Setting Up Financial and Recordkeeping Systems

Financial management and recordkeeping systems are frequently the bane of an entrepreneur's existence. Perhaps the problem is that the creative side of entrepreneurism is often at odds with the "bean counting" side. Taking time to organize a good system can be tedious and time consuming, but it only takes one visit by a tax auditor or a turndown for a loan by a bank to convince any business owner that an organized system would be useful.

Why are financial management systems so important? Because they provide you the basis for all the reports you need to make to governmental agencies, banks, and potential funders, plus they provide you with an overall picture of how your business is doing and where it is headed. Financial statements are a way to track your progress towards your goals and provide you with the information needed to make decisions as you go along.

Your basic recordkeeping system should be easy to use, understandable, reliable, accurate, and timely. Let's look at the basics of what such a system should include. You will want some type of business journal to record transactions (receipts, disbursements, sales, purchases) and a well-organized filing system. Additionally, you should be generating monthly reports on cash flow, accounts receivables, accounts payable, payroll, an overall income statement (balances income against expenses), and a balance sheet (which gives an overall picture of the current worth of the business).

Your first step in setting up an ongoing system is to get a baseline set of information for your business. You will need to estimate your startup costs and the money you have available on hand to start the business. The usual rule-of-thumb is that you should have enough money on hand to operate your business for a year. Some of the operational expenses that might be included are:

  • Down Payments on Property, Rent, Equipment
  • Equipment
  • Legal/Accounting Services
  • Licenses/Permits
  • Loan payments
  • Marketing
  • Office Space
  • Professional Fees
  • Remodelling/Installation of Equipment
  • Salaries, including one for yourself
  • Supplies
  • Utilities

It is important to make as accurate an estimate as possible of your expenses in each of these areas and any other categories that you might anticipate. When in doubt, error on the side of estimating too high. You can be assured that there will be unanticipated expenses at some time during that first year. If you do not have this money available, you need to plan how you will meet these expenses. Your startup costs will be the subset of these expenses that you will need to get the business operational. Once you have this information in hand you are ready to tackle setting up your operational financial management and recordkeeping systems.

Financial Management

In setting up a financial management system your first decision is whether you will manage your financial records yourself or whether you will have someone else do it for you. There are a number of alternative ways you can handle this. You can manage everything yourself; hire an employee who manages it for you; keep your records inhouse, but have an accountant prepare specialized reporting such as tax returns; or have an external bookkeeping service that manages financial transactions and an accountant that handles formal reporting functions. Some accounting firms also handle bookkeeping functions. Software packages are also available for handling bookkeeping and accounting.

Bookkeeping refers to the daily operation of an accounting system, recording routine transactions within the appropriate accounts. An accounting system defines the process of identifying, measuring, recording and communicating financial information about the business. So, in a sense, the bookkeeping function is a subset of the accounting system. A bookkeeper compiles the information that goes into the system. An accountant takes the data and analyzes it in ways that give you useful information about your business. They can advise you on the systems needed for your particular business and prepare accurate reports certified by their credentials. While software packages are readily available to meet almost any accounting need, having an accountant at least review your records can lend credibility to your business, especially when dealing with lending institutions and government agencies.

Some of the type of reports you might see in a financial management system and what they mean are:

Income Statement
An income statement simply shows income and expenses for a given time period. It gives you a picture of you are making money or losing money over that time.

Balance Sheet
A balance sheet looks at the bigger picture of your business comparing all your assets to all your liabilities. It essentially tells you if you closed the business and sold everything today, how much money would you have (or how much would you owe). The reason this is called a Balance Sheet is that Assets need to balance (equal) Liabilities. The amount you would have if everything were liquidated today is called Net Worth and is listed under liabilities. If you would lose money, the net worth is negative.

Operating Budget
A budget for the business projects sales and expenses to estimate the flow of cash over each month of a year. This helps you predict times that you may have cash shortfalls and prepare for them. It also allows you to compare over the year how you are performing in relation to your projections.

Cash Flow Statement
This may be one of the most critical and least understood documents you can prepare. Some of the information that can be gained from this statement is:

  • Are the operating activities generating cash? It is not critical if they are not, but it is a good sign if they are.
  • Which working capital components have large uses of cash? What might be happening to cause this? This helps you understand how the cash got used.
  • How much cash is provided for or used in investing activities? Compare this year's capital expenditures to last year's capital expenditures. Were there any significant increases or decreases? A reduction in capital expenditures may indicate a cash flow problem.
  • What cash is provided by or used in financing activities? This will tell you how much debt has been paid (or borrowed.) It will indicate if you are using more debt or have paid down your credit line in the past year. It will also tell you if there were other unusual financing activities which were not highlighted elsewhere in the analysis.

These are only a sampling of the many types of financial reports that might be appropriate for your business. For a more comprehensive overview of what types of reports you might want to generate and what they mean, it is wise to buy a good reference book on accounting.


While you may be able to hire others to manage your financial operations, good recordkeeping systems are your business. Your recordkeeping system will be the basis for all your financial management systems so accurate processing and easy access to these records is critical.

The basic financial systems for your business should include information from the following functional areas:

Banking Relationships -- Checking/Credit

Bill Payment -- Payroll, Taxes, Suppliers, Rent

Money Collection -- Cash, Credit, Payment Terms, Collections

Purchases -- Suppliers

Sales -- Pricing, Marketing, Advertising

Information Gathering and Reporting -- Cash Flow, Balance Sheet, Net Worth

Other Professional Relationships -- Accountant, Bookkeeper, Suppliers

Systems need to be developed to keep track of each of these types of information.

For a start, set up a separate checking account for your business. If you need to make cash purchases, write a check for petty cash so that is recorded in an official record - don't take money from your cash receipts to pay expenses. You need to be able to substantiate receipts with your records. Petty cash itself needs a separate ledger supported by receipts so that cash transactions are recorded appropriately. Cash is one of the weak points of many businesses. Inadequate control can siphon away income and it can also leave you open to unexpected governmental audits.

Set up a ledger to record all transactions. This can be handwritten or generated with a computer software package. The important component is to keep track of each financial transaction, categorizing each entry. Each type of business will have different types of categories for transactions. If you are in doubt about which ones to use, pick the categories on Schedule C of the U.S. Internal Revenue Service forms. If you are going to be filing taxes in the United States for a business, you are going to need to have your income and expenses categorized that way at reporting time anyway. Keep your ledger up-to-date daily. Don't put this off. You will forget details.

Store receipts in the same order they are in the ledger. Some people go so far as to have a separate envelope for each month of receipts by category. That depends somewhat on how many transactions a month you have. Businesses with only a few transactions monthly clearly have fewer receipts to manage and can get by with a simple system. The important thing is to have a clear cut place to put everything as soon as it occurs so that you do not spend valuable time at the end of the month trying to piece together needed details that have long since been forgotten.

Check your bank statements and any credit statements monthly. That means keeping the check book balanced and the credit card statements cross referenced with purchase receipts. And reconcile bank statements faithfully.

Basic information should be kept on each customer and what they buy, unless you are handling a huge number of small transactions and have a very large customer base. This customer information can be a valuable tool in marketing and learning who your customers are and what they want. If you are offering credit, credit reports on clients can also be part of your information database.

Ditto for employees. Have a way to keep track of personnel forms, including all the tax forms you will need for reporting payroll. Many office supply stores have forms already available that are set up to gather precisely the information you will need. If you are paying and/or deducting auto expenses, they will also need to be recorded.

Each piece of equipment needs it receipt and service schedule recorded so that if a problem arises, the information is readily available. This information is also needed for calculation of depreciation.

Is this list getting confusing and long? This is a lot of paperwork to manage. Let's take a look as some organization systems that can help make some sense of all this.

Organization of Record Systems

One method that works for many small businesses is to have a calendar devoted only to deadlines and other events that may affect the business. It can have tax dates, equipment repair schedules, payroll payment schedules, and even dates for reconciliation of accounts in it. Note everything on it that affects your business so critical deadlines don't slip by while you are involved with the day-to-day running of your business.

At a particularly busy time in my life I used to also note on my master calendar critical events in my kids' lives in green so that I would not miss something like a school play just because I had not planned far enough ahead for filing my taxes. The green events inspired me to get the other deadlines completed early so that I could be relaxed and truly enjoy the special moment with my children.

Besides a master calendar, the other critical component is good filing. Information is no longer information if it cannot be retrieved when it is needed. The two most common types of filing systems are alphabetical by category or chronologically by date. Many people file chronologically within category. Different types of systems work for different types of businesses and different types of people. Feel free to experiment a little while you still have a relatively small filing system.

Some types of records occur infrequently, but need to be kept permanently. Items such as corporate records, licenses, permits, insurance forms, bank accounts, rental agreements, equipment leases or other legal forms need to be filed somewhere they can be accessed quickly when they are needed. Other categories such as suppliers, customers, employees, correspondence will need to be updated frequently, preferably daily, so it may be desirable to split them off in a separate file. While a good filing system is important, don't fret too much about setting it up perfectly at first. You will find it evolves over time. The primary issue is to set some system up and to form the habit of keeping it up regularly. Then, try to revisit the system setup itself at regular intervals to see if there are better ways to organize it to ease the flow of information.

One last question that is always asked is how long do I have to keep business records? Receipts, cancelled checks and other documents that support some reporting requirement need to be kept until the statute of limitations expires on that report. For U.S. federal taxes that is three years from the date the tax return was due or filed or two years from the date the tax was paid, whichever is later. Some records should be kept indefinitely. Records in this category are property records, corporate records or insurance documentation. Employers must keep all employment tax records for at least four years after the tax is due or paid, whichever is later.

For those records that you can't decide about, consider how difficult they are to replace. Most banks microfilm checks and you can get copies from them with adequate notice. When in doubt, check with the institution to see what their policy is on recordkeeping. Their policy might give you good guidelines for your storage. The bottom line is that you want to store as little as possible, but you do want to have records available when and if they are needed.

Perhaps you can now see why there are people who make a good living just setting up recordkeeping systems for businesses. There are a lot of factors to consider. I always recommend you do it yourself because it is your system and you will be the one who has to maintain it. If you do not tend toward the compulsive end of the spectrum, however, make certain that you hire someone who is. The professionalism of your business operation is going to be dependent upon these systems. Your financial systems are the underpinnings of who you are as a business. Make certain they reflect the quality you want your business to project.