Introduction

A manufacturing company is a commercial business that converts raw materials or components

into finished products. These products are intended to meet the expectations and demands of
customers.

Unlike other stock selling and service companies who sell their time, manufacturing companies
create new product from scratch. So, manufacturing companies are different than other type of
business. Manufacturing businesses have to account for their raw materials and processing costs,
but they also have to work out the value of the finished items they create.

Setting up accounting function

You don’t want to get too far in the game without establishing a simple accounting system, but
you also don’t want to make it too complicated. The early stages are the time when you need to
establish the structure that will support your company finances, and help define your financial
strategy, as you grow.

To set up accounting function for your business, the following need to be considered:

1. Set up a simple accounting system. In the beginning, you just need a simple, low-cost
accrual-based accounting structure. There are many light-weight options available, such as Mint
or InDinero. While these aren’t true “accounting systems,” they are great for tracking expenses.
More substantial are low-cost, easy-to-use systems such as Quickbooks. There are also high-end
options available, of course

2. Set up your Accounts. At the core of whatever accounting system you use will be your chart
of accounts (COA). It’s essentially an accounting system, designed specifically for your
company, that aligns with your financial structure and helps you to track and report your income
and expenses.

3. Open a business banking account. A business banking account with online component will
help to eliminate unnecessary manual processes and better manage cash flow. Bank account
should automatically invoice customers and help to avoid cash shortfalls, by pulling in
receivables and stretching out payables. Also, the account should seamlessly integrate with the
accounting software.

4. Separate personal and business expenses. It seems obvious that you’d want to keep your
business expenses distinct from your personal ones, but, it’s surprising how many entrepreneurs
conflate the two. At best, this leads to confusion. At worst, you could be sued and forced to pay
additional taxes. The company could even be stripped of its corporate status. Avoid this by
establishing corporate checking and savings accounts and maintaining a separate income
statement and balance sheet. Use checks from your business banking account, or separate
business credit/debit cards to pay for all of your business transactions.
5. Keep records of receipts and invoices. I always recommend recording all receipts. You can
keep physical copies or in the cloud, but be sure to keep track of your records so you’re not
trying to dig them out come tax time.

6. Be mindful of tax obligations. Speaking of taxes, make sure that you start thinking about
taxes before you start earning revenue. This starts at the very beginning when you select the best
legal entity for your company. You’ll also want to do your due diligence to understand all of
your federal, state, and city tax obligations, including regional fees and registration. Since you’ll
be separating your business expenses and keeping records, this will make it easy for you to
deduct business expenses. Stay on top of your payroll taxes and 1099s and pay quarterly taxes.
Hiring a tax professional is the best way to stay on top of your tax situation.

7. Set up a system to collect payments. Setting up a formalized accounts payable system early

helps you to maximize cash flow and create essential financial reports. Work with a professional
to identify the best tracking system for your needs. Once the system is set up, you’ll need to enter
every expense and establish your invoice AP schedule. Place vendors on net 30 payment terms
and work hard to ensure that you always pay your bills on-time and up-front. This will help you
to build a reputation for financial stability.

8. Create a payment collection process. Setting up an AR process will help you to improve

cash collections. Your system should allow you to list all open invoices and balances. For new
clients, put your payment terms in writing. Establish credit guidelines and create a collection
timeline so clients know what is expected. In these early days, your payment collection process
should be simple, so you can just accept.

9. Select a payroll provider. If you have employees in these early stages, you’ll need a payroll
provider. Depending on your needs, you may choose a provider who offers piecemeal services or
one that provides a full-service HR solution, including employee benefits. Whichever solution
you go with, make sure you cover worker’s compensation and payroll taxes as well.

10. Forecast expenses. Record all of your anticipated expenses to help you to manage your cash
burn. If you can see that you will run out of cash, that’s when you’ll need to start raising funds
and move on to the next level of financial management and planning.

Manufacturing Accounting Systems

Business owners have many options when choosing a manufacturing accounting system. While
some systems are more suited for internal decision making, others are made for external financial
reporting. Understanding how some of the most prevalent manufacturing accounting systems
work can help you make sure you choose the right one for your small business.
Job Order Costing
For companies that manufacture many types of products, or make products in batches, job order
costing is the most likely accounting system to use. Under job order costing, small-business
owners trace materials and labor costs directly to products. That is, the company records how
many hours of labor and how many units of materials are used to make the product, multiplies
these figures by the cost per unit and tracks the cost by job. Overhead costs, those costs that
cannot be easily traced to individual products, are then allocated to products.
Process Costing

Process costing is used by companies that continuously produce a few homogenous products. For
example, an orange juice manufacturer, a gravel mine and a maple syrup bottler would all be
likely to use process costing. Under a process costing system, costs are aggregated within
departments, with each department being treated like a job in a job order costing system. For
example, an orange juice company may have juicing, bottling and labeling departments. In a
process costing system, the materials and labor costs of juicing would be aggregated in the
juicing department accounts. This would be combined with allocated overhead costs related to
juicing before transferring the entire balance to the bottling department accounts. Here, the costs
already incurred would be added to labor, materials and allocated overheads from the bottling
department. This process continues until the product is finished.
Activity Based Costing

Activity based costing is an accounting system often used by manufacturers to improve decision
making. Unlike job order costing and process costing systems, activity based costing systems
only assign costs to products that are related to manufacturing activities. For example, even
though costs of heating and cooling the factory are necessary for production and would be
included as overhead costs in a job order or process costing system, these costs would not be
assigned to products in an activity based costing system. In addition, nonmanufacturing costs
that are related to manufacturing activities, such as customer support costs and selling costs, are
assigned to products in an activity based costing system. Many small-business owners believe
that this type of costing system allows them to make more sound decisions, because more
relevant costs are accounted for and non-relevant costs are not.
Variable Costing

Because of the way that accounting standards treat certain overhead costs, when companies
produce more goods than are sold, causing inventory to increase, net income becomes artificially
inflated. Variable costing is a technique that managers use to remove this effect from net income.
By excluding overhead costs that do not vary as production levels change, managers are able to
compare profit levels as inventory balances fluctuate across years. While this method is not
allowed for external financial reporting, it can be valuable for internal decision making.