Financial transactions hold more sway over your startup than you might think – even if you’re just noting down profits and losses. They encompass all the money coming in and going out, directly impacting your cash flow, profitability, and overall financial health.
Tracking these transactions helps you make informed decisions, including budget allocation, pricing strategies, resource investments, hiring decisions, and debt management, all of which directly impact your company's growth trajectory and long-term success.
A smart way to monitor your financial transactions is through double-entry accounting. This method provides a holistic view of how transactions affect both sides of a business’s finances.
But what exactly is double-entry accounting? And why is it so important for startups? Here’s what you need to know about the double-entry system of accounting.
What Is Double-Entry Accounting?
Double-entry accounting is a bookkeeping method where each financial transaction is recorded with two entries: one as a debit and the other as a credit. These entries are made in separate columns of an accounting ledger.
This system ensures that the accounting equation (assets = liabilities + equity) remains balanced for every transaction, providing a comprehensive and holistic view of a company's financial health and how each transaction impacts different aspects of its finances.
Why Is Double-Entry Accounting Important For Your Startup?
As a startup, you are most likely working on making money, repaying loans you took to start your business, and aiming to earn profits for your investors. In this phase, it’s really important to know exactly where you stand financially.
Double-entry accounting can help you make spending decisions, including calculating what investments you can afford or knowing when to cut spending. It can also provide valuable information for investors when you're seeking funds.
Principles Of Double-Entry Accounting
Double-entry accounting is based on this simple equation: Assets = Liabilities + Equity.
Your assets are what the business owns. Your liabilities are what your business owes. And once assets are added up, and any liabilities are subtracted, what’s left over is equity. Equity is the value of the business to the business owners once they settle up assets and liabilities.
Getting familiar with the principles used in double-entry accounting will help you better understand how it works.
Dual Aspect Principle
The dual aspect principle means that every business transaction affects the company as a debit and a credit. That means you'll record both a credit and debit in accounting for each transaction.
For example, if your company pays a bill it owes, you would debit accounts payable to show you paid the bill and credit your cash account to record the payment.
The cost principle says the cost at the time of a transaction is the cost you record.
Let’s say you bought office furniture. The cost principle states you should record the cost at the time of purchase without accounting for depreciation or increased value over time.
Revenue Recognition Principle
The revenue recognition principle means revenue is recorded when it's earned instead of when you receive payment.
Imagine your business makes a sale on the first of the month, but the customer’s check doesn’t clear until the following week. You would record the amount earned on the day of the sale, not on the day the check cleared.
Benefits of double-entry accounting
Double-entry accounting can benefit your startup by providing more accurate financial records, error and fraud detection, and a clearer picture of your financial position. As your business grows and your accounting becomes more complex, double-entry accounting can help you stay on top of your finances.
Accurate Financial Records
You have more accurate financial records when you track how each transaction impacts your assets and liabilities.
Accurate records make preparing important financial statements, like income statements, easier. When you construct detailed income statements, you can use them to make decisions and prove your company's value to potential investors.
Error And Fraud Detection
Double-entry accounting simplifies detecting errors and fraud because the same transaction's debit and credit entries must always be the same number. If these don’t match, something is wrong.
Sometimes, the numbers not matching up simply means an error happened, such as transposed numbers or incorrectly imported invoices. But it could also signal fraud if the value of an item is over-reported to make assets appear larger.
Clear Picture Of Your Financial Position
With double-entry accounting, startups may have an easier time tracking their money's movement and how liabilities and assets change. It forces your finance team to constantly compare how much money you owe (liabilities) to how much you've earned (assets).
Once you settle these numbers, you get the equity amount, which gives you the overall picture of the company's worth. This big-picture view can help you when making decisions about your company's future.
Key Considerations For Implementing Double-Entry Accounting
Shifting from single-entry accounting to double-entry accounting may benefit your business. But you need a solid plan with steps and tools to smooth the transition.
Consider the following topics as your startup prepares to adopt this new accounting method. Make a plan outlining how you’ll add necessary tools and introduce them to your fiance team.
Accounting Software Selection
You'll want to select the right accounting software when implementing a double-entry journal system of accounting. Look for double-entry journal software incorporating traditional ledger styles with options for the double-entry account credit vs. debit for each transaction.
Chart Of Accounts Design
Implement a clear chart of accounts — or structure of accounts— to organize your financial records. This should be done in a way that mirrors double-entry accounting principles. Categorize each transaction under a subject such as:
- Operating costs
As you move to double-entry accounting, a well-designed chart of accounts will make it easier to see where credits and debits balance out between categories.
Internal Controls And Processes
Developing internal controls and processes to work as checks and balances as you implement the new system is essential for accuracy. When your finance team sets up internal controls and processes, you can feel confident your records are accurate.
Some examples of internal controls and processes you may choose to implement include:
- Separation of duties
- Establishment of responsibility
- Access control audits
- Occasional reconciliation
- Physical controls
Integration With Other Financial Systems
To make your accounting system more efficient, look for double-entry software that integrates with other financial systems. This means finding programs where you can easily integrate invoices, accounts payable, and tax information from one central dashboard.
Keeping everything in one place can save time and help reduce errors. It also gives a birds-eye view of your company's finances which helps during a transition to a different accounting system.
Compliance With Accounting Standards And Regulations
As you implement double-entry accounting, make sure to stay in compliance with typical accounting standards and regulations. Internally, your finance team or fund accountant has likely discussed the standards they want to use.
Also, make sure there are enough resources to comply with external regulations like tax remittance as your team adjusts to the new process.
Use Startup-Friendly Bookkeeping Systems For Double-Entry Accounting
In the fast-moving world of startups, time is money. With more accurate financial records, you’ll have the reliable data you need to make decisions faster. Augment your startup's accounting resources with startup-friendly account bookkeeping systems that let you harness the power of double-entry accounting.
Investigate what kinds of double-entry bookkeeping systems are out there as you consider double-entry accounting and what it could do for your startup.
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