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Online Business Accounting Basics

May 15, 2008
Accounting is a factor of online businesses, especially small businesses, that is largely ignored until the necessity arises, and by then it can be a little late to make up lost ground. Whether you run an online small business or a multinational corporation, a good knowledge of basic accounting is essential to you.

If you fail to maintain adequate records of your financial affairs, and make important business decisions on inadequate financial information, your business could well fail before it even gets off the ground. It doesn't matter how good you are at what you do, or if you have a fantastic product that the market wants, poor online business accounting practices could leave you destitute with no business to run.

Your financial records can be used to provide you with advance warning of things not going as they should, and enable you to take remedial action before going under. This is difficult for many entrepreneurs to understand, especially if they have a good product and what they consider to be a good business model. Financial statistics can show what might seem like insignificant trends, but that could be a forewarning of things going wrong.

There was a company once that offered 30 day terms, but their major customer was happy to pay fairly quickly in return for a small discount. This is common business practice. After about a year the major customer went into receivership owing the company a substantial sum of money, and since the receiver was unable to pay anything but a very small proportion of what was owed to each creditor, the company was forced to borrow money to remain solvent, and eventually went out of business about a year later. It was unable to recover from its major customer going into receivership.

There were two reasons for this of course, one being the loss of business from their major customer. However the main reason was the lost payments that their customer could not pay. They had to borrow to pay their own suppliers, and that was the beginning of the end.

Subsequent analysis indicated that the customer had defaulted fairly early on in the agreement to make quick invoice payments, and over time their payments had lengthened and lengthened. Eventually they owed over four months invoices which amounted to a considerable proportion of the small business income. It transpired that the accounting was basic to say the least, and none of this had been noticed until too late in the process.

The customer had been requested payment after being two months overdue but was not put on stop because no information was passed on to production or dispatch areas, even though the business only employed just under 30 people. By the time the so-called finance department put a stop on the account it was too late.

This is an example of bad accounting and a lack of actions at critical points. With a good accountancy system, the slowdown in payments would have been logged and the situation monitored. The whole sorry tale could have been avoided if the correct information had been passed to those who should have known of the situation, particularly the owner who had no idea what was happening.

So what should you do to avoid this happening? Good online business accounting practices are easy to put in place and maintain. Many small businesses cannot afford a full time accountant, but still apply good accounting practices. An example of this is the 'double entry' system, whereby you record each transaction twice. What you do is have two accounts, and for every entry enter it as a debit in one and a credit in the other. The sum of the two accounts as should always cancel each other out. If they don't then you should look for the error. That will be a good start.

Then you should always carry out analysis for each customer, and record the difference in time between invoicing and receiving payment. Once that time difference reaches a pre-determined warning level, then you must contact the customer. You should also have a stop level at which you stop supplying until payment is made. That is good accounting practice, and that way you won't allow a customer to become dangerously over credited - that applies irrespective of the size of the customer.

These are two simple ways for a small business to keep track of accounting errors and bad payment records of customers. Simple but essential, and they could be critical if you fail to stick to them. The company in my example (a real company incidentally) could still be going strong today had they applied the second of these two practices.

Even if you are too small for an accounting department, at least apply some simple basic accountancy principles, sufficient for you to keep track of your income and outgoings and whether or not your customers are paying their invoices. That way you could save your company a lot of grief.
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