one month and $80 in the other month.
Our P&L should be concise and descriptive. If we have an account with only $125 spread out throughout the year, odds are, we can combine it with another account. If we have an account with a very small amount of transactions, it's better to try and group it with another account.
In addition, you'll notice that there are a very few groupings here that have been set up properly.
We have payroll fees, salaries and wages, and employee benefits, all scattered under different groupings, while ideally, they should all be in the same grouping.
Lastly, there's no numbering here. That's fine. You don't need to number your P&L, but generally if you number then you can control the order of where things go. Otherwise, your accounting system is just going to apply everything alphabetically, by default, which again could be fine, but could also not result in the best design of your P&L.
Now, let's go over a good P&L and see what makes it good.
One of the first things that you'll notice, is that we have numbering everywhere as mentioned earlier. In addition to that, check out the groupings.
You now understand specifically how much you're spending for your 'Office', between your rent, your office supplies, your utilities, professional services. Again, another great grouping would be payroll.
In addition to that, you only have meaningful accounts. In a prior example, we had showed, different components like 'car & truck', and 'travel'. But ideally, components like 'car & truck', travel, parking, tolls, etc should all be just grouped together, under travel.
And lastly, we have our 'other income and other expenses', as well as our 'costs of goods sold'. Each section contains the relevant information in accordance with GAAP.
Okay, now let's go over a balance sheet. This is an example that I commonly see whenever I work with a new startup and it relates to showing way too much detail. Ideally, you should keep the proper work papers with that level of detail while showing information on a summarized basis in your chart of accounts.
So, in this example, this company is listing every single note holder. Now think about it. The readers of the financial statements can really be anyone. It can be your internal company, or a bank, or an investor. Do you really want each person who reads your financial statements to understand and have access to who exactly loaned you money? You may not want to provide that level of detail. Moreover people may not feel comfortable being on your actual balance sheet. Instead, you could just have one account called notes payable, with your work papers showing the details of who contributed what.
Similarly, let's look at the equity section. This is a common account that I see called 'opening balance equity'.
This is an account that is created by your accounting software any time a new bank or credit card is imported without importing all the historical transactions.
This should never have a balance and should not exist. If it does, it means that you haven't properly imported all your transactions.
Let's go over an example of a properly formatted balance sheet.
We have our current assets at one place.
We have all our fixed assets in our accumulated depreciation. We have all our liabilities commonly laid out.
We have one section for convertible notes with the principal and the accrued interest and no other detail.
And then we have the different type of stock that we offered.
This could be at the par value and the additional paid in capital, as well as our retained earnings.
Josh Aharonoff CEO and Outsourced CFO
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