Accounting for Startups

As the old saying goes, numbers don’t lie. Understanding the basic principles of accounting is important for your startup’s financial health, setting a solid foundation on which to grow.

In this article, we’ll go into the fundamental concepts and tools for startup accounting. From handling cash flow and budgeting to making sense of your financial statements, to managing investments and funding, we’ve got you covered.

Also, this guide is related to our articles on understanding retained earnings, cash vs. accrual accounting, and understanding gross vs. net profit.

This list includes:

• Importance of accounting in startups
• Accounting software for startups
• Cash flow management techniques
• Basic bookkeeping for startups
• Understanding financial statements

So, without further ado, let’s get started!

Basic accounting principles for startups

Let’s look at the two primary accounting principles: accrual and cash basis accounting. 

Accrual vs. cash basis accounting

Accrual basis accounting records transactions when they happen, not when the cash is exchanged. In other words, once you bill a client it gets marked as revenue, and when you are billed it’s marked as an expense. All this happens regardless of when the money leaves or hits the bank. 

In contrast, cash basis accounting is a straightforward system where only the actual flow of money is recorded. You’re paid by a client? That’s when it becomes revenue. You pay an invoice? That’s when it transforms into an expense. No cash going in or out, no revenue or expense recorded.

Applying these principles to startup operations

Startups often lean towards accrual accounting as it offers a realistic look at financial activity and profitability, even when cash has not yet been transferred. 

Let’s say a client owes you for a service that you have already provided: it’s recorded as income even if the cash has yet to reach your account. It’s then easier to align your expenses and income to the period they belong in, offering a clear picture of the way the business is moving.

However, for startups keen on keeping a tight eye on their cash flow, cash basis accounting works best. It follows a simple rule: record the cash when it comes in, mark it out when you pay the bills. This way, you know exactly how much cash you have on hand at any given time.

There are pros and cons to each method, and your choice will depend on factors specific to your startup. Do you primarily make cash sales, or do you rely on credit? Could your sales volume be described as king-sized, or is it more modest? Are there certain legal or regulatory requirements you need to follow in your field? 

Based on the answers to these questions, one method may be more suited to your startup over the other.

Setting up your accounting system

Whichever principle you choose to go with, you’ll now need to set up your accounting system, and luckily there’s software for that. It isn’t as daunting as it sounds, and getting it right from the start can save you a lot of headaches down the road.

What’s the right accounting software for startups?

You’re going to want something that’s user-friendly, cost-efficient, and most importantly, tailored to the needs of small businesses. Platforms like QuickBooks or Zoho Books are perfect for this. They’re designed with small businesses in mind and can deal with everything from invoices to payroll. They also grow alongside your business, so you won’t have to swap out software as you expand.

These platforms usually operate on a subscription basis, which means they’re more budget-friendly for startups, too. Plus, they’re cloud-based, so you can access your accounts and financial data from anywhere.

Set up a scalable system from the beginning

This may not seem a priority when you’re just getting started, but you should choose an accounting system that can scale with your small business. When you’re just starting, your accounting needs may be relatively simple. But as your operation grows, so will the complexity of your finances. You’ll have more revenue, more expenses, more employees, maybe more locations. The volume and intricacy of your financial data will multiply quickly.

If your accounting system isn’t set up to handle this growth, you’ll find yourself scrambling to keep up and may even need to switch solutions, costing you valuable time. That’s time you could be spending on developing your business, not untangling financial knots. 

So make sure your chosen software can grow with you. Look for scalability features like additional user accounts, different access levels, advanced reporting, or multi-currency support–all things you’ll need as your business expands and your accounting requirements become more complex. Cloud-based systems like those we mentioned earlier are typically more scalable than their traditional, on-premise counterparts. They’re updated continually by the provider, so you’ll automatically have access to new features and improvements, too. 

Don’t forget about integration

How well does your chosen accounting software play with other systems? For example, your software should be able to sync up with your bank accounts and credit cards; this will make keeping track of income and expenses and reconciling your books much, much easier.

The software should also be able to integrate with other essential systems, like your point-of-sale system, inventory management system, or payroll software. Basically, it should serve as a central hub that brings together all your different financial data.

Managing cash flow

Money is the fuel that keeps your business engine running, and when it comes to the finances of your small business, cash flow is king. Cash flow management is simply tracking this flow, keeping a close eye on what’s coming in and what’s going out. You’ll look at things like product or service sales, cash received from customers, and payments for expenses like rent, utilities, salaries, and supplies.

When checking your cash flow, look for patterns or trends over time. Are there seasons or months when your sales spike? When do your biggest bills tend to come in? 

Think of your business’s cash flow as its pulse. If the pulse is strong and regular, your business is healthy. But if not, it could indicate underlying issues that need to be addressed. 

Here are some techniques and tools that can help. 

1. Monitor cash flow regularly: Checking your cash flow once a month or once a quarter isn’t enough. Weekly, or at times daily, monitoring can provide a more accurate, real-time view of your company’s financial health.
2. Cash flow projection: Cash flow projection is essentially looking ahead to anticipate your future cash inflows and outflows. This proactive approach can help you tackle potential shortfalls or identify investing opportunities. 
3. Have a cash reserve: Always aim to have a certain amount of cash set aside. This reserve can be a lifeline during lean periods or unforeseen circumstances.
4. Use accounting software: Accounting software makes keeping the books easy, and gives you insights into your cash flow. Plus, many software suites come equipped with forecasting tools, so you can more effectively plan for the future.
5. Invoice promptly: Don’t delay in sending out invoices for the goods or services you’ve provided. The quicker you invoice, the sooner you’ll likely be paid.
6. Stay on top of receivables: If customers aren’t paying their invoices on time, your cash flow will suffer. So stay on top of your receivables. Regularly review who owes you money and don’t be shy about chasing down late payments.

Budgeting and financial forecasting

Budgeting and financial forecasting are another element of accounting for startups–and any business, really. Here’s how to get started.  

Analyze your income and expenses: The first step towards creating a budget or making a financial forecast starts with understanding your income and expenses. Collect all your financial data, including sales figures and costs, both variable and fixed.

Create a budget plan: Next, list the costs you expect to incur and the revenue you hope to generate in a given time period. Include everything from salaries, cost of goods sold, utilities, rent, marketing costs, insurance and taxes. 

Develop financial forecasts: Financial forecasts are effectively an extension of your budget. Using historical data and future projections, create an estimate of your future revenues and expenses. Tools like spreadsheet software or dedicated forecasting software can help you streamline this process.

Adjust and refine, revisit and revise: Review your budget and forecasts frequently. Your budget isn’t set in stone, it should be a flexible tool. Market conditions change, costs fluctuate, and revenues may fall short or exceed expectations. Revisit your budget and forecast regularly and revise as needed, based on circumstances and your actual income and expenses.

Bookkeeping basics

If bookkeeping is going to be your responsibility as startup owner, you need to be organized. Let’s start by breaking down tasks based on their regularity.

• Daily tasks: These are the things you should be keeping tabs on every day, like recording all transactions–whether that’s cash going out or coming in. 
• Weekly tasks: Weekly tasks can include duties like running payroll, paying bills, reconciling bank transactions, and checking cash flow.
• Monthly tasks: At the end of the month, close your books and run financial reports such as the Profit and Loss statement, Balance Sheets, and Cash Flow statements to get a clear snapshot of your financial health for that particular month.

Over time, you’ll get a good grasp of your day-to-day financial workings and establish a rhythm which works best for your business.

Hiring vs. DIY: When to bring in a professional bookkeeper

When you’re just starting your business, it’s possible to handle bookkeeping by yourself using software platforms designed for small business owners. It’s affordable and with a bit of a learning curve, manageable. 

But as your business grows, so will your financials. If bookkeeping begins to eat away at the time you should be dedicating to growing your business, it might be time to consider hiring a professional. You’ll free up time and get the peace of mind that comes with knowing a specialist is handling your finances. They can set up systems, solve problems, and make sure you’re compliant with all necessary tax laws. 

Understanding financial statements

These cover cash flow related to your main line of business, like income from sales or payments for supplies. Investing Activities detail cash from buying or selling assets like property or equipment. And Financing Activities show cash flow from borrowing or paying back money, or issuing and buying back shares.

It’s worth taking the time to learn how to read and interpret these statements–it’ll significantly improve your business decision-making. 

From the Balance Sheet, you can assess your company’s liquidity and stability. High liabilities compared to assets might indicate financial risk, while robust equity can suggest a healthy financial buffer.

The Income Statement can show you whether your company is profitable and highlight areas where costs are too high or revenues too low. It can also reveal trends over time, helping you understand if your profitability is improving or declining.

Finally, the Cash Flow Statement can show you how effectively your company generates cash, where it’s coming from and where it’s going.

Investments and funding

As you run your startup, you might find yourself in need of funding sources to keep growing. Types of funding can typically be divided into two arenas: equity and debt. Here’s how to approach them with confidence and clarity. 

Equity financing involves selling shares of your company to outside investors. In return for their money, investors become partial owners of your business and gain certain rights like having a say in major company decisions. They might not expect immediate returns, but rather to share in the profits as your business grows.

Debt financing is very different. It means borrowing money from a lender with the promise to pay it back over a specified period, with interest. It’s like taking a mortgage on your house or a student loan, but for your business. The plus here is that you retain total control over your business. But of course, the debt must be repaid whether your startup succeeds or fails.

Payroll management

You have to decide how often you’ll pay employees, categorize them correctly for tax purposes, and establish procedures and a system for overtime, bonuses, commissions or other additional compensation.

Nothing is more significant for an employee than getting paid on time. So make sure you set your pay periods in response to your business needs and legal requirements. You might opt for weekly, bi-weekly, or monthly payment schedules.

Employees should be classified as either exempt or non-exempt based on federal regulations. This determines eligibility for overtime pay. 

Common accounting mistakes and how to avoid them 

Amid the endless work of a startup, accounting can slip through the cracks sometimes; here are a few common errors and tips on how to steer clear of them. 

1. Mixing personal and business finances

Keeping personal and business funds together can create an accounting mess, leading to inaccurate financial reports, troubles during tax season, and an unclear picture of how your business is doing.

Open separate bank accounts and always use your business account for business transactions. This makes your financial reports more precise, simplifies your tax filing, and gives you a clearer outlook on your business finances.

2. Lack of regular record keeping

Not maintaining thorough financial records can make it difficult to track your business performance, let alone conduct accurate planning and budgeting. 

Maintain regular financial records and keep them up to date–digital tools are your friend here!

3. Incorrect tax filing

Incorrect classification of employees and misunderstanding tax regulations can lead to incorrect tax filings, triggering penalties and/or interest charges, and potentially causing damage to your business reputation.

Make sure you are familiar with your tax obligations, deadlines, employee classifications, and all the deductible expenses applicable to your business. Consult with a tax professional if needed. 

4. Neglecting to reconcile books with bank statements

Failure to cross-check your books with your bank statements often results in discrepancies, causing confusion and lack of clarity.

Regularly comparing your books with your bank statements will help highlight inconsistencies like this, if there are any. Don’t wait until the end of your fiscal year. Doing it monthly can save you from a cumulative headache.

Conclusion

Accounting should not be an afterthought in your business strategy. Make it an integral part of your business plan from day one and fine-tune your practices along the way. With sound accounting routines in place, you can confidently steer your startup towards growth and stability. Keep going, you’re doing great!

Next, check out our articles on operating income vs. net income, cash flow vs. revenue, and how to do bank reconciliations.

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Author: Julia Kelly

Co-founder at Rigits

I write about how small business owners can better understand and utilize their financials for growth.

Julia Kelly