Startup Accounting: A Beginner’s Guide to Money Management
Starting a business is an exciting journey fueled by passion, drive, and a great idea. But behind every great startup is sound accounting.
As a founder, you may see accounting as a boring chore that takes time away from building your product or service. But properly managing your finances is crucial for startup success.
Accounting helps startups track cash flow, comply with regulations, analyze business performance, and make strategic decisions. It provides the financial information you need to keep your startup afloat.
This beginner’s guide breaks down the accounting basics every entrepreneur needs to know. With the right financial foundations, you can pursue your business dreams while avoiding common money management mistakes.
Why Accounting Matters for Startups
Imagine driving a car with a blurred windshield. You can’t see what’s ahead, where you are, or how fast you’re going.
Now picture managing a business without accounting insight. It’s just as scary.
Accounting gives startups financial visibility. It helps you:
- Track cash flow – Know how much cash you have on hand and where it’s going. Poor cash flow management is a top reason startups fail.
- Make informed decisions – Analytics on sales, profitability, burn rate, etc. guide smart business choices.
- Value the company – Metrics like revenue growth help determine your startup’s worth. This matters for attracting investors.
- Manage taxes – Stay compliant and avoid penalties by recording business income and deductions.
- Identify issues – Spot problems like high customer acquisition costs early when they can still be corrected.
Think of accounting as your startup’s GPS, showing where you are and where you need to go next.
Don’t DIY Your Startup’s Accounting
With so many expenses in the early days, creating financial statements yourself may seem logical. But DIY accounting is risky.
Common issues with handling your own books include:
- Errors – Lacking accounting expertise leads to mistakes. Incorrect or incomplete financials undermine good decision making.
- Inefficiency – Time spent keeping books takes away from developing your product, marketing, or other priorities.
- Compliance risks – Miss filing a tax return or submitting inaccurate records and you could face IRS fines.
- Limited insights – Basic bookkeeping lacks the analytics you get from advanced accounting.
- Convoluted records – Disorganized finances make it harder to access key details when you need them.
Unless you have an accounting background, it’s best to partner with accounting professionals. The investment pays dividends through accurate reporting, tax savings, and advisory services.
Startup Accounting Services: What You Need & When
Startups should work with qualified accounting professionals from day one. However not all accounting services are equal. Choosing the right provider for your needs and stage is key.
Accounting During the Early Stages
In the idea and seed stages, focus on tracking finances, safeguarding records, and basic reporting:
- Bookkeeping – Record daily transactions like sales, payroll, and expenses. Use bookkeeping software like QuickBooks or Xero to automate where possible.
- Bank reconciliations – Compare bank account records to bookkeeping records monthly. Identify any inconsistencies.
- Financial statements – Create monthly profit and loss statements and balance sheets, even for pre-revenue startups. Review cash flow, burn rate, profitability by product line, and more.
- Receipt organization – Keep receipts and documents organized for easy access later. Scan or take photos of receipts to digitize records.
- Tax prep – File appropriate federal and state tax forms for your business structure.
Scaling Accounting as Your Startup Grows
Once you begin generating traction, level up accounting activities:
- System integration – Connect bank accounts, credit cards, POS systems, ecommerce platforms, and other tools to your bookkeeping system for automated data imports.
- Advanced reporting – Track more KPIs like customer acquisition cost, lifetime value, sales pipeline health, return on marketing spend, and churn rate.
- Forecasting – Use data to forecast future cash flow, profit and loss, and other metrics. Create budgets to guide business plans.
- Audits – Prepare for annual financial statement audits once you begin seeking larger funding rounds. Audited statements build investor confidence.
- Advisory services – Consult with accounting advisors on financial decision making, accounting controls, tax strategies, and preparing for liquidity events.
Choosing the Right Accounting Provider
Not all accounting firms are suited for startups. Here are tips for choosing the right provider:
- Industry expertise – Seek out firms experienced working with startups in your vertical. For example, SaaS accounting needs differ from ecommerce companies.
- Scalability – Ensure the provider can adapt as your accounting needs evolve from early bookkeeping to mature audited statements.
- Technical proficiency – The firm should be skilled with leading small business accounting tools. Cloud-based expertise is ideal.
- Specialization – Some firms focus specifically on startups and small businesses rather than serving enterprises. These providers understand your environment best.
- Advisory services – Beyond reporting, can the firm advise on accounting processes, growth planning, investment readiness, and other strategic priorities?
- Cost – Compare rates. Beware providers with fees too low to sustain accurate service.
- Culture fit – Find a provider that aligns to your startup’s style and values. You want an accessible point of contact, not an elusive big firm.
Doing due diligence ensures you choose the right accounting partner for the long haul.
Accounting Fundamentals Every Founder Needs to Know
Even with pros handling your books, you should speak the language of accounting. Financial literacy helps you better leverage your accounting team.
Here are startup accounting basics every founder should understand:
The Accounting Equation
The accounting equation is the foundation of your books. It states:
Assets = Liabilities + Equity
This shows that what your business owns (assets) comes from what it owes (liabilities) and what owners have invested (equity).
Master this relationship, and you’ll better grasp your startup’s finances.
Key Financial Statements
These three reports track business performance:
- Income statement – Shows revenue, expenses, and profit/loss over a period. Assesses operational success.
- Balance sheet – Details asset, liability, and equity balances at a single point in time. Measures financial health.
- Cash flow statement – Tracks cash inflows and outflows. Helps manage liquidity.
Review these periodically to diagnose strengths, weaknesses, and opportunities.
Accrual vs. Cash Basis Accounting
Understand these methods for recording transactions:
- Accrual – Revenue is recorded when earned and expenses when incurred, regardless of cash flow timing. Provides a full picture of operations.
- Cash – Revenue and expenses are recorded when cash changes hands. Better for cash flow management.
Accrual is preferred for financial reporting. But cash basis can complement for projecting liquidity needs.
Key Accounting Controls
Controls safeguard your finances and data:
- Separation of duties – No one person handles end-to-end transactions. Split key tasks like approving expenses, recording transactions, and reconciling reports.
- Approval workflows – Require managers to review and authorize transactions like payroll and large purchases before they are recorded.
- System access – Restrict access to accounting systems to essential personnel. Limit access levels based on roles.
- Backup processes – Ensure accounting data is properly backed up and secure from risks like fires, floods, or malware.
- Physical security – Lock up confidential accounting records like tax documents to prevent unauthorized access.
Financial Ratio Analysis
Use ratios to interpret performance:
- Gross margin – Gross profit ÷ revenue shows profitability on sales
- Customer acquisition cost (CAC) – Marketing $ ÷ new customers shows the cost to acquire customers
- Churn rate – Customers lost ÷ total customers shows customer retention
- Burn rate – Negative cash flow per month shows liquidity drain
Benchmark to set goals and identify when more funding may be needed.
Startup Accounting Red Flags
With financial fundamentals in place, you can better spot risks that may require intervention, like:
- Revenue declines – Lower sales increase cash burn. Review pricing, product quality, marketing, and other drivers.
- High CAC – If the cost to acquire customers exceeds customer lifetime value, unit economics don’t work.
- Low gross margins – Problems like high product costs can be addressed before profitability suffers further.
- Frequent short-term borrowing – Relying on loans or credit to make payroll could signal deeper issues.
- Mission creep – Expansions into non-core business areas spread resources too thin.
Accounting illuminates business health issues while there’s still time to troubleshoot.
Key Accounting Decisions for Startups
As the business scales, you’ll need to make some structural accounting choices:
Choosing a Business Structure
Common options like LLCs and corporations have different tax and liability implications. Weigh options with your accountant.
Selecting an Accounting Method
Accrual accounting is preferred but cash basis has benefits for early-stage projection. Again, discuss tradeoffs with advisors.
Setting Up an Accounting System
Use accounting software to automate processes. Integrate with other business platforms for efficiency.
Hiring In-House Accountants vs. Outsourcing
Adding an accountant can make sense as you grow but outsourcing provides expertise without a salary.
Determining When to Conduct Audits
Audits add overhead but help attract investors. Weigh costs vs. benefits with your accountant.
The right accounting decisions provide stability as your business grows.
Startup Accounting Best Practices
Running balanced books from day one instills the financial control every startup needs. Here are some recommendations:
- Separate business and personal finances completely. Never comingle funds.
- Create an approval matrix so no one person has solo spending power.
- Set up controls like requiring two signers for large disbursements.
- Take advantage of free accounting tools for startups like Wave, ZipBooks, and SlickPie. Upgrade as you grow.
- Review financial statements monthly, noting trends, ratios, and risks.
- Meet with accountants quarterly to address any issues and discuss next steps.
- Consult accountants before making major business moves like acquiring a company.
- Develop and monitor budgets across business units using past data.
- Keep immaculate expense documentation and receipts. Never estimate or miscategorize.
- Store accounting records using robust cloud backup and encryption.
With these tips, you can build a solid accounting foundation and avoid many novice financial missteps.
Know the Books to Grow the Business
For non-accountants, diving into accounting can feel like homework. But financial fluency is a startup superpower.
Mastering your books doesn’t just keep you compliant and out of IRS trouble. It unlocks key insights so you can make smart choices to build a thriving, sustainable business.
So don’t relegate accounting to the financial team alone. Make time each month to review reports and develop your number savviness. Understanding the equations, ratios, and principles that drive your finances will pay dividends.
With the right accounting acumen, you can move your startup dreams from idea to reality.
So tackle the books head-on. Your business (and your accountant) will thank you.
