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Launching a startup requires an investment of time and money. Your time is your own, but often the money funding new businesses comes from investors or bank loans, and lenders want assurances they invested their money wisely. One of the priorities of any startup owner is (or at least should be) establishing an accurate accounting system. The process is pretty straightforward but requires some effort. Here we’ll go over the basics of accounting for startups.
Why is startup accounting so important?
Accounting allows startups to understand their financial situation, determine future profitability, track invoices and upcoming payments, manage payroll, and submit company taxes promptly and accurately. Accounting for startups also gives investors and lenders peace of mind through regular reports on the startup’s financial health.
A startup that neglects accounting flirts with financial disaster. Without proper accounting, you can’t track profits and could lose out on important sales or contracts. Investors will be concerned, to say the least, and likely to demand financial data you cannot provide. A lack of accounting increases the risk of violating tax law and could land you in serious legal trouble. A lack of accurate data could compromise future business growth or kill the startup before it has a chance to develop.
What are the benefits of accounting for startups?
Now that we have that dire warning out of the way, what are the advantages of solid startup accounting? Using an accounting business from the beginning of your startup instills good financial habits you’ll use for years rather than starting with mistakes and misinformation. As anyone who has ever made a New Year’s resolution knows, establishing a good habit takes less effort than breaking a bad one, which applies to accounting as much as anything else.
Proper startup accounting gives you an accurate understanding of where your business is financially, how it performed in the past, and how you can expect it to perform in the future. Accounting helps you analyze your performance compared to competitors, identify and evaluate potential investment opportunities, and keep your investors and employees informed of your progress.
On an operations level, startup accounting lets you track debts, invoices, services rendered, and goods received. Your payroll will operate smoothly, and you can comply with taxation and other financial regulatory laws. You’ll be able to identify trends in your annual cash flow and better understand potential tax credits and deductions.
What type of accounting is best for startups?
Startups typically use one of two accounting methods: cash basis or accrual basis.
Cash basis accounting tracks business income as it is received and expenses are paid. A relatively simple type of accounting, cash basis accounting is best suited for small businesses with basic accounting needs.
While cash basis accounting only tracks income when an invoice is paid, accrual-basis accounting counts income from the moment a contract is signed or a product is delivered, whether or not the income has been received. On a cash basis, accrual tracks expenses from when they were paid.
Accrual basis accounting is a more complex system, but over time provides a more accurate long-term financial picture than cash basis systems. An accrual basis accounting system better serves startups that plan to scale up over time.
What financial records does a startup need?
One of the primary purposes of accounting is to track, update, and store financial records, a purpose made much easier with accounting software. Your accounting system needs to maintain the following financial documents:
- Accounts payable to detail how much your startup owes
- Accounts receivable to track the status of unpaid invoices
- Balance sheets to provide an overview of your company finances, including assets, liabilities, and equity
- Cash flow statements to allow you to estimate future cash flow and meet your business obligations
- Profit and loss statements to summarize your revenue and expenditures
- Tax returns to correctly file and pay taxes and to maintain seven-year financial records
In addition, your accounting software must create, track, and maintain documents such as gross receipts, purchases, expenses, employment taxes, and business assets for tax purposes.
How to get started with startup accounting
Accounting for startups begins with a simple but essential step: opening a business bank account to keep the startup’s finances separate from other properties or personal investments. You’ll most likely need a checking and savings account, although smaller businesses can get by with just a checking account. When you open your accounts, consider applying for a business credit card to help pay for startup-related expenses.
Next, you must set up your bookkeeping system to track daily invoices, payments, and other transactions. Your bookkeeping system should include the following:
- A chart of accounts (COA) to track revenue, cash., supplies, and rent. A COA usually includes your accounts payable and accounts receivable reports.
- A regular bookkeeping schedule to maintain and update financial records.
- Detailed information on any terms and conditions for customer credit, if applicable to your business.
- Versatile accounting or invoice software.
Should you do your own accounting?
Accounting for startups can feel overwhelming if you don’t have a certified public accountant (CPA) on staff. At the same time, startups often have limited funds, so hiring a CPA may not be possible. If you’re confident enough, you can get by without a CPA with the help of some good accounting software, which significantly simplifies accounting tasks. In the early days of a startup, you also might want to track your financials personally to fully understand how your business is doing.
If you don’t understand accounting, you should at least consider outsourcing accounting to a CPA. The need for a full-time accountant increases as your business grows. A backlog of bills and unread financial statements suggests it’s time to hire an accountant.
Startups with creditors and investors should seriously consider hiring a CPA from the outset. These stakeholders will follow your accounts closely and express concern if your finances are inaccurate. Whether you plan to hire a CPA or handle accounting for startups yourself, going in with a clear understanding of the responsibilities and financial skills needed greatly increases the chance of your startup thriving.