Last week we covered how to deal with your corporation tax. One of the things I mentioned is that as part of your system to deal with CT, you need to track expenses correctly.
There are a million different systems to track expenses, ranging from "stuff all the receipts in an envelope and get a bookkeeper to track them" to using accounting software and tracking everything yourself. It doesn't really matter which system you use so long as you're comfortable with it and you know that it works and how it works.
At the end of the day, as the business's founder, you are personally, legally responsible for your company's record-keeping. If you screw it up, you can't turn around and blame someone else. You're the Director, it's your fault, and "not knowing" is not considered an excuse. If the bookkeeper screws up, it's still your fault.
Keeping track of expenses is really not hard at all, so if you do screw it up in a big way, it is really through your own sloppiness. Read this article, and this hopefully won't happen.
Many books about accounting (and many accountants) end up recommending a horrendous, antiquated system like SAGE or QuickBooks. This is often because they're written by accountants who are familiar with those systems and would rather everyone used them so they don't have to learn new systems. That's fine for the accountants, but from personal experience, most of those legacy accounting systems make me prefer to stick a sharp pencil in my eye rather than launch the horrible software.
What I'm going to recommend should work until you get to the stage of having a few (up to 10 or 20) people on (profitable) payroll - a small, profitable company. If you're VC-funded and you've hired 50 people, you probably won't be allowed to do this, but for most people bootstrapping their own business, or who have taken a small amount of seed capital, this system will work and will be relatively little effort.
My expense tracking system is based on a web-based product called FreeAgent (referral id included). It's slick, it's modern, it can track transactions and receipt scans together, and it's cheap (if £30/m breaks your bank, you have other issues). I don't normally recommend that people take on fixed, recurring expenses early on in their business's life, but this is one that is worth spending money on right away so your accounting is entirely sorted out from day one.
However, a tool is not a solution all by itself. "Buying FreeAgent" is no more a solution to your expense tracking than "Buying FogBugz" is a solution to your bugs. People, processes and tools, in that order, as I've said before.
So let's look at those three aspects of a possible expense-tracking system using FreeAgent.
What people do you need involved in solving this?
Well, when you're by yourself, it's just you. And yet, even then, you might find it helpful to get a virtual secretary to spend an hour a week doing the manual, boring part of the work (linking receipts to transactions), so that it happens even when you're distracted or simply can't be bothered. We (GrantTree) pay £30/hr (inc. VAT) to a freelance personal assistant to spend one hour a week doing this (I'm happy to recommend her if you email me). Even (or perhaps especially) if you're by yourself, you may wish to hire such a person to get rid of the drudgery. However, I recommend doing it yourself for at least a month or two so you fully understand what's involved.
However, even with a PA doing the reconciliation work, the rest of your team (that includes you) needs to be committed to the idea that expense tracking is not optional. If you don't scan your receipts in time, there's nothing your PA will be able to do for you.
So, the "people" side of this process includes anyone who's capable of paying for things out of the company account, or of charging expenses to the company. They need to understand that having messy accounts is not acceptable, and so they need to be diligent about scanning invoices and receipts correctly and on time so that they can be reconciled with banking transactions without too much fuss.
This is the way GrantTree's expense-tracking process happens, which you can use as a model for your own expense-tracking.
First of all, all business expenses are, ideally, made on the company card. This ensures that they're not missed in the reconciliation. Of course, you should only give a company card to people who can be trusted not to misuse it - but even if they do charge inappropriate expenses in, you can always deduct those from later payments. FreeAgent supports tracking this type of mishap.
The second step is that any payment should result in a receipt scan in a pre-agreed "new receipts" directory. This is actually very easy to do without fuss, by using an iPhone app called MobileAgent, which costs a whopping £2.99. Go on, treat yourself. What MobileAgent allows you to do is to point to a DropBox folder and scan receipts directly into there, on the move. This means you don't need to keep paper receipts. Hurrah! So, every person with access to the company bank account should be scanning receipts into there as soon as possible after making the expense. MobileAgent will include the date in the file name, so that it's easy to reconcile later.
Thirdly, on a regular basis (e.g. once a week) you should import expenses from your online bank account interface into FreeAgent. So long as your bank support export in QIF format (which pretty much all of them do), you'll be able to do that.
This import needs to happen before the reconciliation (done by yourself, your virtual PA, or someone else), which is the fourth and final step. Once a week, your PA should go through all the unexplained transactions in FreeAgent, and match them with receipts in the common folder. Unless you've got a lot of transactions, this should not take more than one hour a week.
As part of this final step, any transactions that can't be explained, and any receipts that can't be matched, should be highlighted to the people with access to the business card. Since we're still only a week away from the oldest unexplained transaction, it should be easy to figure out what happened. What you don't want is a situation where an expense from 3 months ago is unexplainable. That sucks, and ends up causing you worry, especially when you need to file a VAT return.
Does this process need to be weekly? Not necessarily, but the more regular it is, the less problems you will have. I recommend weekly, but it's up to you.
If you just implement those 4 steps, your expenses will be tracked properly so that you are well prepared to file correct accounts. There are other things to think about too, like capitalisation, categorisation, and other such concepts, but those are things to know rather than things to do. The process above can remain the same for quite a long time into the life of your business.
We've already covered this, but basically the tools to support this process are:
- an online accounting tool (FreeAgent, Xero or KashFlow - any of them should do);
- a mobile app that can scan receipts as they happen, either directly into your accounting system or into DropBox; all three of the solutions mentioned above have iPhone apps.
Part of the process of reconciling expenses is to categorise them. That's a whole topic in itself, and I'll write about that next week. Capitalisation is also an important concept for larger equipment expenses.
The process we've outlined will put you in a good position to ensure that you always file your VAT returns correctly and without fuss. VAT is a whole topic in itself, so it will also be covered in a later article.
If you make expenses by cash or on a card that doesn't belong to the company, you can still enter those. Every person who can make such expenses should have an account in FreeAgent, and they can then create the expense manually in the system, or with MobileAgent. FreeAgent will automatically track who is owed how much for expenses, and how much of those expenses has been paid back to the user, which is a really nice time-saving feature. These types of expenses should be done just as promptly as normal expenses, by the way, for the same reasons.
The key take-away from this article should not be that you need to follow my system to the letter (or even at all). This is just an example of a system that works. Tailor it to your own business, adapt and evolve it as you gain your own experience and opinions on the topic. The key objectives of the system are that every invoice or receipt is explained promptly and correctly, and with a minimal amount of time wasted running around trying to remember what happened 3 months ago. Whatever works for you to achieve that is probably the right system for you.
The series so far:
1. How to register a company in the UK
2. How to: deal with your Corporation Tax (UK)
3. How to: track your expenses (UK)
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So, finally we come to this third option which, I believe, presents features of both. Product companies were covered here and services companies were covered here.
The third alternative: productised services
First of all, what is a productised service? It's a service which you've systematised and supported by tools, automation, processes, etc, so that you've decoupled the benefit given to the client from the amount of time spent on your side. In other words, whereas in a services company the ratio of X units of time for Y units of income is relatively fixed, in a productised service, X/Y can be all over the place. Some clients will be extremely profitable, and others less so (but still worth serving - otherwise, turn them away, of course).
Accounting services are a great example of productised services. Though many accountants will charge for time above and beyond their "standard service", most of them have packaged things like "yearly accounts" or "VAT returns" into a fixed price deal. This leaves them free to optimise the delivery of those services so that they take a minimum amount of time, while still charging the client the same amount.
Even large consulting companies, like Accenture, try to productise their services. Back when I was there, Accenture was very keen to sell what they called "Managed services", where they would take over an entire function of the business and deliver it for a fixed price, enabling them to manage the costs internally and deliver the service in an efficient way without undercutting their own revenues.
Productised services don't have to, and in many cases, shouldn't, be marketed as such, or else clients may try and push down your prices if they think it doesn't take you that long to deliver (conveniently forgetting the time it's taken you to systematise the service so it can be delivered more efficiently). "But you're getting a lot of value out of our service" doesn't always work, especially not with smaller companies, so think carefully before marketing your productised service as such.
Productised services have a number of advantages. Similarly to products, they can scale much more easily than services. Once a service is properly systematised, it is easier to actually carry out, which makes recruitment much easier, since you don't need your people to be as highly skilled. You won't be able to deal with a sudden million orders, but you can ramp up capacity pretty damn quickly if you need to.
Like products, the margins can also be quite high, because most of the time-consuming parts of the service have been automated or simplified so that the human time spent is small compared to the return. Unlike products, however, the process doesn't move along without human involvement, which means you have to keep working on it - but you can structure productised services so that there is a recurring component, which provides similar benefits.
Since this is a service (and perceived as such), people naturally understand the value of it and are willing to pay real amounts of money (in the thousands or tens of thousands) which they would not be likely to throw into a product by a small company.
Because it is a service, unfortunately, you must do the sales directly - it is difficult to sell services without any salespeople. However, the advantage is that you can tailor your pricing to the type of client, and how much value your productised service brings them. If your service will provide £100k of value to one client and £1m of value to another, it stands to reason that your proposal for the second client will have a markedly higher price tag than the first (which might be based on a percentage, or some other calculation method). This is difficult to achieve with most typical startup products, since you often don't know who you're selling to until too late.
Finally, another advantage of productised services over both products and services is that they can be taken in either direction if needed. If customers start to require a lot of bespoke work, you can evolve towards a normal service model. If, on the contrary, the customer base just keeps growing, you can automate more and more of the service until it becomes self-service. This makes productised services a great way to kick off a product business, by generating these product-related revenues early on and using them to continue building out the self-service aspects of the product (in effect cannibalising your own service with your product).
Productised services are not good at all stages of a company. Google could not and should not run AdWords as a productised service, for example. At that scale, you need maximum automation. But they could have done so in the early days of AdWords. Nor are they always possible in the very early stages, before you have any idea what your market wants (but then, why are you starting a business in that industry?).
I'll address the paths to a productised service, from either a product or a service, in later articles, but hopefully in this article I've made the case for why there is a third model, which sits in between products and services, and which should be worthy of your consideration when trying to figure out how the hell you'll get your company off the ground, particularly if you're a new entrepreneur and are taking my advice to stay away from investment until you have your basic business skills figured out.
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Working for a no-shot startup ✶
Randall Bennett suggests, among other things, that you should not feel bad about working for what he calls a "no-shot startup" (one where inexperience meets enthusiasm and results in some kind of startup disaster), because you will still learn from those, and:
Crucially, the biggest advantage of working lower down the spectrum is that mistakes don’t stick with you. In general, mistakes don’t typically stick with you, but the further up the spectrum you go, the tighter knit the community. Make a mistake at the bottom of the spectrum, and there’s enough people making mistakes that it’s unlikely your mistakes will give you a bad reputation. On the other hand, screw up a company with $41mm in funding, and those mistakes are more likely to follow you.
That's a fair point. Conversely, I expect that most investors with $41m to swing around won't invest in a team that hasn't cut their teeth on previous ventures. And in fact, they didn't, since the colors.com team, to take the example Randall presents, is actually pretty solid and experienced.
Randall adds that after starting at the bottom, once your first hopeless venture dies out, you should work at moving up the ladder, into more and more successful startups.
I think there's a very valuable further point to make.
Once upon a time, MBAs used to be designed for people who had 5, 10, or more years of business experience, to enable them to formalise and structure their knowledge of what makes a business tick. This was before the trend became to do an MBA 2-3 years out of university, or, god forbid, right afterwards.
The key point there is that until you have some of your own experience to drawn on, most of the things taught in an MBA won't stick, because deeply, viscerally, you won't understand why they're important.
The same is true for startups, but in reverse. Until you've worked (either as a founder or as a very early employee) in a broken startup, you won't know, deeply and viscerally, why the things that successful startups do matter. There are many lessons that you can only understand by contrasting them with the failure case. That's when the insights happen... "Aha! That's how you're supposed to do that."
In short, breaking your teeth on a "no-shot startup" before joining a successful one will help you make the most out of your time at the latter.
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Stop looking for a cofounder ✶
Sacha Greif offers some tips about why you shouldn't look for a cofounder, and try using freelancers instead. Pull quote:
Hiring a freelancer is not that expensive. You can hire someone for a month for a couple thousands dollars, and a month is plenty of time to build a prototype if that’s all you’re doing.
If you say that you can’t manage to come up with even $3000 or $4000, that tells me two things: first, you don’t have any monetizable skills, so you don’t sound like a very good person to build a startup with.
Second, you’re not very resourceful, and that doesn’t play in your favor as a startup co-founder either.
Sacha also goes into several reasons why freelancers are a better thing to look for, if you need help, rather than cofounders.
I think Sacha is spot on about those reasons, but he's missed one that trumps them all:
I don't think it's actually possible to "look for a cofounder", especially not if you already have a project under way. As I've pointed out before:
...networking to find a cofounder is like going to a party to find a wife. You might meet lots of interesting, and potentially eligible, partners while out networking/partying, but those who respond favourably when you mention what you're looking for on the first "date" are probably not the ones you want to marry.
Hanging around places where you might meet potential cofounders is great. Building relationships is great. Working on projects that you're both passionate about together is great. But going out networking explicitly to try and find a cofounder is misguided and will probably cause you trouble.
If you've settled on the idea already, it's time to get early employees, not cofounders. They should be paid. If you can't do it without getting other people's help and you have no money to hire others, then this is not the right idea for you - find one that's more within your reach, or build relationships with potential cofounders and find ideas together.
What you should almost never say is "I have an idea, I should now look for a cofounder".
Update: Also relevant, via Slimy:
A co-founder is not what you need, unless you already have one, and you have as good a relationship with them as the best relationship you've ever had with anyone in your life. If you KNOW you're not going to have a problem, then great.
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