Accounting Negligence is the most common cause of failure of startups in India

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Accounting mistakes

We are living in an era where about 400-500 new startups are registering in India every day. Many of these companies are known as start-ups. There is a myth in India about start-ups. Whenever we talk about a start-up, we frame a picture of a young guy/girl of the age of 20-25 from IT college, or a college drop out. However, this is a very wrong perception we keep in our mind. For me, Start-ups is a new venture based on innovation or an idea started by any person. Indian Startups are generally idea based rather innovation base. Indians are poor in innovation.

Thanks to the miserable educational system and IT colleges in India that even today Indian doesn’t have innovation which can be commercially used. Also if there are any, those will be countable on fingers. As such the startups in India are the idea based and Idea based starts up are those who run their businesses differently. Since we lack in innovation, we have never been cost-effective. As we are not able to save on cost, this led to an expensive product, and that’s where we fail. The biggest failure of our startups is not the ability to run the business, but not able to identify the profitability of the product. As soon as a startup begins its operation, because of massive cost, it starts incurring a loss which shifts the focus of the entrepreneur to the business operation instead on the marketability or development of the product. Since the focus is shifted, the idea is to take the back seat, and the ultimate result is the death of a start-up.

Now, this is the situation with almost every failed startup. The question here is why we are failing. Is it the cost which is eating us? Is it really the loss which is resulting in closing the business? The answer is yes, the loss lead to the closure of business but have we ever tried to read and understand the loss. Have you given a thought, how you could reduce those losses? Have you ever tried to understand the profitability of your product? Finally, have you ever hired a qualified accounting and finance professional whose job is to look after these questions?

The answer for many of the failed Startups will be “No.” If your answer for the many of the above question is “No” then, in that case, you could have saved your startup. The biggest problem in India is that we don’t give much attention to the accounting and financial data of the company. Accounting and finance data are something which shows the company its actual growth and how its business shaping, but those things never come up on paper. When it comes to company financial health, everything will be there in mind, but nothing comes on the paper. That’s where we miss the many little information which may sometime completely change our decision. A professional accounting and finance service are “Must” not only for the big businesses but for a small start-up.

These professionals provide the entrepreneur a meaningful presentation of business accounting data and help them in taking the proactive decision which is best for the business. Let me give you a couple of examples to explain how and professional can save your business. The first example is a costing method which professional can apply for your business. The second one is my personal experience with my startup client.

Have you ever heard the concept of marginal costing? Marginal costing is a must for any startup as this concept tells you the profitability of your product and can help you understand what real loss is and what is the false loss. Marginal costing divides the cost into the variable cost and fixed cost. If your product price is more than variable cost, then this suggests that your product is profitable. Now, this is entirely a different view of looking at the overall cost. This is where a professional help you. Now let me explain to you what variable cost is and what is fixed cost. A variable cost is an expense that changes in proportion with production output. Variable costs increase or decrease depending on a company’s production volume; they rise as production increases and fall as production decreases. Example of variable cost can be Direct material; Service received Direct labor, the salary of employees for development of the product. These expenses will consume in the proportion of final product sold. It means that variable cost is correlated to the product of the company. Fixed costs are expenses that remain the same regardless of sale. Whether a firm makes sales or not, it must pay its fixed costs, as these costs are independent of sales. Examples of fixed costs are rent, employee salaries, insurance, and office supplies. Whether you sell 1 product or 1,000, this will be the same. Therefore, As I mentioned above if your product price is more than the variable cost, then it’s a good sign for the business. Business has to focus now to increase the product sale to cover the Fixed cost but mere incurring the loss because of fixed cost is just a false loss. This marginal cost analysis gives us an idea of whether the product is profitable or not. If the product is profitable then, the business can never be failed.

The second example is my personal experience while providing services to one of the start-ups. The company was in the business of digital marketing. The company got a big export order from its US client. The order itself was bigger than the total domestic sale of the company. It’s a big boost for the company, and the management was excited about this. The company reached out to us for agreement review, and while reviewing the agreement, we came to know that the order may not be beneficial for the company. The company had to import service from one of the social media platforms in order to provide export service to its export client. Here it is essential to understand the GST law. There is no GST on the export of service however if there is an import of service, then it is the responsibility of the importer to pay GST on the import of service. This resulted in huge GST payment of 18% on Import upfront. It would have resulted in a blockage of working capital of the company as these GST will not completely set off with the output liability, and such would have been carrying forward for the subsequent months. As the margin company was expecting on the contract was 10%, this would have resulted in the total outflow of money from the company. It could have been a disaster for a start-up.  As per our advice, Company manages to convince the US client to maintain their own social media account and will pay the value for company services. It turned out to be boon for the company.

These above examples suggest that a Startup need to have qualified professionals in accounting and finance in their team for their venture to grow. But what is stopping businesses from hiring qualified professionals?  Broadly there are three reason which is we can witness across the country.

The mentality of Entrepreneur:

Entreprenuer Mindset

India has a tradition where the owner or entrepreneur believe in the family-owned businesses or closely controlled businesses where most of the keep position and key decision-making power lies with the family members. We have such a mentality that nobody knows my business better than me. These are the biggest problem that we deprived ourselves of taking professional services. These businesses generally have a team on unqualified staff who can maintain their book of account. Since they don’t make the professional services, they deprived themselves of getting meaningful information from the accounting data which doesn’t provide them with minute detail which can be beneficial for the entrepreneur. Also, with the unqualified staff, they miss coping with the regulatory changes (Like Income tax, GST, companies act, etc).

Affordability of services:

Affordable Services

To get a professional accounting and financial services are not cheap. One need to pay minimum 10-15 lakhs per annum to get an in-house professional. For the startups whose turnover is 1-2 crore cannot afford these professional. So as an alternative they hire unqualified professionals, and nobody pays attention to the accounting what it should get.

The attitude of Professional:

Few entrepreneurs outsource their accounting to the third party. These outsource company have become a mere data processing, and they don’t care about business growth and how is company shaping. This attitude of Accounting outsource company is not helping any of the start-ups. In the name of professional accounting outsource company they do the bookkeeping, and they don’t even report the businesses about the wrongdoing. Many IT startups in Bangalore and Hyderabad have outsourced their accounts to these outsourcers, but these outsourcing company is not providing them any meaningful information.

Few other Entrepreneur relies on their CA’s and auditors. My take is that most of the time we see that auditor doesn’t involve in the day to day consultation and they do their job at the end of the year which again is not fruitful to the startups as they need professional help on a daily basis.

Conclusion

All the above discussion shows how important Accounting and Finance is for a startup to run their business. A startup can not afford to avoid professional accounting and finance services. It is essential to have a professional who can at least review the monthly accounting to provide the businesses a meaningful data and alert the businesses if they are going wrong.