A startup requires solid accounting practices allowing its founders, business leaders, and financial managers real-time visibility to an accurate picture of its financial health.
Because of the unpredictable nature of startups, access to accurate financial information is vital to allow for nimble analyses that can identify opportunities for improvement and growth and provide strategic decision-making insights.
This article will take an in-depth look at best accounting practices, the different types and methods used, and what’s involved in keeping accurate financial records. We’ll provide best practices and illustrate why efficient accounting is vital for your startup.
What Is Startup Accounting?
Accounting is how your business records, organizes, and understands its financial information. Accounting processes include reporting, summarizing, analyzing, and projecting business transactions using financial statements.
Financial statements provide a concise summary of your financial transactions over a specified accounting period and illustrate your startup's cash flow and operations status, providing an accurate picture of your startup's level of success and financial health.
Accounting vs. Bookkeeping
Bookkeepers generally focus on completing day-to-day tasks like financial data entry, while accountants focus more on ensuring data accuracy and compliance with correct formatting.
Accountants are responsible also for preparing reports on the business's financial health for internal and external interests.
See also: Bookkeeper Vs. Accountant: What's The Difference?
Types Of Accounting
There are many accounting systems available for startups. We’ll look at some below to help you decipher which type would work best for your business.
- Financial accounting: Summarizes the financial transactions from a business’s accounting period into financial statements, such as P&L statements, cash flow statements, and balance sheets. At larger businesses, these documents are typically audited by an external regulator and act as a measure of your company's economic performance. At startups, these statements are available to key external stakeholders such as investors and board of directors.
- Managerial accounting: Managerial or management accounting uses the same processes as financial accounting and records financial information intended solely for internal stakeholders. They use this information to make informed decisions about your business.
- Tax accounting: Tracks incoming and outgoing funds associated with your startup's operations concerning their effect on your tax burden. The Internal Revenue Service (IRS) regulates tax accounting.
- Cost accounting: Records financial information related to the costs for producing your service(s) or product(s). Startups use this information to budget, make predictions, and analyze business performance.
- Accrual basis accounting: Records revenues and expenses when related transactions occur regardless of when funds change hands. By including anticipated accounts receivable and accounts payable, this commonly used method provides an accurate picture of a startup’s financial health, allows for strategic decision-making, and can prepare your business to scale.
- Cash basis accounting: Creates a more immediate recognition of revenues and expenses by recording them only once funds for a transaction have been exchanged. While this method can be more straightforward and portray how much cash is on hand, it can be misleading in accurately representing your business's health and growth.
Generally Accepted Accounting Principles (GAAP)
GAAP is a commonly used set of rules, regulations, standards, and procedures created by the Financial Accounting Standards Board (FASB) to develop financial reporting consistency across industries.
Private companies do not have to comply with GAAP guidelines. However, if you're looking to raise venture capital or take out a business loan, your financial reports will have to follow GAAP to fulfill the requirements dictated by financial institutions. Because of this consistency, using the GAAP system can make it easier for your startup to compare its performance to other businesses in your industry.
For businesses with operations headquartered in another country, including Canada, Australia, the United Kingdom, and Mexico will follow a different system called International Financial Reporting Standards (IFRS).
Financial Records: What To Keep And For How Long
Financial records will help you identify income sources, keep track of deductible expenses, monitor your business's progress, prepare financial statements and tax returns, and act as backup for items reported on your tax returns.
For most startups, you must keep financial records for at least three years for auditing purposes. While private companies are exempt from annual audits, several scenarios might require a startup to undergo an audit, such as securing a bank loan, line of credit, or other fundraising activities.
See also: Keeping Business Records: How Long Is Too Long?
4 Basic Accounting Processes And Tasks
The accounting process involves several procedures that collect, process, record, summarize, analyze and communicate financial information.
1. Maintaining accounting software
Your accounting software will serve as your business's ultimate financial record. Every transaction must be recorded in detail and categorized within the software, which organizes the data to enable accurate reporting and analysis.
Sometimes accountants manage the software directly, but most times, a bookkeeper will enter the bulk of the data into your software, and your accountant will ensure accuracy and completeness.
2. Reconciling bank accounts
Bank account reconciliation is an essential accounting process for your startup. Typically done once you receive your bank statement at the end of each month, this arduous task involves comparing the bank's transactions and balances with your recorded business transactions and balances. This process allows you to catch any errors from your or the bank's record keeping.
3. Preparing financial statements
- A profit and loss statement (P&L) or income statement summarizes the expenses, revenue, cost of sales, and gross margin that your company has incurred during a specified accounting period. The P&L is the most common financial statement for businesses of every size and is the report analyzed by potential investors.
- A balance sheet provides a snapshot of what a company owes and owns, such as liabilities, assets, and shareholders' equity. This report is used as a basis for computing rates of return and evaluating capital structure.
- A cash flow statement summarizes the amount of cash and cash equivalents coming in and out of a business in much more detail than a P&L statement. The cash flow statement demonstrates how well a startup generates cash to pay its debts and fund its operating expenses.
4. Financial planning & analysis
A sound business plan that includes meaningful financial projections is one of the most significant contributors to a startup's success. Financial planning and analysis (FP&A) go beyond the record-keeping and financial reporting of accounting by analyzing your business's financial statements and other financial and operational data.
FP&A professionals undertake the following processes to help align and measure your financial health and business strategies with your financial goals, including budgeting, forecasting, and analytics.
See also: What Every Founder Should Know About Building A Startup Financial Model
Why Accounting Matters For Your Startup
1. To support planning for growth
For your startup to grow and scale, you'll likely need capital. For external funding, expertly prepared financial statements and cash flow projections can help convince investors and lenders that your business will be profitable and offer them a good return on investment.
2. To help in raising funding from investors or selling your business
As mentioned earlier in this article, if you're looking to take out a business loan, line of credit, or raise venture capital, your financial reports must follow GAAP. Experienced accountants understand the GAAP system, which uses the accrual accounting method, and can prepare you for exit scenarios such as mergers, acquisitions, or initial public offerings.
See also: How To Raise Pre-Seed Funding For Your Startup
3. To properly collect money due to your business
Accounts receivable (A/R) represents the money your business expects to receive from customers for the goods or services you’ve provided. The efficient collection of your A/R is essential to your business's cash flow. These figures are a necessary to calculate your profitability and provide the most precise gauge of your startup's revenue.
4. To remaining compliant
Whether you’re at the beginning stages of building your startup or planning for future growth, using a GAAP-compliant accounting system will help prepare your business to scale to any size. From correctly categorizing and storing financial records to establishing clear controls and approval workflows, every effort counts to stay ahead of potential audits (which are more common than startups may think!). A fundraising round, due diligence for an acquisition, or applying for a bank loan or line of credit could require a startup to undergo a financial audit.
See also: How To Make Sure Your Startup is Audit Ready (And What To Do If You’re Audited)
5. For paying taxes correctly
A solid accounting system managed by experts will make tax return preparation all that much easier and more accurate. It will also ensure you can maximize your tax deduction opportunities, like the R&D tax credit (Research & Experimentation Tax Credit), which offers additional tax credit incentives for companies pursuing innovation. If your accounts are not in order, you’ll likely miss out on maximizing this serious tax benefit for startups.
Why Zeni Is The Ideal Accounting Partner For Startups
Zeni is a full-service finance firm that handles startups' bookkeeping, accounting, yearly tax, and CFO needs with speed and accuracy.
With Zeni, startups get accurate, GAAP-compliant books and access to finance concierge that is 10x faster than other accounting options thanks to Zeni’s AI-powered processes. The Zeni Dashboard gives founders 24/7 access to real-time financial data and key startup metrics, including your net burn, cash on hand, and cash zero date, so you can get the insights you need instantly and at no extra cost.
Most bookkeeping firms charge at an hourly rate, which can be an expensive surprise each month depending on the number of transactions, complexity, and overall business needs. With Zeni, you’ll pay a set monthly fee based on the amount you spend to run your business, so it’s easier to budget your bookkeeping costs even as your business grows.