Which method offers the most accurate, secure, and holistic portrait of a business?

THE ACCRUAL METHOD!

Why is the accrual method the better choice?

While many small and medium sized businesses and CPAs opt for the cash basis, many bad decisions can be made inside the books of businesses using the cash basis.

We HIGHLY recommend using the Accrual basis method for business accounting in order to prevent manipulation of the financial statements. And when coupled with the Statement of Cash Flows during reporting, you also benefit from having the most accurate and holistic picture of a company’s fiscal health.

Cash and accrual accounting are like sibling rivals in the accounting realm—one clashes with the other, but you can definitely see the resemblance.

Even if you don’t handle your own financial reporting, it’s vital to know how each one works so you can choose the best bookkeeping practices for your business. 

Overview: What is the difference between cash and accrual accounting?

Cash accounting records income and expenses as they are billed and paid.

With accrual accounting, you record income and expenses as they are billed and earned. 

As long as your sales are less than $25 million per year, you’re free to use either the cash basis accounting or accrual method of accounting.

Why should you choose one over the other? We’ll explain the basics of the cash accounting and accrual accounting methods, as well as the pros and cons of each so that you can make an informed decision.

What is cash basis accounting?

Let’s begin with cash basis accounting. With this method, you record income as it’s received and expenses as they’re paid.

Cash basis accounting only records your expenses when money leaves your account to pay suppliers, vendors, and other third parties. 

In other words, if you have a small stationery business that purchased paper supplies on credit in June, but didn’t actually pay the bill until July, you would record those supplies as a July expense.

It’s important to note that this method does not take into account any accounts receivable or accounts payable.

This is because it only applies to payments from clients—in the form of cash, checks, credit card receipts, or gross receipts—when payment is received.

Who uses cash basis accounting? 

Because of its simplicity, many small businesses and sole proprietors use the cash basis method as their primary method of accounting.

If your business makes less than $25 million in annual sales and does not sell merchandise directly to consumers, the cash basis method might be the best choice for you. 

Some of the benefits include:

Shorter learning curve

Fewer items to record

Easier tracking of expenses and revenue

Example of cash basis accounting:

If you invoice a client for $1,000 on March 1 and receive payment on April 15, you would record the income as received for the month of April, since that’s when you actually had the money in hand. So the breakdown looks like this:

The invoice is sent for $1,000 in March

You do nothing in March

You receive payment in April

You record the income in April

What is the accrual method of accounting?

With the accrual accounting method, income and expenses are recorded when they’re billed and earned, regardless of when the money is actually received.

Accounting standards outlined by the generally accepted accounting principles (GAAP) stipulate the use of accrual accounting for financial reporting, as it provides a clearer picture of a company’s overall finances.

Who uses accrual accounting? 

While it’s perfectly acceptable for small businesses to use accrual accounting as their primary method of accounting, it’s not required.

However, according to GAAP regulations, any business that is either publicly traded or produces over $25 million in sales revenue over a three-year period is required to use the accrual method. 

Example of accrual accounting:

Using the example from above, if a small business bills a client $1,000 on March 1, you would record that $1,000 as income in March’s bookkeeping—even if the funds didn’t clear your account until April 15.

The invoice is sent for $1,000 in March

You record revenue in March

The same holds true for accrued expenses. In this case, if your small stationery business buys paper supplies on a credit card in June, but doesn’t actually pay that bill until July, you would still record that as a June expense.

Let’s break this down:

You bought paper supplies in June

You record the expense in June

Accrual vs. Cash Basis: Which is better?

Accrual accounting is the winner if you’re looking solely at popularity, as it’s the most widely used as well as the most accurate when it comes to portraying a holistic view of a company's financial health.

Cash basis accounting is still a popular option, however, due to the simplicity of the overall process. 

Advantages and disadvantages of accrual accounting:

Unlike cash basis accounting, which provides a clear short-term vision of a company’s financial situation, accrual basis accounting gives you a more long-term view of how your company is faring.

This is because accrual accounting gives an accurate picture of how much money you earned and spent within a specified time period, providing a clearer gauge of when business speeds up and slows down over the course of a business quarter or a full year.

Additionally, it conforms to nationally accepted accounting standards.

This means that if your business were to grow, your method of accounting would not need to change.

Advantages:

Creates a more accurate financial picture: It can give small business owners a more realistic idea of income and accrued expenses during a certain period of time.

This can provide you (and your accountant) with a better overall understanding of consumer spending habits and allow you to plan better for peak months of operation.

Conforms to GAAP principles: Because the accrual method conforms to GAAP, it must be used by all companies with more than $25 million in annual sales. Since the $25 million sales revenue mark can be high for most small businesses, most will only choose to use the accrual accounting method if their bank requires it.

Scales with your business: You may not be there now, but in a few short years you could double or triple your revenue, pushing you over the $25 million mark.

If you already use the accrual accounting method, there’s no need to change—it simply grows with you.

Disadvantages:

More resource-intensive: Many small business owners view it as more complicated and expensive to implement due to complexity and extra paperwork.

Since a company records revenues before they actually receive cash, the cash flow has to be tracked separately to ensure you can cover bills from month to month.

Inaccurate short-term view: The cash method gives you a better picture of the funds in your bank account.

If you don’t have careful bookkeeping practices, the accrual accounting method could be financially disabling for a small business owner.

Your books could show a large amount of revenue when your bank account is completely empty.

Advantages and disadvantages of cash basis accounting:

The cash method of accounting certainly has its benefits, including ease of use and improved cash flow. While the cash basis method of accounting is definitely the simpler option of the two most common accounting methods, it has its drawbacks as well.

Advantages:

Simplified, familiar process: Cash basis accounting is a simplified bookkeeping process that is similar to how you might track your personal finances.

It’s easy to track money as it moves in and out of your bank accounts because there’s no need to record receivables or payables.

Income taxes: For tax purposes, you don’t have to pay taxes on any money that has not yet been received.

For instance, if you invoice a client or customer for $1,000 in October and don’t get paid until January, you won’t have to pay taxes on the income until January the following tax year.

For individuals and extremely small businesses, this can be crucial to keeping your business afloat when cash flow is restricted.

Disadvantages:

Inaccurate financial picture: Since it doesn’t account for all incoming revenue or outgoing expenses, the cash accounting method can lead you to believe you’re having a very high cash flow month when in actuality, it’s a result of a previous month’s work.

No accounts receivable or accounts payable records: Because the method is so simple, it does not require your CPA or bookkeeper to keep track of the actual dates corresponding to specific sales or purchases.

In other words, there are no records of accounts receivable or accounts payable, which can create difficulties when your company does not receive immediate payment or has outstanding bills.

Doesn’t conform to GAAP: If your business were to grow larger than $25 million in annual sales, you would need to update your accounting practices.

If you think your business could exceed $25 million in sales in the near future, you might consider opting for the accrual accounting method when you’re setting up your accounting system.

How to choose the right option for your business:

For small companies that do business primarily through cash transactions and do not maintain large inventories of products, the cash accounting method can be a convenient and reliable way to keep tabs on revenue and expenses without the need for a great deal of bookkeeping.

However, for the most accurate and updated accounting view of your financial health, accrual accounting might be the better choice.

There are also some other factors to keep in mind.

The complexity of your business:

Depending on your industry and the complexity of your books, one accounting method may be more sustainable than the other.

For example, a business with multiple accounts, hundreds of employees, and various LLCs will probably want to stay away from cash basis accounting because it won’t give the company the big picture view it’s looking for when it comes to financials on the income statement, balance sheet or cash flow statement. 

Sales revenue:

Another reason to choose one over the other would be based on your sales revenue.

According to GAAP, if you exceed $25 million in annual revenue, then you are required to use the accrual method.

For many small businesses, this isn’t an issue at the moment but maybe in the future, so it’s something to keep in mind. 

Publicly traded:

Having a publicly-traded company or one that may go public is another stipulation of the GAAP guidelines.

Publicly traded companies have a duty to report an accurate view of their financial well-being to shareholders.

The best method for this is the accrual system of accounting. 

Moving forward:

Before moving along through your small business accounting checklist, understanding which accounting method to use is, without a doubt, an imperative decision for your business.

That’s not to say it can’t be changed later — only that it’s harder to switch once you get comfortable with one way or the other.

Bottom line, whether you choose cash or accrual accounting, remember to understand both options and stay within compliance with GAAP for your state.

Accounting Cycle FAQs:

We know the accounting cycle can seem daunting at times, so we wanted to cover common themes and answer your most urgent questions.

What is the most important step in the accounting cycle?

• Each step in the accounting cycle is equally important, but if the first step is done incorrectly, it throws off all subsequent steps. If you’re unable to track your transactions accurately, the following steps won’t be able to create a clear accounting picture.

Why is the accounting cycle important?

• The accounting cycle is important because it gives companies a set of well-planned steps to organize the bookkeeping process. It helps you avoid falling into the pitfalls of poor accounting practices.

• Without the cycle, companies could risk going out of order, mishandling their records, and ultimately damaging their financial statements which could give a bad picture of the company’s financial health

How many steps are in the accounting cycle?

• Each company decides if they would like additional steps, but the accounting cycle typically includes these 8 steps:

1. Identifying transactions

2. Recording transactions

3. Posting the general ledger

4. Trial balancing

5. Analyzing the worksheet

6. Adjusting journal entries

7. Producing the financial statements

8. Closing the books

As we noted above there are 8 steps to the entire accounting process.

Think of each step as a pillar that stands all on its own, and when brought together delivers a comprehensive visual of a company’s financial standing (sort of like a company’s financial report card).

The detailed steps of the accounting cycle are as follows:

1. Identify your transactions:

Bookkeepers or accountants are responsible for recording the transactions over the accounting timeline.

For example, a marina that sells boats will need to keep track of each transaction that is made through purchases of equipment, parts, or services rendered over the accounting period.

They will also want to take note of important information to make categorizing and following steps easier.

Important info to identify includes:

• Transaction dates

• Product prices

• Amounts paid

2. Record the transactions:

Storing information is a crucial part of the accounting process and can happen either at the point of sale (during the first step) or as a second step on its own.

This can be done manually but many companies use accounting software for simpler storage recall and organization of transactions.

A few notes to remember when recording transactions:

• Maintain chronological order of transactions

• When using credits and debits, they must always balance each other out

• Include important notes for the accountant for easier reconciliation

Luckily, accounting software can easily track all of this information for you

3. Post transactions to the general ledger:

Think of the general ledger as a summary sheet where all of the transactions live and are categorized.

The general ledger is the master list of any transaction information listed in journals or subledgers.

4. Create the trial balance:

For the fourth step in the accounting cycle, transactions will need to be balanced at the end of the period.

The accounting period can vary (monthly, quarterly, annually) depending on the company.

The trial balance provides the company with insight into the balances in the account and discovers any discrepancies.

Since no accounting method is seamless you will almost always find some discrepancies when balancing your books.

5. Analyze the worksheet:

Arguably one of the most intricate steps in the accounting process is the worksheet analysis.

When you have credits and debits from your transactions that don’t balance (as in one cancels the other) you have to make corrective adjustments accordingly.

6. Adjust journal entries:

The final step before you create your financial statements is making any adjustments, which need to be made to account for any corrections for accruals or deferrals.

An example of an adjustment might be a salary or bill that is paid later on in the accounting period.

Since it was recorded as an account payable when the cost originally occurred, it requires an adjustment to remove the charge.

7. Create financial statements:

In this step, we generate financial statements—including the balance sheet, income statement, and cash flow statement—from the trial balance.

Here’s a brief explanation of each financial statement and some must-know accounting formulas:

The balance sheet summarizes a company’s financial position as of a specific date.

It’s a financial statement that subtracts assets from liabilities to determine equity:

Assets – liabilities = equity

The most crucial part of the balance sheet is the profit and loss statement.

An income statement reports a business’s profit or loss over time—typically, a month or year.

It’s a financial statement that subtracts revenue from expenses to determine net income or profit:

Revenue – expenses = net income

Net income increases equity in the balance sheet.

Many business owners focus on the balance sheet and income statements.

But the cash flow statement is equally important.

The statement of cash flows reports cash inflows and outflows over time.

Accountants or business owners can separate cash flow into three activities:

• Operating

• Investing, and

• Financing

The ending balance in the cash flow statement must equal the company’s cash balance on the balance sheet.

8. Close the books:

Ask any accountant and they will confirm that finally closing the books is extremely satisfying.

This happens at the end of each accounting period, signifying that the next accounting cycle can begin.

Then we begin the accounting process all over at step 1.

The number one thing you should get help with when starting a business is setting up financial systems, according to a recent QuickBooks survey of 965 seasoned small business owners.

They recommend bringing in an expert to ensure your systems are set up correctly and efficiently from the start.

And yet, more than a third of future business owners (38%) who plan to start a business in the next year say they’ll be setting up their financial systems on their own. Without expert input. Another 9% aren’t sure whether they’ll be asking for help or not.

But current business owners warn that accounting mistakes stemming from improper financial systems can have a negative impact on your business:

Correcting accounting errors is time-consuming.

Common accounting mistakes can be avoided, if you have better systems in place.

Accounting errors may result in interest costs, penalties and fines.

If you submit a tax return to the IRS that isn’t correct, it may cost you.

Stakeholders, including investors, creditors and regulators, rely on the accuracy of your financial statements.

If the financial data isn’t accurate, stakeholders will lose confidence in your business.

Most importantly, you can’t make informed business decisions if your accounting system produces bad data.

You can’t evaluate the financial health of your business if your financial systems aren’t operating correctly, and that can have serious consequences.

So make the effort to improve your accounting procedures and get your financial systems right from the start.

Here are seven common accounting mistakes (posturing as accounting best practices), and how you can fix them.

Small business accounting starts with the chart of accounts.

1. Not updating the chart of accounts:

The chart of accounts is the listing of each account and the description, and many businesses don’t create enough account categories to produce meaningful accounting reports.

If you don’t frequently review and update your chart of accounts, you’ll produce inaccurate accounting records.

Assume, for example, that you operate a hardware store using seven departments.

Each of your accounts can have a subaccount for each department.

If company-wide revenue is account #5000, for example, the revenue outdoor department can be account #5100, and the revenue lumber department can be account #5200.

Using sub-accounts allows you to generate relevant financial reports by department, which helps your firm manage profit and expenses at a more specific level.

Keep your chart of accounts updated.

Accounting software is a great tool to streamline your accounting methods and do more work in less time.

2. Not using technology for accounting tasks:

QuickBooks Online accounting software has a number of features that make life easier for an accounting professional:

The software reduces the risk of data entry errors.

If you try to post an accounting entry that is not in balance, the software will give you an error message.

You can link your accounting software to your bank account and your credit card accounts.

Accountants can upload a bank statement into the software, and perform the bank reconciliation in far less time.

A bookkeeper can scan receipts into the accounting software, which eliminates the need to keep paper files.

You can also scan receipts using a mobile device.

Use accounting software for your bookkeeping and accounting tasks, and minimize the use of spreadsheets.

Why Spreadsheets Are A Bad Idea:

Using spreadsheets requires far more time, and the risk of error is much higher.

Here’s why:

Spreadsheet tabs may not be properly linked.

You may not use the current version of a particular spreadsheet.

Spreadsheets can’t be integrated with bank statements, credit card reporting or payroll records.

Training is more difficult because using spreadsheets requires more steps and input work.

As your business grows, the number of small transactions increases, and so does your accounting work.

If you’re posting more transactions each month, spreadsheet data entry makes accounting more difficult.

Technology can also improve your invoicing process.

Automated Invoicing:

You need timely payments from your customers, in order to maintain positive cash flow in your business.

One way to improve your business finances is to automate your invoicing process.

Most of the invoice data for repeat customers stays the same, and using technology for automation can sharply reduce the processing time.

You can use the QuickBooks to set up recurring invoices for clients who place the same orders each month.

The invoicing application will fill in the customer’s name, billing address and email address when the client’s name is typed into an invoice template.

The template will also input products and services, based on the customer’s last order.

Once the template loads, you can verify that the customer information is the same, and make adjustments to the items and amounts listed on the invoice.

Mistakes happen when you fall behind.

You get a big week of customer orders and new business, but you don’t get to that bank reconciliation. If your company is growing and you can’t keep up, hire people to help you with your business needs.

3. Working without qualified accounting staff:

The people responsible for managing your accounting process will change dramatically as your company grows.

When a business is formed, the owner may take on all the accounting responsibilities.

As the number of accounting transactions increases, the owner typically hires a bookkeeper and keeps responsibility for the accountant’s role.

Finally, company growth may require the owner to hire a CPA to build out an accounting department or supervise the bookkeeper and take on the other accounting tasks.

Here are the differences between the bookkeeping role and the responsibilities assigned to an accountant:

Bookkeeping Responsibilities:

Bookkeeping refers to the recording of financial transactions in an accounting system.

Business owners hire bookkeepers to post customer sales transactions, inventory purchases and business expenses into the accounting software.

Using the services of a bookkeeper frees up the owner’s time for more important tasks.

Accountant’s Role:

An accountant can use the transactions prepared by a bookkeeper, along with payroll data and other records, to generate monthly financial statements, including the balance sheet and income statement.

Accountants use their higher level of training to make decisions and judgment calls that bookkeepers don’t address:

Transaction review: The accountant reviews the bookkeeper’s work, and your accountant may take responsibility for posting more complicated transactions.

Adjustments: Accountants post the adjusting entries for depreciation expense, interest earned on bank balances and other transactions.

Financial statements: The accountant generates the balance sheet and income statement, along with any other reports that management uses to make decisions.

As your business grows, you may be hesitant to hire an in-house bookkeeper.

It’s a common small business problem because hiring a full-time employee is a big expense.

Make this necessary investment in order to grow your business.

If you take charge of your accounting, you can put better controls in place to prevent fraud.

4. Not segregating duties:

You can reduce the risk of theft by segregating duties between different employees.

Now, this should make logical sense: the less responsibility any one worker has, the less likely it is that theft can occur.

Let’s think about your company’s cash account as an example.

Whenever possible, these three specific duties should be kept separate:

Custody of assets: The person who has physical custody of the checkbook should not have any other duties related to cash processing.

Let’s assume that the administrative assistant has the checkbook in his desk.

Authority: Who has authority to sign a check?

If you own a restaurant, for example, your manager may have authority to sign checks for purchases of food received at the restaurant.

That same manager should not have access to the company checkbook.

Recordkeeping: This duty refers to posting accounting entries and reconciling the bank account.

The role of the accountant must be segregated from the other duties, and the accountant should never have the ability to sign checks.

If you use a petty cash account, you need to monitor the account balance closely to prevent theft.

Accounts receivable is another account that presents a risk of theft.

For a very small business, it may not be possible to segregate these duties.

Maybe the owner handles two, or even all three, of these tasks.

A growing business, however, needs to separate these duties.

Consistent internal auditing helps prevent theft.

Payroll is often the most time-consuming task for a business.

5. Not outsourcing payroll processing:

Outsource the payroll function to free up your time and ensure that the process goes smoothly.

Five Steps For Payroll Processing:

A small business must complete five steps to calculate payroll tax obligations and submit tax payments:

I. Data collection:

When an employee is hired, you need to collect withholding tax information on Form W-4.

Employers must withhold federal income tax, and may withhold dollars to pay for company-provided benefits.

If, for example, you offer a retirement plan, a worker may want payroll dollars withheld and invested in the plan.

II. Calculating net pay:

The net amount of employee pay is the gross pay less tax withholdings, less any benefit payment withholdings.

You’ll also calculate withholdings for Medicare tax and Social Security tax.

III. Payments:

You must pay the employee’s wages by check, or via direct deposit to a bank account.

IV. Reporting:

A tax filing for federal tax and state tax withholdings must be submitted to the IRS and the state department of revenue.

Retirement plan contributions, state unemployment payments, Medicare taxes and Social Security taxes are reported to other entities.

V. Withholding payments:

All of the tax and benefit payments must be forwarded to the taxing authorities, retirement plan firms and other benefits providers.

Keep in mind that your business must address changes to payroll, which complicates the process and requires more time.

Tax laws may also change the amount of taxes you must withhold from pay.

Every year, employees may be added, promoted or let go.

Workers also may change the tax and benefit withholdings, based on salary changes or family changes.

The tax due for a particular employee can change frequently over time.

Outsource the payroll process to a third-party firm.

A payroll company can make adjustments for changes in the tax law, and add or subtract employees, as needed.

All of your accounting processes should be documented in a manual.

6. Operating without a procedures manual:

Every routine task you perform should be documented in a procedures manual.

Your manual should list each routine task, how the task is performed and who is responsible for completing the work.

A procedures manual clarifies how you do business, and reduces confusion about your operation. The manual is also a great training tool for your staff.

Finally, every business should operate using a budget.

7. Starting the fiscal year without a budget:

This may be the toughest habit to change.

Savvy business owners create a budget before the start of each calendar year.

When you create a budget, you’re forced to consider a number of variables in your business.

By taking on your business challenges in the budgeting process, you’re more likely to make better decisions.

Once the bullets start flying in the New Year, you’ll be busy and distracted…

Without a budget, you may make some poor decisions.

It starts with cash management.

Cash flow management:

No business can operate without sufficient cash inflows each month, and many firms do a poor job of forecasting expected cash flows.

Here are several factors that impact the amount of cash a company will have to operate:

Accounts receivable:

• The dollar amount of credit sales that are not collected in cash, and the average amount of time it takes to collect the receivables in cash.

Inventory:

• The dollar amount of inventory needed to fill customer orders over the next several months.

Debt payments:

• Interest payments and any repayments of principal due in the next few months.

These factors help determine the amount of cash required to operate.

If cash inflows are insufficient, the firm may have to access a line of credit, or raise more capital through a stock or bond offering.

Create a customized report to project your cash flow for each new month.

Your firm may invest a large amount of cash into inventory.

Forecasting inventory purchases:

Create a budget for inventory purchases, based on your projected sales for the year.

Every company should plan for an ending balance in inventory at month end, which allows the business to fill customer orders in the first few days of the next month.

The formula for ending inventory is: (beginning inventory + purchases – sales = ending inventory), and ending inventory is often based on a percentage of monthly sales.

Assume, for example, that a hardware store’s beginning inventory balance of lawn mowers is 50 units, and that the company forecasts 300 mower sales for the month.

If the business wants 30 mowers (10% of expected sales) in ending inventory, the number of mowers purchased should be (300 projected sales + 30 ending inventory – 50 beginning inventory = 280 purchased).

Use the ending inventory formula to ensure that you maintain a sufficient amount of inventory.

You’ll put in a lot of time and effort to change your accounting practices, and the work will pay off.

Next year can be better:

Successful business owners make continuous improvements.

Changing accounting practices will improve any business, regardless of the firm’s life cycle stage.

Newly formed businesses, mid-size firms, and large companies all have room to improve.

Use these tips to reduce errors, save time, and streamline your business.

Next year can be better, and you can make it happen now.

How To Set Up A Chart Of Accounts:

Each time you add or remove an account from your business, it’s important to record it into the correct account.

The chart of accounts helps you do just that. Read on to learn how to create and utilize the chart to keep better track of your business’s accounts.

What is the chart of accounts?

The chart of accounts, or COA, is a list of the account numbers and names relevant to your company. Typically, a chart of accounts will have four categories.

The four primary account types, or general ledgers in a standard chart of accounts are:

1. Asset accounts

2. Liability accounts

3. Income accounts

4. Expense accounts

Put another way, a chart of accounts is a lot like the game Jenga.

If you take a block away from one section of your business, you have to add it back someplace else.

Accounting systems, by definition, have a general ledger in which your asset accounts (what you own) match your liability accounts (what you owe).

While useful in theory, it’s challenging to implement in reality.

Because current assets never quite match current liabilities, accountants often use other account types that serve as the “missing Jenga blocks” to ensure an accurate general ledger.

To better understand the balance sheet and other relevant financial statements, you need to first understand the components that make up a chart of accounts.

Knowing how to keep your company’s chart organized can make it easier for you to access financial information.

Within each category, line items will distinguish the specific accounts. Each line item represents an account within each category.

Some may also display equity accounts on their company’s chart.

An equity account is a representation of anything that remains after accounting for all operating expenses and revenue accounts.

A Breakdown Of The Main Account Types:

The main account types include

• asset

• liability

• ncome, and

• expense accounts

See specifics on each account type below.

I. Asset accounts:

Your asset accounts could include anything you own that has value, like:

• Buildings

• Land

• Equipment

• Vehicles

• Valuables

• Inventory

Including liquid assets, such as:

• Checking accounts

• Other bank accounts

Additional asset accounts would include items like:

• Accounts receivable

• Notes receivable

The chart of accounts streamlines various asset accounts by organizing them into line items so that you can track multiple components easily.

Asset accounts can be confusing because they not only track what you paid for each asset, but they also follow processes like depreciation.

II. Liability accounts:

Your liability accounts include things like current or short-term liabilities such as:

• Accounts payable or bills

• Payroll taxes

• Income taxes payable

• Bank loans

• Credit card balances

Also, non-current or long-term liabilities such as:

• Mortgages

• Deferred tax liabilities

• Personal loans

Current liabilities are classified as any outstanding payments that are due within the year, while non-current or long-term liabilities are payments due more than a year from the date of the report.

When entering a loan into your company’s chart, be sure to adhere to the following steps:

• Make sure that you only include the amount of the loan.

• Log just the principal amount and forgo the interest owed when you make each monthly payment and enter the payment in your accounting system.

• Then, split the payment into an amount subtracted from what you owe, and an amount of interest paid, which will go into an expense account.

III. Income accounts:

Income tends to be the category that business owners underutilize the most.

Below are the most common types of revenue or income accounts:

• Sales income

• Rental income

• Dividend income

• Contra income

Most new owners start with one or two broad categories, like “sales” and “services.”

While some types of income are easy and cheap to generate, others require considerable effort, time, and expense.

It may make sense to create separate line items in your chart of accounts for different types of income.

Instead of lumping all your income into one account, consider what your various profitable activities may be and sort them by income type.

When you can see which locations or events bring in the most cash flow, you can manage your business more wisely.

For instance, imagine you have a store that sells an array of items:

On your chart of accounts, you could create line items for “income from food sold” and “income from books sold.”

Then compare the profit levels and cost of goods sold from each category (which allows you to better determine your financial health).

When compiling data in your income accounts category, consider anything that brings money into the company, including things like interest income.

IV. Expense accounts:

Expense accounts represent any money that you’ve spent.

For instance, if you rent, the money moves from your cash account to the rent expense account.

Expense accounts allow you to keep track of money that you no longer have.

Below are more examples of expense accounts to your business may use:

• Cost of sales

• Advertising expense

• Interest expense

• Depreciation expense

• Salaries or wages

• Interest expense

• Depreciation expense

It’s also a good idea to break up expenses into separate accounts.

For instance, if you ship a lot of products, you may want to track your costs from different shipping carriers separately.

Within each line account, you can create sub-categories for the various expenses associated with each carrier.

How To Set Up The Chart Of Accounts:

Setting up your chart of accounts is relatively simple.

First you’ll need to create your blank chart and assign the columns.

The chart of accounts is typically broken down into the following 3 columns:

1. Create business account names

The account name is the given title of the business account you’re reporting on (i.e., bank fees, cash, taxes, etc.).

2. Assign account numbers to business accounts

Account numbers are the numbers assigned to each account name. The most common number sequences for each account are:

Assets: 1,000 to 1,999

Liabilities: 2,000 to 2,999

Income: 4,000 to 4,999

Operating expenses: 6,000 to 7.999

3. Organize account names into one of the four account category types

Each of your account names should be assigned an account type or general ledger.

Choose from the 4 main account types: asset, liability, income, and expense.

Below is an example of what your chart will look like once you’ve added all of the necessary components.

Once you’ve set up your chart, you can then begin adding specific account names and the account category they’re associated with.

Tips For Keeping Your Chart Of Accounts Organized:

Now that your COA is set up, it’s important to keep it organized as you continue to add or adjust accounts.

The following tips will help you set your chart of accounts up for success.

Use simple account names:

When setting up your line items for the first time, keep it simple.

Make sure that your line items have titles that make sense to you and your accountant.

Use straightforward titles like “bank fees,” or “bottling equipment.”

Create sub-accounts:

As time goes by, you may find yourself wanting to create a new line item for each transaction.

However, doing so could litter your company’s chart and make it confusing to navigate.

Instead, take advantage of your accounting software’s sub-accounts.

For instance, imagine you need to create a new account for “PayPal fees.”

Instead of creating a new line on your chart of accounts, you can create a sub-account under “bank fees.”

Similarly, if you pay rent for a building or piece of equipment, you might set up a “rent expense” account with sub-accounts for “building rent” and “equipment rent.”

Add financial statements:

Add an account statement column to your COA to record which statement you’ll be using for each account–cash flow, balance sheet, or income statement.

For example, balance sheets are typically used for asset and liability accounts, while income statements are used for expense accounts.

Track account movement:

Your chart of accounts is a living document for your business and because of that, accounts will inevitably need to be added or removed over time.

The general rule for adding or removing accounts is to add accounts as they come in, but wait until the end of the year or quarter to remove any old accounts.

Accounting software can help manage your chart of accounts:

As your business grows, so will your need for accurate, fast, and legible reporting.

Your chart of accounts helps you understand the past and look toward the future.

A chart of accounts should keep your business accounting error-free and straightforward.

This will allow you to quickly determine your financial health so that you can make intelligent decisions moving forward.

Benefits of an S-Corp and Benefits of a Partnership:

When paying an annual business return, your corporation status or the type of business you run plays a huge role.

Some business owners pay double taxes, and some can pass their income to shareholders, who then pay taxes on their share of income. In this case, the business is not taxed.

An S-Corp, or S Corporation, and a Partnership enjoys such a benefit – they are both not double taxed.

On the other hand, a limited liability company (LLC) and C Corporations are double taxed.

The income that these businesses make is taxed both at company and shareholders’ level.

What is a Partnership?

A partnership is merely an agreement between two or more people to run and manage a business and share losses and profits.

The arrangement may be written or just verbal.

There are many types of partnerships that people can choose to get into.

Some have equal shares of liabilities, income, and loss.

But some will have shareholders with a limited liability.

Nevertheless, partnerships have a slight difference to S-Corps, but they are largely similar in the way they are taxed.

What are the tax advantages of a partnership?

A partnership is also viewed as a pass-through entity.

It is not taxed at corporate level.

Partnerships enjoy tax-free property transfers

Partners can deduct losses from the business on their own individual tax return.

Conclusion:

Obtaining the S-Corp status for a small business comes with tax benefits, so do partnerships.

However, even though both are pass-through entities favored with several tax benefits, general partners’ share of income in a Partnership is subject to self-employment taxes.

LLC vs. S Corporation: What's the Difference?

An Overview:

Choosing the right business structure is crucial to the success of your business.

An LLC is a limited liability company, which is a type of legal entity that can be used when forming a business that offers protection to the owner(s) from personal liability for debts and other obligations that a business might incur. In other words, the personal assets of the owner cannot be used for legal claims against the business.

LLCs are common because they provide the liability that's similar to a corporation, but they are easier to establish and with fewer regulatory requirements than other types of corporations.

LLCs allow for personal liability protection, which means creditors cannot go after the owner's personal assets.

An LLC also allows pass-through taxation, meaning business income or losses are recorded and taxed on the owner's personal tax return.

LLCs are beneficial for sole proprietorships and partnerships.

An LLC with multiple owners would be taxed as a partnership, meaning each owner would report profit and losses on their personal tax return.

An S corporation's structure also protects business owners' personal assets from any corporate liability and passes through income, usually in the form of dividends, to avoid double corporate and personal taxation.

S corporations help companies establish credibility as a corporation since they have more oversight.

S corps must have a board of directors who oversee the management of the company.

However, S corps can have 100 shareholders and pay them dividends or cash payments from the company's profits.

An S corporation provides limited liability protection but also offers corporations with 100 shareholders or fewer to be taxed as a partnership.

An S corporation is also known as an S subchapter.

In some instances, a business may be both an LLC and an S corporation.

(You can form an LLC and choose to be taxed as an S corporation, but your business can also operate under the default taxation system for LLCs.)

A business must meet specific guidelines by the Internal Revenue Service (IRS) in order to qualify as an S corporation.

The business structure that you choose can significantly impact some important issues in your business life.

These issues include exposure to liability and at what rate and manner you and your business are taxed.

It can also impact your financing and your ability to grow the business, the number of shareholders the business has, and the general manner in which the business is operated.

Both LLCs and S corporations surged to the forefront around the time of the Small Business Job Protection Act of 1996, which contained a number of changes to basic corporate tax law, such as enabling S corporations to hold any percentage of stock in C corporations. C corporations, however, are not allowed to own stock in S corporations.

LLC and S corporation are not an either-or comparison – you can structure and operate your business as an LLC but still be taxed as an S-corp.

There are several factor differences to keep in mind when you’re thinking about setting up an LLC as an S-corp.

Taxes:

By default, an LLC is taxed like a sole proprietorship or partnership. the owners are considered self-employed and must report business income and expenses on their personal tax returns.

Each owners’ share of the profits is subject to federal, state and self-employment (Medicare and Social Security) tax.

Currently, the self-employment tax rate is 15.3%, and you’ll pay this tax on all your profits until you reach the maximum annual Social Security contribution ($142,800 in 2021)

Some LLC owners save money on self-employment taxes by electing S-corp taxation.

This is because as an S-corp owner, you don’t have to be self-employed - you can become an employee of the company and pay yourself through regular payroll.

Your salary will still be subject to Medicare and Social Security taxes, but any company profits over and above your salary will not.

However, the IRS scrutinizes S-corp owner salaries closely, and your salary must be reasonable, based on standard salaries in your industry, your geographic location and your experience.

In other words, it must be accurate and can’t be unreasonably low to take advantage of the tax benefits.

For example, say you’re the sole owner of an LLC that made an annual profit of $100,000. And suppose a reasonable salary in your area for someone who does the same work as you is $70,000.

Under the default LLC taxation, you’ll pay self-employment taxes on your full $100,000 of profit.

But if your business is taxed as an S-corp, you’ll only pay payroll taxes on your reasonable salary of $70,000.

The other $30,000 will still be subject to income tax, but not Medicare or Social Security taxes.

Historically, owners of S corporations have taken advantage of this tax benefit by classifying their income as zero percent salary and 100% distributions, thereby completely avoiding payroll taxes.

In recent years, the IRS has become privy to this tax avoidance strategy and can impose hefty penalties.

Get advice from an accountant before deciding on a tax classification for your business or determining what a “reasonable” salary should be.

And be aware that setting your company up as an S-corp. may cause additional costs related to having employees and running payroll.

Key Takeaways:

An LLC is a limited liability company, which is a type of legal entity that can be used when forming a business.

An LLC offers a more formal business structure than a sole proprietorship or partnership.

While LLCs and S corporations are two terms that are often discussed side by side, they actually refer to different aspects of a business.

An LLC is a type of business entity, while an S corporation is a tax classification.

An S corporation election lets the Internal Revenue Service (IRS) know that your business should be taxed as a partnership.

To become an S corporation, your business first must register as a C corporation or an LLC and meet specific guidelines set by the Internal Revenue Service (IRS) in order to qualify.

Limited Liability Company (LLC):

Unlike partnerships and corporations, LLCs don’t have their own IRS tax category.

Instead, they’re usually taxed in the same way as sole proprietorships or partnerships, depending on whether the LLC has one owner or multiple owners.

However, an LLC can also elect to be taxed as an S corporation (if it qualifies) or a C corporation (C-corp).

Limited liability companies (LLCs) are popular due to their basic benefits of liability protection and are typically used by a sole proprietor (single owner) or a company with two or more owners (partnership).

LLCs protect the owners' personal assets from losses, company debts, or court rulings against the company.

LLCs may also provide some tax benefits since they are taxed differently than a traditional corporation—or a C Corporation.

An LLC can be used for a company of any size, such as a doctor's or dentist's office, or as a legal entity that owns commercial property.

Also, an LLC can be established by family members who conduct business in states that allow LLCs.

Before establishing an LLC, entrepreneurs should consider the various characteristics that are associated with forming an LLC, which include the following.

Ownership of an LLC:

An LLC is allowed to have an unlimited number of owners, commonly referred to as "members."

These owners may be U.S. citizens, non-U.S. citizens, and non-U.S. residents.

Also, LLCs may be owned by any other type of corporate entity, and an LLC faces substantially less regulation regarding the formation of subsidiaries.

LLC Business Operations:

For LLCs, business operations are much simpler than other corporate structures, and the requirements are minimal.

While LLCs are urged to follow the same guidelines as S corporations, they are not legally required to do so.

Some of these guidelines include adopting bylaws and conducting annual meetings.

For example, instead of the detailed requirements for corporate bylaws for S corporations, LLCs merely adopt an LLC operating agreement, the terms of which can be extremely flexible, allowing the owners to set up the business to operate in whatever fashion they most prefer.

LLCs are not required to keep and maintain records of company meetings and decisions in the way that S corporations are required to do.

Management Structure of an LLC:

The owners or members of an LLC are free to choose whether the owners or designated managers run the business.

If the LLC elects to have the owners occupy the company management positions, then the business would operate similarly to a partnership. 

LLC Taxation and Fees:

Limited liability companies are taxed differently from other corporations.

An LLC allows pass-through taxation, which is when the business income or losses pass through the business and are instead recorded on the owner's personal tax return.

As a result, the profits are taxed at the owner's personal tax rate.

A single-member LLC is typically taxed as a sole proprietorship.

Any profits, losses, or deductions that are business expenses that reduce taxable income are all reported on the owner's personal tax return.

An LLC with multiple owners would be taxed as a partnership, meaning each owner would report profit and losses on their personal tax return.

LLCs avoid the double taxation, which C corporations must pay because they pass all company income through to the tax returns of the individual owners.

A C-Corporation (or C-Corp) is a legal structure for a corporation in which the owners, or shareholders, are taxed separately from the entity.

C corporations, the most prevalent of corporations, are also subject to corporate income taxation.

The taxing of profits from the business is at both corporate and personal levels, creating a double taxation situation.

The fees for establishing an LLC can vary by state but expect to pay nearly $500, which might include the following:

Articles of incorporation fee, which might cost $100.

Annual reporting fees, which can cost a few hundred dollars per year.

Attorney fees if you have a lawyer draw up the legal documents.

Tax and accounting fees if you use an accounting firm to prepare financials and file taxes.

How to Form an LLC:

Below are several of the steps involved in forming an LLC. 

However, please check with your local state since they may have additional forms and requirements.

Choose a name.

The company name should follow the state guidelines in which the LLC will be formed.

Also, the chosen name cannot already be an existing business name that's recorded and established.

Assign a registered agent.

Your LLC may be required to have a registered agent, which is a person or company that handles any legal papers on behalf of the LLC if there is a lawsuit.

Your local office of the Secretary of State should have a listing of local companies that can act as a registered agent.

File articles of organization with your local office of the Secretary of State.

The articles of organization might also be called a certificate of formation or certificate of organization.

Articles of organization are essentially legal forms that outline basic information about the company, and each state may have specific requirements.

However, most states usually require the following: the name and address of the LLC, a description of the general purpose of the LLC, a list of the owners, and the name and address of the registered agent.

Create an operating agreement.

An operating agreement is an internal document that stipulates how the LLC will be run and how it will be managed.

The operating agreement should include procedures for how members will be managed if there are more than one and how profits and losses will be divided between the members.

The operating agreement should also outline the procedures for adding new members and when members leave.

If an operating agreement is not in place and a member leaves, a state may require the LLC to be dissolved.

However, the operating agreement doesn't need to be filed with your state's office.

Instead, it should be kept within your business records and updated as necessary.

Apply for a federal ID number, if necessary.

you have more than one owner, you'll need to establish an employer identification number (EIN), which is a federal ID number that identifies the company.

If you're a sole proprietor, you don't necessarily need an EIN number unless you want it taxed as a corporation instead of a sole proprietorship.

File business licenses, permits, and establish a bank account.

It's important to check with your local state, county, and town offices to determine if there are business licenses and permits that need to be filed.

Depending on the type of business that you'll be operating, your state may require a permit or license to be in place before you can begin operating your business.

Also, if the LLC will be selling goods that are subject to a local sales tax, you'll need to file with your local tax office so that you can collect the sales taxes and remit them to the state.

It's important to note that the above list is not comprehensive since each state may have additional requirements.

Once established, many states require LLCs to file an annual report, which the state may charge a fee.

These fees can sometimes run in the hundreds of dollars per year.

LLC Pros and Cons:

There are distinct advantages and disadvantages to establishing and operating a limited liability company.

LLC Pros:

As stated earlier, an LLC gives the owner or owners limited liability, which means that each owner is not personally liable for any company-related lawsuits or any debts that belong to the company.

In other words, creditors cannot take or collect money from your personal assets to satisfy the debts of the business.

Creditors are only able to take assets from the company.

LLCs are simpler to establish and operate when compared to a corporation.

Corporations typically must have appointed directors, officers, and board meetings. 

LLCs also have tax benefits since the company's income, or losses are reported on the owner's personal tax return.

This prevents the profit generated from the business from being taxed at the business level and also taxed again at the personal level when the owner takes a salary from the company.

Instead, the profit from the business passes through the business entity and is only reported once for tax purposes on the owner's personal tax return.

Another benefit of LLCs is that they are extremely flexible when it comes to their structure.

There are no limits to the number of owners, called members, and LLCs can operate with only one owner, similar to a sole proprietorship. LLCs also allow the owner to designate a manager to run the business, which could be one of the designated members, a non-member, or some combination of both.

LLC Cons:

One of the disadvantages of an LLC is when ownership needs an injection of cash or money.

If the LLC had gotten turned down for a bank loan, it could be difficult for the owner to attract money from outside investors.

A corporation might be able to raise cash from venture capitalist firms, which provide money to businesses in exchange for a share of the profits.

Venture capitalists usually only fund corporations and not privately owned LLCs.

An LLC can be more costly to form and operate when compared to a sole proprietorship or a partnership.

As stated earlier, there can be filing fees for an EIN number and also annual fees for filing the annual report.

Pros:

Personal liability protection.

No double taxation.

Easier to establish and operate than a corporation.

Flexible structure.

Cons:

More costly to establish than a sole proprietorship or partnership.

Must file an annual report, and the fee can cost hundreds of dollars.

Cannot attract outside investment other than banks.

The choice of business entity is going to be guided largely by the nature of the business and how the owner envisions the business unfolding and growing in the future.

S Corporation:

An S corporation's structure also protects business owners' personal assets from any corporate liability and passes through income, usually in the form of dividends, to avoid double corporate and personal taxation.

Below are some of the characteristics of S corporations.

Ownership of an S Corporation:

The IRS is more restrictive regarding ownership for S corporations.

These businesses are not allowed to have more than 100 principal shareholders or owners.

S corporations cannot be owned by individuals who are not U.S. citizens or permanent residents.

Further, the S corporation cannot be owned by any other corporate entity.

This limitation includes ownership by other S corporations, C corporations, LLCs, business partnerships, or sole proprietorships.

S Corporation Business Operations:

There are significant legal differences in terms of formal operational requirements, with S corporations being much more rigidly structured.

The numerous internal formalities required for S corporations include strict regulations on adopting corporate bylaws, conducting initial and annual shareholders meetings, keeping and retaining company meeting minutes, and extensive regulations related to issuing stock shares. 

Further, an S Corporation may use either accrual or cash basis accounting practices.

Management Structure of S Corporations:

In contrast, S corporations are required to have a board of directors and corporate officers.

The board of directors oversees the management and is in charge of major corporate decisions, while the corporate officers, such as the chief executive officer (CEO) and chief financial officer (CFO), manage the company's business operations on a day-to-day basis.

Other differences include the fact that an S corporation’s existence, once established, is usually perpetual, while this is not typically the case with an LLC, where events such as the departure of a member/owner may result in the dissolution of the LLC. 

LLCs and S corporations are business structures that impact a company's exposure to liability and how the business and business owner(s) are taxed. 

S Corporation Taxation and Fees:

S corporations can elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.

The shareholders of the S corporation would report the flow through of income and losses on their personal tax returns.

As a result, the assessed tax would be calculated based on their individual income tax rates.

This pass-through feature helps S corporations to avoid double taxation, meaning the company's income is taxed at the corporate level and again when dividend income paid to shareholders is taxed on their personal income tax returns.

S Corporations must use Form 1120S to file their taxes.

Form 1120S is a tax document that is used to report the income, losses, and dividends of S corporation shareholders

The fees to establish an S corporation can vary significantly, depending on the complexity of the corporation and state in which it's established, but some of the fees can include:

Fees for the articles of incorporation, which might be $100 to $250, depending on the state.

Lawyer fees to process the legal documents can range from a few hundred dollars to a few thousand dollars if the S corporation structure is more complex.

Annual reporting fees within the state might be required and can cost $500 to $800 per year.

Accounting costs for financial reporting and tax services should be considered.

Insurance costs can vary depending on the type of business.

How to Form an S Corporation:

1. Choose a name.

The company name should be chosen that is not already in use within the jurisdiction of the S corporation.

Typically, the local state or town offices will have a listing of the existing corporations in the area so that you can avoid choosing a name that already exists.

2. Establish and name the board of directors.

A board of directors is an elected group of individuals that act as a governing body representing the shareholders.

The board is required to meet at regular intervals and keep minutes for the meetings.

The board is also required to establish policies for the management team.

Every S corporation must have a board of directors.

3. Issuance of stock for the S Corporation can be in the form of common or preferred stock.

4. File articles of organization with the local office for Secretary of State.

In addition to the articles of organization, it might be required to file a document separately stating the purpose of the business.

Although the guidelines can vary by state, many states require the following information:

• Names and contact information of the management team and the board of directors.

• Name of the S corporation

• Number of shares issued

• How shares are allocated

• Registered agent name

5. File the corporate bylaws.

A document outlining the corporate bylaws is usually required to be filed with the local Secretary of State office.

It typically outlines the procedures for the following:

• Electing and removing directors:

• How shares of stock will be sold

• Holding meetings

• Voting rights

• How the death of a director or officer will be handled

6. File Form 2553 with the IRS.

Once a certificate of incorporation has been received from your local Secretary of State office showing that the S corporation has been organized, you must file form 2553 with the IRS.

The form is called the Election by a Small Business Corporation, which makes the company official with the Internal Revenue Service.

7. File with a registered agent.

Many states require that a registered agent is to be assigned for the S corporation.

The agent should receive all legal documents and correspondence between state and federal agencies.

S Corporation Pros and Cons:

There are distinct advantages and disadvantages to establishing and operating an S corporation.

Some of the advantages include:

Pros:

An S corporation usually does not pay federal taxes at the corporate level.

As a result, an S corporation can help the owner save money on corporate taxes.

The S corporation allows the owner to report the taxes on their personal tax return, similar to an LLC or sole proprietorship.  

An established S corporation can help boost credibility with suppliers, investors, and customers since it shows a commitment to the company and to the shareholders.

S corporations allow the owner to benefit from personal liability protection, which prevents personal assets from being taken by creditors to satisfy a business debt.

Also, employees of an S-Corp are also members, which means they're eligible to receive cash payments via dividends from the company's profits.

Dividends can be a great incentive for employees to work there and help the owner attract talented workers.

There are also some disadvantages to establishing and operating an S Corporation.

Cons:

Although most states allow the income generated from an S corporation to be taxed on the owner's personal tax returns, some states do not.

In other words, some states choose to tax an S corporation as if it was a corporation.

It's important to check with your local Secretary of State office to determine how S corporations are taxed in your state.

S corporations can incur a number of fees, including those for filing an annual report, hiring a registered agent, which handles legal matters for the business, and other fees for the Articles of Incorporation filed with the local Secretary of State office.

S corporations can be more cumbersome to establish and operate than an LLC since they require a board of directors and corporate officers.

Also, filing guidelines and regulations are more rigid for S corporations vs. LLCs, including for the annual shareholder meetings, issuance of stock shares, and keeping meeting minutes.

Pros:

Provides personal liability protection.

Doesn't pay taxes at the corporate level, allowing pass through to a personal tax return.

Can boost credibility with suppliers, creditors, and investors.

Pays dividends to employees

Cons:

Some states may tax S corporations as corporations; not at the personal level.

S corporations can incur more fees than an LLC.

S corporations have more regulations and guidelines that must be followed.

Owner has less control.

Which Structure Is Better for You?

For small business owners or sole proprietors, an LLC is often the easiest and most cost-effective way to incorporate.

A business owner who wants to have the maximum amount of personal asset protection plans on seeking substantial investment from outsiders or envisions eventually becoming a publicly-traded company and selling common stock will likely be best served by forming a C corporation and then making the S corporation tax election.

It is important to understand that the S corporation designation is merely a tax choice made to have your business taxed according to Subchapter S of Chapter 1 of the Internal Revenue Service Code.

An S corporation might begin as some other business entity, such as a sole proprietorship or an LLC.

The business then elects to become an S corporation for tax purposes.

Choosing the right business structure will therefore depend on the size and scope of the company, the number of employees, the level of involvement of the owner(s), and tax considerations.

While more complex business structures can allow for greater tax minimization and sophistication, they are also more expensive to create and maintain, often requiring the professional services of lawyers and accountants.

It is, of course, possible to change the structure of a business if the nature of the business changes to require it, but doing so often might involve incurring a tax penalty of one kind or another.

Therefore, it is best if the business owner can determine the most appropriate business entity choice when first establishing the business.

Which Is Better, an LLC or S Corp?

An LLC is often better for a single owner and likely better for a partnership.

An LLC is more appropriate for business owners whose primary concern is business management flexibility.

This owner wants to avoid all, but a minimum of corporate paperwork does not project a need for extensive outside investment and does not plan on taking her company public and selling the stock.

In general, the smaller, simpler, and more personally managed the business is, the more appropriate the LLC structure would be for the owner.

If your business is larger and more complex, an S corporation structure would likely be more appropriate.

Who Pays More Taxes, an LLC or S Corp?

It depends on how the business is established for tax purposes and how much profit is going to be generated.

Both an LLC and S-Corp can be taxed at the personal income tax level. LLCs are often taxed using personal rates, but some LLC owners choose to be taxed as a separate entity with its own federal ID number.

S corporation owners must be paid a salary in which they pay Social Security and Medicare taxes. However, dividend income or some of the remaining profits (after the owner's salary has been paid) can be passed through to the owner, but not as an employee, meaning they won't pay Social Security and Medicare taxes on those funds.

Why Would You Choose an S Corporation?

An S corporation provides limited liability protection so that personal assets cannot be taken to satisfy business debts by creditors.

S corporations also can help the owner save money on corporate taxes since it allows the owner to report the income that's passed through the business to the owner to be taxed at the personal income tax rate.

If there will be multiple people involved in running the company, an S-Corp would be better than an LLC since there would be oversight via the board of directors.

Also, members can be employees, and an S-Corp allows the members to receive cash dividends from company profits, which can be a great employee perk.

Shareholders of a small business that applies for an S-Corp status do so to enjoy tax benefits.

And these benefits are listed below:

Advantages of an S Corp:

An S-Corp does not pay Federal taxes at entity level, but shareholders are taxed on their share of income from the business.

Shareholders can be company employees, but they pay much less self-employment taxes than LLC owners.

S-Corp shareholders enjoy the same liability protection as an LLC.

S-Corps pay shareholders, cum employees, salary and the payroll taxes on it.

This may save them money on taxes because, just like an LLC, they would pay self-employment taxes on the business’s gross income.

Additional earnings in an S-Corp are distributed to shareholders as dividends.

This may also save money because dividends are taxed at a much lower rate than income.

S-Corps enjoy a once-a-year tax filing requirement compared to C-corps, which must file quarterly.

Disadvantages of an S Corp:

Because an S-corp will mean more complicated tax withholdings, you can expect your accounting fees to increase, especially if you wouldn’t otherwise have employees and payroll expenses.

An S-corp may also require separate tax filings.

Therefore, it may only be worth operating an LLC as an S-corp when your company reaches a certain income threshold, and the additional costs and fees make sense from an accounting perspective.

If you’re on the fence about whether or not it makes sense to structure an LLC as an S-corp, it’s a good idea to speak to an accountant about the specific additional costs and the income threshold that justify the tax benefits of an S-corp.

If you are just getting started with your business and are still unsure about how much income your LLC will generate, you may want to consider holding off on setting it up as an S-corp.

Should I Make My LLC an S Corp?

If you're a sole proprietor, it might be best to establish an LLC since your business assets are separated from your personal assets.

You can always change the structure later or create a new company that's an S corporation.

An S corporation would be better for more complex companies with many people involved since there needs to be a board of directors, a maximum of 100 shareholders, and more regulatory requirements.

The Bottom Line:

LLCs are easier and less expensive to set up and simpler to maintain and remain compliant with the applicable business laws since there are less stringent operational regulations and reporting requirements.

Nonetheless, the S corporation format is preferable if the business is seeking substantial outside financing or if it will eventually issue common stock.

In addition to the basic legal requirements for various types of business entities that are generally codified at the federal level, there are variations between state laws regarding incorporation.

Therefore, it is generally considered a good idea to consult with a corporate lawyer or accountant to make an informed decision regarding what type of business entity is best suited for your specific business.

What is Budgeting?

Budgeting is the tactical implementation of a business plan.

To achieve the goals in a business’s strategic plan, we need a detailed descriptive roadmap of the business plan that sets measures and indicators of performance.

We can then make changes along the way to ensure that we arrive at the desired goals.

Translating Strategy into Targets and Budgets:

There are four dimensions to consider when translating high-level strategy, such as mission, vision, and goals, into budgets:

Objectives are basically your goals, e.g., increasing the amount each customer spends at your retail store.

Then, you develop one or more strategies to achieve your goals.

The company can increase customer spending by expanding product offerings, sourcing new suppliers, promotion, etc.

You need to track and evaluate the effectiveness of the strategies, using relevant measures.

For example, you can measure the average weekly spending per customer and average price changes as inputs.

Finally, you should set targets that you would like to reach by the end of a certain period.

The targets should be quantifiable and time-based, such as an increase in the volume of sales or an increase in the number of products sold by a certain time.

Goals of the Budgeting Process:

Budgeting is a critical process for any business in several ways

1. Aids in the planning of actual operations

The process gets managers to consider how conditions may change and what steps they need to take, while also allowing managers to understand how to address problems when they arise.

2. Coordinates the activities of the organization

Budgeting encourages managers to build relationships with the other parts of the operation and understand how the various departments and teams interact with each other and how they all support the overall organization.

3. Communicating plans to various managers

Communicating plans to managers is an important social aspect of the process, which ensures that everyone gets a clear understanding of how they support the organization.

It encourages communication of individual goals, plans, and initiatives, which all roll up together to support the growth of the business.

It also ensures appropriate individuals are made accountable for implementing the budget.

4. Motivates managers to strive to achieve the budget goals

Budgeting gets managers to focus on participation in the budget process.

It provides a challenge or target for individuals and managers by linking their compensation and performance relative to the budget.

5. Control activities

Managers can compare actual spending with the budget to control financial activities.

6. Evaluate the performance of managers

Budgeting provides a means of informing managers of how well they are performing in meeting targets they have set.

Types of Budgets:

A robust budget framework is built around a master budget consisting of operating budgets, capital expenditure budgets, and cash budgets.

The combined budgets generate a budgeted income statement, balance sheet, and cash flow statement.

1. Operating Budget

• Revenues and associated expenses in day-to-day operations are budgeted in detail and are divided into major categories such as revenues, salaries, benefits, and non-salary expenses.

2. Capital Budget

• Capital budgets are typically requests for purchases of large assets such as property, equipment, or IT systems that create major demands on an organization’s cash flow.

• The purposes of capital budgets are to allocate funds, control risks in decision-making, and set priorities.

3. Cash Budget

• Cash budgets tie the other two budgets together and take into account the timing of payments and the timing of receipt of cash from revenues.

• Cash budgets help management track and manage the company’s cash flow effectively by assessing whether additional capital is required, whether the company needs to raise money, or if there is excess capital.

The Process:

The budgeting process for most large companies usually begins four to six months before the start of the financial year, while some may take an entire fiscal year to complete.

Most organizations set budgets and undertake variance analysis on a monthly basis.

Starting from the initial planning stage, the company goes through a series of stages to finally implement the budget.

Common processes include communication within executive management, establishing objectives and targets, developing a detailed budget, compilation and revision of budget model, budget committee review, and approval.

Types of Benchmarking Examples (Plus How to Use Benchmarking)

Effective evaluations of your company's operations can help you remain competitive, motivate your teams and develop beneficial business strategies.

There are several tools businesses use to monitor and track performance.

Benchmarks are one strategy businesses employ to help them learn more about the efficiency of their processes and their place within the market.

What are benchmarking examples?

Benchmarking examples are instances of companies or departments measuring their results against other departments or others in their industry, a practice that can help them understand how they're performing compared to their competitors.

Different industries use benchmarks in various ways to accomplish unique objectives.

Here are some common examples of areas that may use benchmarking to achieve their business goals:

Call centres:

• Call centres often use benchmarks to understand their customers' satisfaction levels.

• They might ask customers to rate their service experience after interacting with a customer service member or complete a follow-up survey.

• Other metrics companies might measure are data related to waiting times, resolution rate, occupancy, call lengths, and shrinkage. They can use the data to form conclusions about their service, processes, and customer satisfaction rates and, ultimately, improve areas they feel aren't meeting standards.

E-commerce:

• Online shopping sites often rely on benchmarks to establish helpful metrics like average cost per conversion.

• These sites might use a benchmark to assess the performance of individual product categories, predict seasonal sales trends, or reevaluate their target markets using customer records and analytics data.

• By comparing their performance to their own historical numbers and others in the industry, e-commerce sites can learn which areas of their operations are performing well and which aren't.

Technology:

• Technology companies often need to stay innovative and competitive to succeed in their industry. Benchmarks can give technology businesses a better sense of their performance among their competitors.

• Measuring their products' life cycles against industry averages and comparing their products' features and functionality to those similar to their own can provide helpful indicators of their place within the market.

Hospitality:

• Various hospitality industry members rely on benchmarks to help them motivate their teams and assess their performance.

• For example, benchmarks for food costs, bar consumables, retention rates, and employee benefits can help hospitality businesses set their prices, train their staff and evaluate their processes.

• Bars, hotels and restaurants often face fierce competition within the hospitality industry. Understanding their performance against their competitors can help them make informed business decisions.

Health care:

• Clinics and hospitals often collect benchmarking data to evaluate patient wait times, recovery times, satisfaction, and quality of care.

• Measuring these data points internally against other areas can help those in medical settings understand their rates of progress.

• External comparisons can also help health care professionals understand their organization's position within the larger medical setting.

What are benchmarks?

Benchmarks are tools different industries use to understand their performance and position within the market.

They can help companies set standards, improve processes, and measure growth.

Benchmarks can be internal indicators of change when companies compare their current numbers against other areas of their business or historical data.

They might also compare their performance to others in the industry, helping them better understand the larger market and their position within it.

Some companies make their information public and easily accessible so the industry can share effective strategies and realize best practices.

How does benchmarking work?

Benchmarking allows companies to measure their and others' performance to create helpful conclusions about effective business practices.

Here are some popular benchmarking methods companies can use to inform their decisions and gauge their success:

Peer benchmarking:

Peer benchmarking allows companies to view others in their industry and evaluate how their own products and services compare to similar ones in the marketplace.

It can provide valuable insight into market standards and customer expectations, which can inform important business practices and business goals.

If a company finds it's not operating at the level of others in its industry, it can take steps to adjust its operations and improve performance.

SWOT analysis:

SWOT stands for strengths, weaknesses, opportunities, and threats, and it can provide companies with a valuable framework for self-evaluation.

Like peer benchmarking, SWOT offers companies an opportunity to look at the market and understand how their offerings and performance relate to their competition.

However, it can go further than peer benchmarking, offering a more holistic look at competitor activity and a myriad of factors within the market.

Performance benchmarking:

Performance benchmarking is a technique companies use to evaluate a single aspect of their business.

By establishing relevant performance metrics for one section of their operations, they can compare their output to their historical results.

In performance benchmarking, recording helpful metrics is essential to understanding how companies compare themselves to their competitors.

This way, if they adjust their processes or change something about their offering, they can see the corresponding change in their performance data.

Collaborative benchmarking:

Some companies make their relevant metrics and data publicly available.

By doing this and encouraging others in their industry to do the same, businesses can share effective strategies that elevate their field and help everyone perform their best.

An example of this might be open-source software, where companies and individuals make their improvements and result publicly available so others might benefit from their work.

Process benchmarking:

Process benchmarking is a strategy larger businesses can use to compare the performance of their internal branches.

If they have multiple segments of their company working independently to complete similar processes, they can compare metrics to understand whose methods are most effective.

This way, they can share strategies between departments and encourage maximum efficiency across their entire operation.

Why are benchmarks important?

Benchmarks are important because they allow companies to form objective assessments of their performance on a larger scale.

They can help companies make meaning from their metrics and use them to encourage improvement.

Benchmarks are also important because they:

Help companies gain a competitive edge in the marketplace.

Encourage employees to work together toward a common goal.

Relate goals to measurable metrics and performance indicators.

Help companies discover innovative strategies to help their products and services stand out in the marketplace.

Make it easier to evaluate the strengths and weaknesses of a product or service.

What's the difference between benchmarks and KPIs?

Benchmarks differ from KPIs (key performance indicators) because, while they serve similar purposes, KPIs can be stronger tools for helping companies evaluate their progress toward goals, whereas benchmarks serve as reference points to help businesses understand their place within the market's wider context.

Together, both benchmarks and KPIs can provide valuable insights for businesses.

Benchmarks can offer a greater awareness of a company's operational efficiency.

KPIs can show an individual, project, team, process, or organization the progress they've made toward achieving their strategic goals.

With benchmarking, companies often want to understand more about their competitors, costs, customer satisfaction and the overall quality of their product or service.

While this strategy helps companies make conclusions about their ability to meet goals, ultimately, its purpose is to relate their performance to others in their industry rather than their internal goals or values.

They help businesses identify areas for improvement.

KPIs, however, help companies monitor performance and understand how to recognize clues for when they aren't meeting targets.

How to use benchmarking:

If you're interested in using benchmarking to reveal more about your processes and performance, here are some steps you can take:

Set goals: The first step to using benchmarks is to set your goals. Whether you choose something company-specific or industry-wide, setting goals can help you determine what questions you want your benchmark data to answer.

Identify metrics: Once you have your goals in mind, decide on the best metrics to evaluate your progress toward your goals.

If you plan to compare your operations to others in your industry, consider researching the metrics they use, so you have helpful comparisons.

Collect data: Spend some time collecting data on your identified metrics.

Building a robust data set to draw from can help you make the most of your information and create informed analysis and conclusions.

Analyze data: After you've collected all your data, use it to determine how your business strategy is working within the market.

Evaluate: Take your analysis and use it to make assertions about your processes and efficiencies.

These conclusions can inform important business decisions or help you identify areas needing improvement.

Most businesses and organizations set goals in order to achieve the right objectives and fulfill the needs of its stakeholders.

Those goals start at the top and trickle down to every team within the organization, each performing unique functions to advance the business.

There are many different ways to set and measure goals.

One popular way to measure an individual, team or company’s progress toward a goal is by using key performance indicators, or KPIs, which set a standard of success for a specific business objective.

Assessing the performance of a business is an important aspect of determining its success.

Certain indicators can help a company's decision-makers determine what steps to take in the future and where to allocate funds.

These indicators are known as key performance indicators, and they allow a business to quantify its success in various areas.

What are key performance indicators?

Key performance indicators are values that companies can use to measure their growth and determine areas of improvement within their operations.

Key performance indicators (KPIs) are measurable values that determine how effectively an individual, team or organization is achieving a business objective.

Organizations use KPIs to help individuals at all levels focus their work toward achieving a common goal.

KPIs also help businesses understand whether they’re spending utilizing their time, and budget and talent on the right strategies, tasks and tools in order to achieve its goals.

Professionals can also set personal KPIs to gauge their individual success, guide their decision-making efforts and improve performance over time.

By tracking KPIs, both individuals and organizations can better understand their development and evolve with the market.

Are KPIs the same as metrics?

While all KPIs are metrics, not all metrics are key performance indicators.

Specific metrics provide quantifiable information about a certain process or financial aspect of a business.

In contrast, general metrics may not be as useful or important when assessing business goals and objectives.

Types of KPIs

KPIs can be used in nearly any part of a business.

Here are the two main types that may be used to account for the needs of the group using them:

Lagging vs. leading KPIs

Lagging KPIs measure the current state of a business and its achievements toward a goal after a set period of time.

Leading KPIs measure and determine a business’ future state.

High vs. low KPIs

Key performance indicators that target an entire organization’s goals are called high KPIs.

These indicators measure the company’s success as a whole.

KPIs that target smaller projects, such as departmental strategies, are called low KPIs.

Are certain KPIs more important than others?

Some people believe that financial KPIs are the most important, but your organization's most vital key indicators will depend on your specific objectives and industry.

If you are trying to grow your business or obtain funding or investments, financial KPIs may be the most critical to monitor and assess because potential investors will want to review these numbers.

However, if your business objectives are focused on employee retention or customer satisfaction, other indicators could be more valuable and insightful.

What makes a good KPI?

A business’s ability to track its progress toward a goal is only effective as the quality of its KPIs.

Using the “SMARTER” framework, a good KPI should have the following qualities:

Specific: A KPI should be a detailed, simple and clear description of what exactly you want to achieve.

For example, “Improve customer satisfaction” is too broad.

A better KPI is, “Improve customer satisfaction ratings by 10% by the end of Q3.”

Measurable: As demonstrated in the example above, KPIs should be quantifiable to establish an exact definition of success.

When thinking about ways to measure, consider using dollar amounts, percentages or raw numbers.

Achievable: It's best that your KPIs are ambitious yet attainable within reason.

This ensures individuals working toward them are motivated and challenged but don’t burn out.

It also helps set realistic expectations with stakeholders and company leadership.

Relevant: Your KPI should help advance the larger key business objective(s) of the team above you.

For example, if you're on a client success team that falls under the company’s marketing organization, your KPI should align with marketing objectives.

All KPIs should align with a larger key business objective.

Time-bound: Select an ambitious yet realistic amount of time in which you’ll measure your progress toward a KPI.

For example, you might decide you want to achieve a certain amount of renewal sales by the end of a quarter, month or calendar year.

Evaluate: Regularly examining your KPIs is a great way to ensure you’re still working toward the right objectives.

During your evaluation you might ask questions like:

• Is my KPI still relevant?

• What are the main blockers to success?

• Do I have the right budget, tools, talent and support?

After this KPI period is complete, what should be measured next?

Reevaluate/Readjust: Consider reevaluating your KPIs at specific periods—perhaps halfway through your KPI timeframe and once again at the end.

Take this time to determine whether it's necessary to make changes to your KPIs so they’re up to date, achievable, relevant and in line with company objectives.

Tips for creating KPIs

As you create your own business KPIs, use these tips to increase your chances of success:

Review targets with employees: By reviewing targets, goals and objectives with the members of your workforce, you can get a sense of what is most important in the business and adjust the KPIs accordingly.

Be willing to evolve: It's important to be willing to evolve and update KPIs over time, as certain targets may become obsolete or your organization may achieve its goal in one area, providing space for new goals and objectives.

Use a dashboard: Tracking KPIs online or through a software platform provides instant access to real-time results.

Providing access to those metrics through a dashboard ensures that all employees and business leaders can review the information regularly.

Reflect your business processes: As you consider what KPIs to use in your business, make sure that all of the indicators you select reflect your business process and industry-specific needs.

How to create KPIs

Follow these steps to choose and implement key performance indicators:

1. Determine your end goal

Create a clear vision of what you're trying to accomplish.

Keep this objective simple and straightforward.

Your KPI should be connected with a key business objective that is both strategic and impactful to the organization.

Without a clear vision, you risk working toward something that ultimately wastes time, energy, money and resources.

Consider meeting with your manager to ensure you’re setting good goals and having them review your KPIs after you’ve set them.

2. Ask key performance questions (KPQs)

Consider developing KPQs, or questions that determine whether you’ve met an objective.

When crafting KPQs, try to avoid simple yes-or-no questions such as, “Have I met my sales quota?”

Instead, ask open-ended, thought-provoking questions such as, “How might I market my product portfolio better?”

The answers to your KPQs will give you good information to create useful KPIs.

Other examples of KPQs include:

• What result do I want to achieve?

• Why is that outcome important?

• How can I define progress?

• How can I affect the result?

• How will I know I’ve reached my end goal?

3. Identify what information you already have

Before assigning metrics to address your KPQs, see if another department or manager is already collecting that information.

If so, you can simply adjust the equation and apply it to your business strategy.

Collecting existing data also helps to set a realistic target for your KPI.

4. Collect supporting data

Take time to collect additional information to create a KPI.

Depending on the objective, this information might be industry trends, demographics, traffic averages, email performance, conversion rates or competitor analysis.

Use this information to inform your key performance indicators.

Avoid simply measuring the same KPIs as your competitors.

Every business is unique and what works for one company might not work for another.

Dedicate time to clearly pinpoint what metrics will benefit your company based on it's strengths, weaknesses, opportunities and threats.

5. Determine how frequently you’ll measure each KPI

Next, identify a good cadence for checking in on progress toward the KPI.

It's best to predetermine how and when you’ll measure, including which tool you’ll use to pull the data upfront.

Keep in mind that your KPIs can, and in most cases should, evolve and be updated.

As businesses evolve, it’s important that KPIs are revisited and adjusted to reflect those changes.

Monitor KPI status regularly to make sure it’s still useful and tracking the information you intended it to.

6. Set short- and long-term goals for the KPI

For example, if your KPI is to sell 2,400 memberships to your service over the course of a year, it's best to break it up into short-term milestones.

In this scenario, you might set short-term goals to sell 200 new memberships per month.

Then, you can use this rate to determine whether you need to change expectations or strategies as you go.

Failing to reach a goal doesn’t mean that selecting a certain KPI was a bad decision.

On the contrary, you can use the data you collected and the information you learned to improve performance in the future.

By identifying your shortcomings, you can make adjustments accordingly.

Remember, KPIs are designed to help companies and individuals make sound business decisions and to continuously improve over time.

7. Delegate responsibility for KPIs

There are many moving factors when it comes to KPI development and maintenance.

Make sure you have clearly assigned individuals or teams to specific tasks.

The assessment, data collection and interpretation, monitoring and presenting of KPIs should all be accounted for.

8. Share KPIs with appropriate leadership and stakeholders

Contribute to your organization’s success by communicating strategies, progress and outcomes.

Be transparent when discussing what you’re measuring and why.

This can help employees and stakeholders feel invested or “bought-in” to the goals.

All team members must be aware of the objectives so they can work toward them and provide feedback as necessary.

Key performance indicators aren’t static, and you must update them as your organization’s needs evolve.

Reporting on KPIs

Once you’ve measured a key performance indicator, you may want or be required to present your progress in a KPI report.

This is typically useful for project leaders, team leaders, managers and supervisors to communicate with company management, department heads or other stakeholders.

Here are three KPI report categories you might create depending on the information your audience needs and your goals:

• Analytical report

• Operational report

• Strategic report

This report details the KPI and works to explain what impacted your results most.

This might include historic KPI data for comparison.

This report provides data about how KPIs measure an organization’s daily operations so management can make well-informed decisions.

This report reflects the health of the organization and its progress so stakeholders can determine whether the company is meeting goals.

What to include in a KPI report

While your report should be written to address the needs of the audience in a way that appropriately reflects your goals or projects, there are a few key pieces of information that might be helpful to include.

Here are a few examples of key information you might include in your KPI report:

Goal: Clearly identify which objective the KPI is evaluating.

Metric: State the quantifiable, relevant and actionable key performance indicator you’re using for measurement purposes

Rationale: Explain why you or your team chose this KPI and how the resulting data contributes to the company’s success.

Frequency: State how often you measured your key performance indicator and at what frequency you’ll re-examine it.

Source: Identify where you gathered the data and consider sharing a formula for calculating the data.

Visuals: Use a chart, table or graph for easy comprehension.

If applicable, compare it with previous visuals of the same type to track progress over time.

Comments:

Here you can briefly add any other relevant information or interpretation of the metrics you obtained.

KPI reporting tips

Here are a few additional tips for preparing your presentation:

Be concise.

Your report should be succinct and easy to understand.

Consider refining your data to only the crucial takeaways.

Use visuals.

Charts and trend graphs can make results easier to retain.

Simplify technical information.

Be sure to explain technical terms using resources such as glossaries.

Be truthful.

Be honest, regardless of the results of the report.

If a key performance indicator shows the company or department did not reach its goal, craft a plan for how you’ll achieve better outcomes in the future.

Include historical data.

If the company has run previous metrics on this key performance indicator, compare current data with past data to evaluate progress.

Offer regular reporting.

Schedule regular updates across the lifespan of the KPI to present and compare data as it changes.

Monitor progress and determine how often you’ll present your findings to stakeholders on an ongoing basis.

Examples of KPIs by industry

A company’s key performance measures will vary depending on the industry and the organization’s objectives.

For example, a technology company might measure growth by comparing each year’s earnings, while a retailer might look at same-store sales.

Some KPIs will be more quantitative than others.

For example, earnings are generally much easier to measure with hard numbers while user satisfaction with a product, service or site is open to interpretation.

Performance indicators can be based on finances, customer service, marketing, sales, manufacturing, human resources, supply chain and more.

Below are some possible KPIs for different industries.

Sales and finances

Examples of sales and finance-based KPIs might include:

• Earnings before interest, taxes, depreciation and amortization (EBITDA)

• Net profit (how much revenue the company retains after paying taxes, expenses, etc.)

• Gross profit (how much revenue the company retains after deducting the production cost of goods sold)

• Costs (to figure out ways to lower them)

• A comparison of projected vs. actual revenue

• A comparison of expenses vs. budget

• Debt vs. equity ratio

• Day sales outstanding (DSO) (the average number of days it takes to receive payment after a sale)

• Regional or national sales

• Sales from new customers

• Repeat sales revenue

• Proposals issued and/or lost

• Deals closed

• The number of prospect meetings across a set period

• The number of returned items

• The number of online vs. in-store sales

• Inventory turnover (how long it takes for products in inventory to get sold)

• Average sale size

• The cost of maintaining sales staff

• Marketing

Examples of marketing key performance indicators might include:

• Dollars spent on marketing over a certain period

• Online traffic (the number of visitors to the company website)

• Organic online traffic (the number of visitors to the company website via a search engine)

• Web traffic (to determine how many visitors are new vs. returning)

• Mobile traffic

• Click-through rate (the ratio of web traffic that clicks on a particular ad)

• The number of visits to a particular piece of content

• SEO rank (where your web content appears in search engine results for certain keywords)

• Social media traffic growth

• Sales revenue earned from online marketing campaigns

• Marketing qualified leads (a potential customer who has indicated he or she is likely to buy the company’s product or service)

• Sales qualified leads (a potential customer who’s been researched, vetted and determined likely to buy the company’s product or service)

• Cost per lead

Customer relations

Examples of customer service-based key performance indicators might include:

• Customers gained over a set period

• In-store foot traffic

• Percentage of customers who don’t continue paying for service or buying products

• Cost of customer acquisition

• Customer lifetime value (to determine how to best gain and retain customers)

• Customer retention

• Customer satisfaction or customer satisfaction score

• Survey-based net promoter scores (to determine whether customers would recommend the company to others)

• Customer support tickets and their response or resolution times

• The number of calls to customer service

• The number of customer complaints via email, phone or other methods

Human resources and employment

Examples of human resources or employee-based key performance indicators might include:

• The number of new hires

• Cost per hire

• The number of promotions

• Employee turnover

• Employee satisfaction via survey responses

• Retirement rate

• Absenteeism rate (to determine how much productivity has been lost due to employee sick or personal days)

• The rate of training and development based on test scores pre- and post-training

• Salary competitiveness ratio (to determine how your company’s average salary compares to your competitors or the industry as a whole)

8 Key Performance Indicators for a Startup Company To Use

Businesses use key performance indicators to measure their value and success.

Startup companies may use them to find ways they can expand their sales and achieve sustained financial health.

If you're part of a startup company, learning about key performance indicators may help you measure goals and advance your workplace's growth.

Startup companies may use key performance indicators to help them increase their brand awareness, boost their sales and help sustain their finances.

Key performance indicators also allow companies to gauge their success and estimate their future financial health.

Why are key performance indicators for startups important?

Here are some reasons it's important for startup businesses to use key performance indicators:

Show growth: Using key performance indicators can give startup companies insight into their recent progress, which allows them to estimate future growth.

They may look at their most recent cash flow statements and monthly burn value to determine the rate at which they may grow in the upcoming sales period.

Identify areas of improvement: Key performance indicators allow startup businesses to recognize areas of improvement within their business model.

For example, if a company recognizes that it has a low runway, then company staff may conduct fundraisers to increase their workplace's runway and help it sustain growth for a longer period of time.

Give investors insight into sales potential: It's important for startup companies to gain investors to grow their business and expand their budget.

Key performance indicators allow investors to identify a startup's financial forecast and determine if they want to invest in it or not.

1. Total addressable market

The total addressable market is a key performance indicator that measures a company's target audience and market size to determine the amount of customers they might attract.

This can help startups determine their marketing needs, which may allow them to have a better idea of their budget.

Startups can find their total addressable market by performing market research and communicating with their target demographic, typically through social media or advertisements.

2. Customer acquisition cost

A customer acquisition cost is the amount of finances that businesses must spend on manufacturing, marketing and distribution that may lead to them acquiring new customers.

It's essential for startup businesses to be aware of their customer acquisition cost since it's likely that customers may be unfamiliar with their brand, so they may need to devote more time, effort and money to gain new customers.

Having a low customer acquisition cost may help startup businesses sustain their growth for a longer period of time since they can spend less money and acquire a larger amount of customers.

3. Customer retention rate

A customer retention rate indicates the amount of customers that remain loyal to a company after a certain period of time.

It's important for startups to have an idea of their customer retention rate so that they can estimate upcoming sales accurately and increase customer retention.

For example, if a startup company finds it challenging to keep customers for long periods of time, it may change its marketing techniques or offer incentives to encourage customers to continue engaging with the company.

4. Lifetime value

Lifetime value measures the average amount of finances that a company may receive from a customer over the course of a company's lifespan.

If startups achieve a high customer retention rate, then they may have a higher lifetime value from each customer.

Determining the lifetime value helps startups estimate their growth and identify potential sales forecasts.

For example, if a customer spends an average of $100 per year at a company, then company staff can estimate that the customer's lifetime value over the next 10 years is $1,000.

5. CAC recovery time

CAC recovery time is a key performance indicator that determines the time it can take for a company to receive a profit from their customer acquisition cost.

This gives insight into the amount of net revenue that a company may receive, which also affects the organization's cash flow and financial growth.

For example, if a toy store spends $150 on average to acquire a new customer, and it takes the new customer six months to spend $150 at the toy store, then the store's CAC recovery time is six months.

6. Monthly burn

The monthly burn is a key performance indicator that helps startups understand their debt and the amount of money they may lose in the beginning months of their launch.

It's common for startups to have a negative cash flow in the early stages of their creation since they may have a higher customer acquisition rate to bring in new customers, or they may have a smaller profit if their sales are lower.

A monthly burn refers to the amount of money that a company has, which is negative cash flow.

For example, if a clothing store generates $10,000 in one month, though they pay $15,000 for inventory and overhead expenses, then their monthly burn is $5,000.

7. Runway

Runway measures the time that a startup has before they run out of finances.

Companies can measure their runway by evaluating their amount of assets and dividing it by their average monthly burn.

For example, if an amusement park has $100,000 left for funding, and their average monthly burn is $10,000, then $100,000 / $10,000 = 10, so the amusement park's runway is 10 months before they run out of funding.

It's common for startup businesses to have a runway of 12-18 months since that's generally the amount of time it takes before startups gain a sufficient amount of steady customers and become profitable.

Startups may increase their runway by boosting finances, usually by adding investors or increasing sales.

8. Profit margin

An important KPI is profit margin because it informs a company of how much money their product or service sells for based on how much the product costs to manufacture.

It gives insight into a company's return on investment and helps a company evaluate its long-term sustainability and growth.

If a startup has a high profit margin, they may have a higher revenue, which can lead to lower CAC recover time.

For example, if a company spends $10 to manufacture a product and they sell that product for $80 to customers, then their profit margin is $70.