Accounting for Startups Made Simple: From Day One to IPO

Running a startup is exciting, challenging, rewarding, and ultimately overwhelming. The early stages of starting a business require you to wear many hats — most of which you likely aren’t an expert in but take on to keep costs down. With all these shoes to fill, it’s easy to get wrapped up in some tasks while letting some of the more tedious tasks fall to the wayside, like accounting.

However tedious, sending invoices, balancing the books, and keeping track of your finances are crucial to the long-term success of your new business. In fact, studies show that the top reason startups fail is due to running out of cash. Your business doesn’t have to be one of them!

If you’re a startup founder or CEO looking for a high-level overview of what accounting for startups should look like, we’ve got you covered. This guide will walk you through the most basic aspects of startup accounting and the importance of committing to healthy accounting practices early on.

When Should Your Startup Formally Start Accounting?

Your accounting processes should start as soon as you launch your business. Keep in mind that your success is based on your profitability or bottom line. This, in turn, is highly dependent on modifying financial strategies as required, balancing the books, and efficient budget management. 

When you adopt good financial management and effective accounting practices, you gain so much more than just reports. This is because you can now spot inefficiencies and tackle these problems head-on before they get too big. Some of the other benefits of rolling out an effective accounting plan for your startup right away include:

• The ability to keep track of your accounts payable and receivable to see what money you owe and what is anticipated to be received
• Having a clear picture of where your business stands financially at a glance
• Understanding the impact of your past activities on your bottom line helps make it easy to plan for the future
• Better analysis of possible investment opportunities
• Better communication with potential investors who need to see your books before granting more capital
• The opportunity to establish credit from banks and suppliers

Most importantly, accounting is not optional. Your investors, banks, and the government all require your financial records.

You should note that while bookkeeping and accounting are both number-related, they are two different concepts. Bookkeeping involves keeping track of your financial records, mostly income and expenses. Accounting, on the other hand, involves interpreting your startup’s financial records and using this information to make strategic business decisions. Both of them are, however, critical for your business’s growth. 

Choose a Startup Accounting Method

One of the first accounting decisions you’ll need to make is choosing which model to use. There are two main accounting methods: the cash method and the accrual method. The approach you choose will impact how you record items such as debts and sales on your financial statements. 

Here’s a quick overview of both methods:

Cash Basis Accounting

Cash basis accounting is the simplest method. It tracks all funds, including expenses when they are paid and income when they are received. You don’t need to keep accounts payable and receivable, which is why most small businesses prefer this method. Cash-basis accounting also makes it easy to identify exactly when transactions occur. 

Accrual Basis Accounting

Accrual basis accounting is slightly more complex. It tracks money when your business earns it rather than when it receives it. So, for instance, if you land a big customer and they sign a contract, technically, your startup earns this money over the period of the contract, not necessarily when it is paid.

This accounting method also recognizes when you owe creditors. It keeps track of all transactions in real-time, even when payment is yet to be executed. So, you can have a bill for something in your financial statements even if the amount hasn’t yet been paid. 

With accrual basis accounting, you need to include accounts receivable and accounts payable in your line items. Accounts receivable are the future funds your business is expecting (items that have been billed but the clients are yet to pay).

Accounts payable, on the other hand, reflect your future cash outflow or items that you have been charged with but have yet to pay. 

This method is highly preferable because it gives you a comprehensive and accurate image of your business that matches income and expenses in the period in which they occur. It’s especially useful when you need to make scaling decisions, report to your investors, and avoid financial mistakes.

If you’re unsure of the method to choose, you can start with the cash basis method and progress to accrual basis accounting as your business grows. 

Key Startup Accounting Documents & Records to Keep

Managing your startup’s finances using a manual system is just not practical for a busy founder. Manual systems are prone to errors that could leave your business open to potential risk. This is why we recommend that you consider an outsourced accounting team to take care of it for you. 

The beauty of hiring an expert team is it gives you one less thing to worry about so you can focus on what matters most — growing your business. 

There are a number of key startup accounting documents and records to keep. Here are the 10 financial elements you should always keep track of: 

1. Business Bank Account Statements

Step one – open a business bank account. We don’t recommend using your personal bank account for your startup needs. This often leads to mismanagement of funds and, eventually, cash flow problems that could negatively impact the business. In fact, a study revealed that around 82% of small businesses fail due to cash flow problems. 

Make sure you maintain two separate bank accounts: a personal account for self-use and a business account to make all your startup’s transactions. This makes it easier to monitor the financial health of your business and to reconcile your bank statements.

A business bank account also simplifies your business administration and tax returns. Additionally, it shows professionalism when you’re transacting with clients and suppliers. 

2. General Ledger

The general ledger records all your business financial information throughout its lifetime. It contains your assets, liabilities, revenue, expenses, profit, losses, and equity.

These items are referred to as ledger accounts, and they’re usually broken down into smaller details to help you identify your main money streams, payrolls, employee expenses, credit card payments, etc. 

The main goal of the general ledger is to balance the debits against the credits within a specified time frame. If you find that the total value of debits across all the ledger accounts doesn’t equal the overall value of the credits, it means that you made an error. 

3. Financial Statements

Financial statements provide meaningful insights from your financial data. You can also use them to determine your vendor ROI cost analysis, net profit margin ratio, and conduct a proper cash flow analysis. 

Here are four financial statements as they relate to your business:

Balance Sheet

A balance sheet highlights your startup’s assets and liabilities to help you determine the financial health of your business. There are three critical elements of this financial statement:

• Assets – These are the things your company owns, including the items in your inventory and total cash, that you can use to create economic value.
• Liabilities – These are the obligations such as outstanding debts and taxes that your startup has that ultimately reduce your business’s overall financial position.
• Equity – This is your startup’s value to all the stakeholders after you’ve accounted for the assets and liabilities. 

The main benefit of a balance sheet is that it gives you an accurate image of your startup’s financial position at any given time. 

Profit & Loss

The P&L statement is sometimes referred to as an income statement, and it highlights what your company’s made compared to what it’s lost. This financial statement first breaks down all your primary revenue sources and then itemizes your key expenses. 

It’s essential to make your profit and loss statement at a detailed level that makes sense for your individual business and then deduct your net expenses from your net profits to determine whether your business has made a profit or experienced a loss within a specified time frame.

Cash Flow

A cash flow statement highlights how money comes in and out of your business within a certain period. Some may confuse it with an income statement, but it’s different. An income statement technically highlights the value your startup has gained or lost, even when it isn’t liquid. 

For instance, if you land a new client, your business may have earned value even though they haven’t paid yet, so this should appear in the income statement. This entry, however, wouldn’t go on a cash flow statement until the funds are transferred into the bank account. Cash flows only record payments that have come in or debts that you have paid.

This is why your startup could have millions of dollars in the account, but you still report losses if you haven’t fulfilled your debt obligation. The money may be in the account, but you technically owe it to others. You may also have a negative cash flow when you’ve made future investments that haven’t started bringing money in yet. 

Understand your burn rate

Your startup’s burn rate is the speed at which it uses up its cash supply or startup capital before it starts generating positive cash flows. It’s the average amount of money that your business spends per month and is simply a measure of negative cash flows. 

4. Implement a Payment System

A payment system is a set of standard procedures or rules that highlight how your business transacts with other entities. You should first start by determining your preferred payment method; cash, credit cards, mobile, check, or online payments. 

5. Bank Reconciliation

Bank statements prove that the details in your other financial statements are correct, which is why reconciliations are essential for business audits. For instance, if one of your customers made a $20,000 payment at the end of the year, this figure should be part of your bank statement.

If there is no record of your business having received this payment, you should investigate it because it could indicate an error from your bank or a missed transaction in your records.

Simply put, bank reconciliations balance out your general ledger against your bank balance. 

6. Credit Card Reconciliation

Credit card reconciliations are almost similar to bank reconciliations but can be more complex. They involve confirming that all card payments are indicated in the general ledger and accounted for as proper business expenses.

One of the things that makes this reconciliation difficult is that multiple parties often have access to credit cards in a typical business setup. The transactions may also be small and sporadic, making them more tedious to track. 

7. Receipts

Balancing or recording your startup’s transactions is not enough. You also need to prove that the transactions actually took place and were related to the business, which is where receipts come into play. They are an extra layer of proof that shows your business engaged with third parties and they acknowledged the transaction. 

Receipts are especially important during your audits, as tax offices need to know that your reported financial position is accurate.

8. Accounts Payable

Accounts payable are the outstanding amounts that your business owes suppliers. They are liabilities paid reflected from invoices received that have not yet been paid. 

9. Accounts Receivable

Accounts receivable are assets owed to you by your customers. Remember the accrual accounting method above? With this method, you can include the accounts receivable as soon as a client signs a contract. On the other hand, if you opt for cash basis accounting, you can only record amounts receivable from customers once the money hits your bank account. 

Depending on your business’s financial stability, you can sometimes use accounts receivable as securities against bank loans. 

10. Taxes

The best way of dealing with tax authorities is to maintain clear and error-free records. As long as all your transactions can be proven, you won’t have a problem filling your tax returns, and you may even be able to apply for tax relief. 

Establish a Process of Regularly Checking Financial KPIs

Startups have a reputation for finding efficient ways of carrying out tasks. There’s just one challenge; most people consider accounting processes to be slow and tedious. However, they don’t have to be if you:

1. Digitize your documents – This makes them easy to track, easy to access from anywhere, and minimizes data entry.
2. Set reminders for important deadlines – This includes filing tax returns.
3. Establish a receipt collection system – It’s difficult to manage receipts, especially when you need to collect from employees, and they may end up getting lost. 
4. Use smart expense accounts – Manually filling out the general ledger can be tedious and time-consuming. Instead, use a smart system where every expense is automatically assigned to the correct account. 

You can also automate or outsource your entire accounting system to streamline the processes. 

Good Startup Accounting Leads to Better Pitches and Funding

As a startup, you can’t afford to neglect accounting processes, especially when you require more funding. For example, if you want a loan from the bank, you’ll have to prove to them that you can comfortably repay it. This means giving them access to your financial information and accounting records.

On the other hand, if you need more investors, you need to convince them that your business is a worthwhile investment based on your current and future net profits or losses. 

Knowing When to Outsource Your Startup’s Accounting

As revenue grows, so does financial complexity. The demands of a startup, on top of figuring out your finances, can be overwhelming. There’s so much to do and achieve that if you’re not careful, you may end up neglecting aspects of your business that are critical to its growth, such as accounting. The good news is that you don’t have to do it yourself.

You can easily outsource your startup’s accounting, allowing you to focus more on running your business. At Hiline, we even grow with you, allowing you to start small and scale up as you grow your business. We also provide you with a dedicated account manager and financial expert to manage your bookkeeping. Let us take care of your accounting needs. Contact us today for an interactive consultation.