Getting your startup off the ground can make you feel like you're flying. You start with little more than a vision, and before long, you're up in the clouds. Once the thrill of takeoff is over, it can be easy to lose your bearings.
That's why experienced pilots learn to trust their instruments. In the same way, the primary purpose of financial accounting is to give your startup the tools it needs to navigate the ups and downs of business and know where you are (financially speaking) now and into the future.
The Importance Of Financial Accounting
Like an instrument panel, accounting gives your startup a good financial sense, helping show where you are, where you've been, and where you're going. A solid accounting and financial management program is crucial for startup success because it gives you concrete data that allows you to better plan and track your spending, while also controlling your resources. The goal is the same whether you're using internal financial accounting software or external financial accounting services. You're able to track your day-to-day financial performance and keep an eye on your startup's long-term financial health.
Financial accounting statements may be used outside an organization, unlike managerial accounting statements. Financial management accounting is used exclusively to aid in decision-making internally.
The Primary Purpose Of Financial Accounting In Startups
The role of financial accounting in a startup is to provide reliable, accurate, and timely data on the organization's finances. This gives business owners and managers a sense of the company's financial positions, debt obligations, and the like. By keeping detailed financial statements, you have greater control and oversight, smoother investor relations, better-informed decision support, more dependable compliance, and more reliable risk mitigation.
Financial Control And Oversight
Financial accounting provides startups the ability to direct and oversee where the money comes from and where it goes. Financial statements in accounting give an accurate record of your company's financial health, so you can track regular expenses and plan for them in your budget.
In business (as in life), it's important to know where your money is going. But it's more than a useful tool for your startup; it's a legal requirement. The Financial Accounting Standards Board (FASB) requires all U.S.-based organizations to submit financial reports that contain information on revenue, expenses, debts, and assets. To meet your legal requirements, you'll need to track your cash flow.
Of course, when you record expenses for the FASB, you're also getting the hard data you need to continually re-evaluate your spending. Cash flow statements let you keep an eye on your startup's costs, so you can decide if the $1,200 spent on coffee last quarter is essential to your company's mission and vision. Expense tracking gives you greater insight into the inner workings of your organization, so you can continue to seek greater efficiency and higher profits.
You'll also be better equipped to recognize fraud or questionable spending before it snowballs into a much more expensive issue. The more frequently you build audits or trial balance sheets into your accounting program, the earlier you will catch potential problems.
Budgeting is fundamental to any good financial accounting program. You'll need a budget to anticipate expenses and plan appropriately to ensure your startup can meet its financial obligations. It's important to remember that your budget is a living document and that you'll need to continually revisit your budget as times, circumstances, and finances change.
Fortunately, building a reasonable budget for your startup isn't rocket science. If your startup is in its early stage and you don't have much data to work with yet, start by brainstorming any and all potential costs and grouping them together into logical categories. Next, you'll need to anticipate monthly revenue, accounting for all money that comes into your company. Be sure to include all forms of revenue, including sales, investments, and accrual from investments. Finally, you'll calculate the total number of expenses to determine your operating number for the fiscal year.
Your startup may have many external stakeholders, but chances are high that one group may be more interested in your balance sheet than most others: investors. Financial accounting provides hard data you can share with your investors to instill confidence and build momentum for that next round of funding requests. Maintaining your financial records demonstrates your startup's commitment to developing quality processes and procedures. Likewise, you want to be able to show investors concrete data regarding the company's growth so that they can have reasonable expectations of their returns on investment.
As your startup gets airborne, you'll probably need some help from outside investors. You may need to go through several structured stages to secure investments for your company as it grows. For instance, when you raise seed money, you're asking investors to support a proof of concept and fund the basic infrastructure of the company. Whether you're just beginning to look for seed money or prepping for an IPO, accurate and transparent financial accounting data is crucial for attracting and securing investments. That's because providing accurate and transparent numbers can also help increase investor confidence.
Initial excitement in your startup may be based on an idea, but financial reports provide the necessary numbers to build investor confidence. Your investors will expect both accuracy and transparency, and financial accounting helps you maintain financial records that are both clear and correct. After all, sloppy numbers can sink or stall an otherwise solid startup.
At the outset, making decisions for your startup will feel like you're flying blind because you don't have much historical data to draw from. Financial accounting is an instrument that helps you keep track of your business's financial status, enabling you to devise the best growth strategies while keeping costs in check.
Financial data is essential for deciding upon (and designing) growth strategies that can lead you to achieve a larger share of the market. Without the data, you may have a sense of how you're doing, but you don't really know. For instance, imagine a startup that sells parkas in Hawaii called Hypothetical Howie's Hawaiian Hats. Comparing income statements, the business owner notices something obvious. The data shows the company has much better performance in online sales, so the owner shifts the focus of the business to have more of an online presence. In this case, the owner used a data-driven market development growth strategy, allowing the company to grow into a new market.
Financial accounting allows you to manage costs by tracking, budgeting, and reassessing your startup's financial commitments. When you have reliable financial reporting, you have a consistent method of cost accounting.
The owners of Hypothetical Howie's Hawaiian Hats wonder if they can do without the overhead expense of a pricey storefront rental space. After checking the same quarter from the previous year, they noticed the rent had increased 10% from year to year. As their growth strategies and business plan shift toward an online model, they recognize that they can cut costs by either moving to a less expensive storefront location or eliminating the company's brick-and-mortar operations altogether.
Compliance And Tax Reporting
Financial accounting ensures your startup company fulfills its responsibility to keep accurate books for the purposes of compliance and tax reporting. A company is compliant if it operates under all applicable laws, including tax regulations.
Like all licensed businesses, startups are legally required to maintain accurate and up-to-date accounting financial statements detailing all financial transactions. Companies follow Generally Accepted Accounting Procedures (GAAP), which is the standard set of accounting practices and principles all publically traded American companies must use to prepare financial statements. There is some flexibility within GAAP regarding your preferred method of accounting. For instance, a startup may choose to use accrual accounting over cash accounting to reflect its ledgers more accurately.
Successfully navigating tax law and compliance is one of the seven accounting issues that startups face. Depending on your budget, it may be wise to lean on financial accountants to help your startup find its way through the foggy world of tax compliance. Likewise, several helpful accounting software platforms can help ensure your startup maintains its legal obligations.
Your startup could be subject to penalties or fees if you're not operating with an accurate and up-to-date financial accounting book. Likewise, if you fail to pay your startup's taxes on time, you can also face serious consequences. These penalties can include steep fines and, in some cases, even jail time. Even so, the IRS and SEC aren't the only entities that can dole out negative consequences. Plus, under the registrations demanded by the Securities Act of 1933, if a startup fails to keep proper financial records, investors may be entitled to their initial investment plus interest. To avoid this and other penalties, you need a financial accounting system in place.
Establishing a consistent routine through financial accounting also protects your startup's resources from fraud. Monitoring business transactions, executing routine audits, and dividing duties will help you either catch fraud early or prevent it in the first place.
In this context, fraud is the intentional attempt to mislead an organization's stakeholders using inaccurate financial data. This can take a host of forms, including embezzlement, inflating assets, or underreporting on loss statements, just to name a few. The most recent report from the Association of Certified Fraud Examiners found that the average fraud case in America went on for roughly 12 months before being detected and cost an organization $117,000 in the process. For many startups, a loss of this size can seal the company's fate. Fortunately, proper accounting policies and procedures can detect fraudulent behavior before it has a chance to jeopardize your startup.
It's a good idea to divide your financial duties so that no one person has full responsibility. For instance, if your business practices require two signatories on a check for amounts over $500, it's less likely that someone will submit questionable statements. Monitoring transactions and routinely auditing accounts will help you catch cases of fraud early, so even if an employee does write a suspicious check, you'll see it in your next financial statement.
A proper financial accounting system makes it possible for you to detect fraud earlier, and it can also help you uncover any troubling trends. The financial statements you build will, over time, provide you with enough data to model "normal" cash flow and financial patterns. If your next financial report deviates from your expected performance, you'll know to dig into the reasons behind the change and keep an eye on it. When you catch a problem early, it's much easier to course-correct than if it goes undetected for several months.
Implement Effective Financial Accounting Practices In Your Startup
A pilot who learns to trust their instruments can soar in all sorts of weather. In the same way, a startup company that understands how to use the accounting instrument panel will fare far better than those who try to just wing it. The primary purpose of financial accounting is that it gives your startup the ability to control and oversee its finances. Having a solid grasp of your organization's financial health will help build trust from investors and aid in decision-making. This ensures compliance with all state and federal regulations and mitigates both financial and legal risks in a number of ways.
If this sounds like something your startup could use, but you feel like you're in the fog, consider reaching out to professionals so you can get up above the clouds in no time.