Carol C. and her partner opened up a women's accessories Web site in the spring of 2004. Carol, a recent retiree, was looking for a fun way to supplement her post-retirement income. With a relatively modest product line, the site was manageable. Sales to date have been moderate.

Meanwhile, as tax season kicked into gear, Carol submitted what she thought was enough information to her accountant, JT, to complete the company's tax return for 2004. What JT discovered was an inconceivable mess.

While Carol's company had retained all vendor invoices and credit card receipts, all sales data and inventory records were kept on paper - hand written.

"The issue with them is that they thought they were keeping good records of all of their accounting transactions, but since they don't really understand the proper way to account for everything, the information that they did keep, was not very helpful. This is why I ended up just using their bank statements and credit card statements to determine all of their financials," said JT, a CPA with an accounting firm in New England.

JT set up Carol's company in QuickBooks in order to make for a much smoother transition next year. Yet, more problems popped up quickly which took JT an entire day to fix.

"When they entered the inventory (in QuickBooks), they should have been charging it to a balance sheet account, called 'inventory.' Instead, they were charging it to a bunch of different accounts (sales, equity, etc). This makes for a lot of adjustments needed by the accountant in order to straighten things out," she added.

"Another thing they were doing wrong was that when entering invoices, they were charging the wrong account (they didn't know the implication of paying a bill and hitting a balance sheet account or an expense account)," said JT.

After all of that, there was an even bigger issue looming over Carol's business.

"Another issue (huge) was that she was not reconciling her bank account! This is definitely a bad thing! If she at least reconciled her bank account, then we would at least know that all of her transactions are present (they might be hitting the wrong account, i.e. expense vs. balance sheet) - but at least we know that they are somehow accounted for," said JT.

After a week's worth of accounting clean up and a few lessons in QuickBooks, Carol was set up the way she should have been from the very beginning. As long as she follows the correct bookkeeping practices, next year all she'll have to do is present her accountant with a disk containing her QuickBooks data file.

To help new e-commerce businesses start off on the right foot, JT put together a list for budding entrepreneurs to follow before building a web site and selling merchandise. These rules apply for any new small business.

She said a new business needs to determine the following when setting up a new business:

1. Select a legal entity.
2. Registering with the tax authorities (IRS, state and local)
3. Accounting (tax or accrual basis): "Who are the users of the financials? Do they need to provide financials to any financial institutions that lent them money? What questions do I need answered to manage the business? Who will be keeping the books/posting entries?"
4. Payroll: "There are lots of requirements for filing payroll taxes."
5. Income taxes: "Proper forms; will estimates need to be made?"
6. Cash planning and forecasting: "You can save a lot of tax dollars by properly planning ahead, and making certain transactions by certain dates - i.e. contributing to a SEP."
7. Internal controls - "Who is going to manage cash? When you spend money, are you sure that you received the goods or services? And, when you receive money, are you sure that the entry was recorded properly?"

"I would definitely suggest that someone setting up a business sit down with an accountant to set up their books (chart of accounts/accounting method); and either hire a bookkeeper or take some basic accounting classes to understand how to record transactions in your financials," said JT. "It makes a lot more work for accountants, because they basically have to recreate an entire year's worth of transactions if those transactions have not been properly accounted for. They need to remember that if they have proper financials, they can be used for a lot of things — like planning and managing your business!"

Fortunately, Carol's business is now in good shape, considering less than a year's worth of financials needed organization. Had she let it go any longer, not only would she have had a huge accounting bill to pay, but she would also have no idea how healthy her businesses was. Lesson learned.

The names in this story were changed or omitted to protect the identities of all parties involved.

Devin Comiskey is the Managing Editor of ECommerce-Guide.com.