Startups and Entrepreneurs guide to accounting and legal compliance
I tried to write an E-Book but I think it is better to discuss it on Tikshare since writing a book requires certain discipline and time. Writing a book also closes the door for mutual discussion.
Here is part of book which were completed. We can discuss the topics on Tikshare itself. Please note upto accounting system is produced here.
STARTUPS & ENTREPRENEURS
- Starting a Business
- Business Structure
- Accounting – Introduction
- Accounting System
- Structuring accounting System
- Implementation of accounting System
- Reporting and Financial Statements.
- Planning your taxes
- Statutory Audits
- Internal Audits
- Funding – How by following this book you can have an edge in securing funding.
STARTING A BUSINESS
The first step to achieve something is to START.
If you got an idea the first thing you need to do is to execute your idea. Idea if not executed is a worthless thought. Great businesses are not built over a night; even they started with an Idea.
Once you have an Idea, you have to execute your idea. You have to convert your idea into a product. People pay for products and not for idea.
This book is strictly written considering the practical aspects and very less to do with theories. Theories are good to read but difficult to follow. The entire book will teach you, how to build your business and take care of your accounting and tax requirements.
How to build a product (Accounting and Tax views)
A product does not mean any physical commodity; a product means value that your customer pays for. A product can be anything, your services, your time or your manufactured products. For a software engineer product is his time, his websites, or his software. For a trader product is what he sells. For a marketer product is his services. It is very essential that you write down your products and what value they provide to your customers.
In India or elsewhere, indirect taxes (we will read about indirect taxes in later parts) are imposed based on the product descriptions. Products are classifieds based on different criteria and it will help your tax consultant to accordingly classify your products for tax purposes.
Why you need advice before you start building your product? Many of you will think why we need have a second opinion from a consultant before you start making your product. Well, you are technical qualified to make your product but there are certain things that you should consider before you start making your product.
A Proper planning is required if you are seriously considering your product for commercial purposes. But I do not advice a consultation at the idea stage. Before consultation you must have a description of your product, market and estimated revenue.
You should have a cost sheet for your product, whether you need a team for your product, whether you will incur expenses during product development.
It is very much advised that before you avail any consultancy you have a solid paper explaining your product. Consultancy will be helpful only if you have proper idea of what your product is and what market it will cater.
Taxes are applicable if you sell something, but some taxes which will not have a significant impact on cost but are necessary. For example, if you hire a team and pay them salaries you need to have professional tax registration. Profession tax is state wise tax collected by government from employees among others.
Your consultant may not be able to comment on applicability of other registrations unless you disclose your product development cycle and cost attached to different stages.
Accounting is something, you should not avoid even at infant stage of your product. Your products costs will be accounted as per applicable accounting standard (Accounting standard are issued by Institute of chartered Accountants of India and are applicable to all companies*).
If you are serious about your product you should be equally serious about accounting also. Reports will help you present your claims to banks, financial institutes and VC’s. You do not have to run at last moment to document your cost. You will end up having a good image and a proper accounting shows your seriousness for you product and business.
Accounting at product development stage will be helpful for you to track the cost incurred and treatment while filing your tax returns.
Coming together is first step to success.
This chapter will help you to decide:
- What are the available options to run a business?
- Factors you should consider before choosing a business structure and type of business organization.
- What business structure you should have?
- How to distribute the ownership among teams?
You must have heard I have a company or I am a co-founder of a company. A little ignorance at your part to understand what a company is can bring embarrassment to you. In this chapter we will understand what are the different types of business setups you have to choose from and why you should choose one.
What are available options to run a business?
In India you can run your business in form of Proprietorship, Partnership (Including LLP) or a company. You should understand the basic concept of what all these terms mean before you decide a business structure.
Proprietorship is a form of running business where business and its owner is same person. Business represents its owner and owner represents business. All registrations required for business are to be taken on name of business owner. The concept of different entity does not exist. All liabilities incurred for business are personal liabilities of its owner.
Partnership (Excluding LLP) is similar to proprietorship in all manners except that 2 or more persons are jointly running the business. Liabilities are not limited to assets held by business. Each partner works as agent for each other and firm, acts of one partner are binding on the acts of all other partners.
Limited Liability Partnership or LLP is a new concept introduced in India. LLP are similar to partnership firms, difference being limited liability and LLP’s are governed by Limited Liability Act, 2008. Partners are not liable for acts of other partners. A LLP have separate legal status from partners.
Company, by the time you read what a company mean you will understand what I meant in opening paragraph. A company is type of business structure where business and its owners are separate legal entities. A company is governed by The Companies Act, 2013 and is highly regulated.
Some of the characteristics of a company are:
- Companies are separate legal entities from its owners (Share holders).
- Companies have to affix Private Limited or Limited after its name.
- Management need not be in hands owners or promoters of company. Management and share holders can be different and share holders cannot interfere in day to day management of company.
- Companies have limited liabilities, any liability should be paid out of company assets and liability of shareholders is limited unpaid share capital.
Factors you should consider before choosing a business structure and type of business organization.
Once you have understood what is the difference between different business structures you can have for your business, next you should understand what factors should be considered before you finalize a structure for your business.
Different factors should be considered before you implement a structure. Different structures have different benefits. The structure which suits best to your needs should be finalized to run your business.
- Risk and Liability: Risk and liabilities associated with your business should be first priority to consider. If you are launching a product which requires funding, you should consider the risk associated and liabilities which your business has to face in case of business disaster. It is always better to choose structure having benefits of limited liability. Your liability in case of disaster will be limited to unpaid share capital.
Business disaster here means financial disasters.
- Ownership and Control: Ownership and control is a big factor which if not seriously handled can bring down your business even before it starts building. You should consider the fact whether you are ready to share your business with others. You not only share your profits but also losses and management. Your partner will be equally involved in management of business. You should ignore your rigidness while deciding ownership of your business. Of course if you have co-founders working on your product, you have to split the ownership.
- Separate Legal Entity:If you want to separate your new business from your personal works, you should consider concept of separate legal entity. Business Dictionary quotes the concept as “A legal entity, typically a business, that is defined as detached from another business or individual with respect to accountability. A separate legal entity may be set up in the case of a corporation or a limited liability company, to separate the actions of the entity from those of the individual or other company.
- Management and Ownership: In case of companies, management is different from ownership. Shareholders cannot interfere in the operations of company. Directors run the management of company, while shareholders earn the dividends.
- Cost: Among other factors you should also consider the cost associated with each structure or type of business organization. While you do not have to spend serious money to form a proprietorship, registering a company involve some cost.
- Compliances and maintenances: while taxes are applicable to all type of business structures, some compliance are meant for specific structures only. For example, Compulsory audit is required for a company irrespective of revenue you generate.
- Funding and Investment: How do people invest in your business? You want only funding but not participation in management. You must consider these before opting for a structure. If you require funding from VC’s or HNI, you should consider having a company. VC’s and HNI subscribe to shares. When it comes to investing, people prefer Companies over other forms of business structures.
What business structure you should have?
Depending upon the various factors explained above, you must have got an idea about your preferred business structure. You know your business and environment under which it operates; you can judge the factors and decide about most suitable business structure.
I discussed the factors based on which you should decide your business structure. You can refer to the discussion post Proprietorship vs Partnership vs PVT LTD-LLP for business.
Other than factors listed in previous sub-chapter, you should also consider whether you are going to issue Stock options (ESOPs) to your employees, even Google started by issuing ESOPs to employees. Flipkart hired best employees by issuing ESOPs. ESOPs boost the morale of employees and they work hard to achieve the goals you have set for your business. Only Companies can issue ESOPs.
How to distribute the ownership among teams?
Being founder of Tikshare.com, even I have faced this. Tikshare.com was registered as a company and ownership or shareholding was divided based on technical factors. It is not necessary that you have to decide ownership based on only money contribution. You should consider:
- Technical know how
- Management role
- Viability of business with or without partners
ACCOUNTING – INTRODUCTION
If you don’t account, you never know where you stand.
Accounting is must and you cannot ignore it at any stage of your business. You should start accounting your expenses and revenues from the first day you start. You need not have a full time accountant unless you feel one is required. You can either yourself account your expenses in simple Excel file or hire for part time.
You may not feel heat until yearend when you have to file your taxes or month end when bills are to be paid.
Accounting not only tells where you stand in terms of finance but also help you assess your improvements in business. Accounting is the only option you have to reconcile your budgets.
How do you know, where you stand after 6 months of starting your business? Accounting answers your doubts, with accounting system in implementation you have numbers in your hand to compare with budgets.
Accounting not only help you understand your financial position but also indicate whether you are missing your budgeted targets.
Government collects taxes based on your revenue, VAT for example is exempted up to 7.5 Lakhs in state of Karnataka , if you do not have proper accounting/book-keeping in place you will find yourself in trouble proving that your revenue is less than 7.5 Lakhs.
Reports prepared using your accounting records will help every time you have a decision to make. Based on your past performance you can prepare estimation for future. Even for that matter, what you think which is more reliable, estimation and projections made using some base or without any data in hand. People will have more faith and believe your projection reports if you can show them your past performance with documentary proof.
Accounting should not be misunderstood as statutory compliance but should be considered as a tool, tool that helps management to make decisions and evaluate performance.
I remember a case where 2 partners separated even before product reached at breakeven point; dispute was on who spent how much and how the share should be allotted in newly formed private limited company. You may open a business with your friends, but how long it will go. Some day even you may have this trust issue unless you have record of all finance transactions. You do not have to mine data from back of your mind to calculate how much each of you spent, you may forget expenses paid by your friend or he may not remember how much you invested from time to time. It becomes very important to keep a proper accounting system to avoid these issues. Initially you may not feel the need of proper accounting but once your business starts performing well, everyone suddenly start looking at their ownership and may feel cheated without looking at your efforts and investment.
By maintaining proper accounts, you have a base to explain to each of your partner their and your investment.
Properly implemented system increases productivity and efficiency.
Structuring accounting System
A system is a set of interacting or interdependent components forming an integrated whole.-Wikipedia
Like other systems you implement for your product, even accounting needs a systematic approach. System implemented properly can increase productivity and helps in cutting cost.
Organized set of manual and computerized accounting methods, procedures, and controls established to gather, record, classify, analyze, summarize, interpret, and present accurate and timely financial data for management decisions. – Businessdictionary
A good accounting system should lay down the procedure and methods to record, document and classify your financial transactions.
You may divide your accounting system in 2 parts. One part on how to gather, record, document and classify your financial transaction and second part on how to generate useful and accurate information from the recorded data.
While documenting your accounting system you should take care of following things:
- GIGO (Garbage In, Garbage Out): First thing, only financial transactions needs to be accounted, anything which has no numbers attached to it does not form part of accounting books. Reports you generate from your accounting data will completely depend on the data you provide for recording and documenting.
If you book-keeper is provided incomplete details, reports will be factually wrong and reports generated will not represent your business accurately.
Your accounting data should be accurate and should have a documentary proof. You must ensure that transactions are recorded on base of some document; document can be either external or internal.
Some of external documents are Purchase bills, Expenses bills erc. Internal documents are transaction approved within your business by your management, example payroll processing, sales bills etc.
- 2. Time: Every month you have to file your tax returns. VAT returns, Vat payments and other tax payments are on monthly basis and should be paid/filed before or on due date. If you accounting system is not properly structured you may miss out the due dates and end up in paying penalties and interest. This could be fatal to your business, in initial stage cost reduction should be our primary target and missing these due dates will hit your bottom line badly.
- 3. Each transaction should be authorized and responsibility should be fixed: Each and every transaction that you will account should be authorized by management. You can fix different monetary limits for each layer of management. In a startup you don’t have liberty to appoint different layers of management. Your financial position does not allow you to have different management layer. However, you can fix a system where transaction of a person is authorized by someone else and not by himself.
For example, your partner who incurred some cost on marketing should be authorized by you to keep the trust and also authorization by you will result in a continuous audit and any defect in calculation or if any document is missed will be corrected.
- 4. Documentation: If you do not have proper documents based on which you recorded transaction, it will put you in trouble to explain the validity of transaction. Income Tax act and every other tax act require documentary proof of what you account and for every number that you consider for filing your returns.
You can consider having a separate file for category of transaction. A separate file for employees, a separate file for your expense etc. Segregation of records at the time of recording helps you to search the documents whenever required.
- 5. Timely reconciliation: Your structured accounting system put emphasis on timely reconciliation of transactions. Reconciliation is a part of audit where any unaccounted transaction or wrong accounted transaction or double accounted transaction can be traced and corrected.
For example, reconciliation of Bank book will help you trace any double payment or wrong payment.
Accounting system for your business should have a complete flow of how transaction will be recorded, who will authorize transactions, monetary limits for each management layer, Documentation, reconciliation and period of accounting.
If you are operating as a company, you may consult how to treat different transactions. You need to follow accounting standard issued by Institute of Chartered Accountants of India. At the year end, auditor will have fewer queries to answer if you have a properly structured accounting system.
Your accounting system should be able to meet the statutory reporting needs, to provide reliable accounting information to different users, and to protect the organization from the possible risks stemming from abuse of accounting data or of the systems itself.
Your accounting system need not to be of 100 pages, it could be of a single page if it covers all the requirements.
Implementation of accounting System
Once you have structured your accounting system. Next step is to implement the accounting system. In starting or till time you have hundreds of transactions to record; you may opt for outsourcing instead of appointing a full time employee.
Whether you should outsource or employee full time will depend on volume of transaction and structure of your accounting system.
In implementing you accounting system you have to answer specific questions such as
- Accounting software to be used.
- Place to keep documents.
- Authorization process
- Recording intervals
- Cut off times
- Recovery in case of disaster
- Documentation procedure
- Documents required for internal and external purpose and how to segregate
- Role of Accounting Manager
- Safety measure in case of outsourcing etc.
Reporting and Financial Statements
Your accounting records are important to comply with statutory requirements and also to support management decisions. The various usage of accounting data is:
- Preparation of financial statements
- Preparation of projected data
- Complying with statutory requirements
- Financial audit and analysis of funds
Cash flow and funds flow statements to scrutinize your financial performance
Thanks for writing this nice book. It is very useful to all who are running business or willing to run businesa.
Its Very Nice.
What About Marketing Strategies, Business Growth plans etc. You can update if you feel so.
Thinking of starting a business?
It's important to consider whether you really understand what's involved and whether you're suited to business and self employment. Start by asking yourself these questions:
- What do I need before starting a business?
- What type of business should I start?
- How do I choose a business name?
- What skills do I need to start a business?
- What are my business goals, objectives and skills?
- How much income will my business need to generate?
- What are the advantages and disadvantages of starting my own business?
- What if i face the Losses in Business, Do i have financial Backups?
I was writing this book from the accounting view. Marketing itself is a big topic and including marketing would be a mistake since I am not a proved marketing professional, but yes trying to achieve that. However I wrote an article for professionals to market their services.
Thank you for appreciation and further points entrepreneurs to take care of.