The Basics of Accounting for Startups
A strong understanding of your business's financial health is essential to the success of your company. Startup accounting provides valuable insight into your startup's cash flow and also allows you to make financial projections. Most importantly, it ensures that your startup is staying compliant.
Startup accounting can be used to generate financial statements and financial reports as well as review financial transactions.
While many startup founders choose to hire an accountant, it is possible to do accounting yourself or by using accounting services. Here’s what you need to know about accounting for startups.
Accounting vs. Bookkeeping
Accounting and bookkeeping go hand in hand. However, there are a few key differences. Bookkeeping involves tracking financial records such as income, deductions, credits, and expenses on a weekly or monthly basis.
Comparatively, accounting takes these financial records and interprets them for various use cases, including communicating with investors, filing taxes, and monitoring the financial performance of your company.
Financial Records to Maintain
Whether you do bookkeeping manually or hire a bookkeeper to manage your startup's financial transactions, there are records and documents you need to maintain. To ensure you or your accountant have all of the necessary information to do your startup’s accounting, you or your bookkeeper need to compile and keep track of all financial records such as:
- Tax forms (including W-2s or 1099s)
- Tax returns
- Bank statements
- Credit card statements
- Canceled checks
- Financial statements
- Proof of payments
- Any additional business transactions or financial reports
Do Startups Need Accountants?
Hiring a startup accountant isn’t required, however, accounting services are strongly recommended no matter your business size or stage. While bookkeeping can sometimes be done internally, proper accounting is crucial not only for securing funding for your startup but also for understanding your business's financial health, which will inform most decisions made about your company.
Benefits of Accounting for Startups
Managing your startup accounting is essential to your startup's financial health. However, there are also several benefits of accounting for startups, including:
Monitoring Financial Health
Being able to monitor your startup’s financial health helps you make data-backed decisions for the betterment of your startup. Accurate accounting processes allow startup founders to get a clear visual of their startup’s financial performance, making it possible to monitor your startup’s financial health through balance sheets, profit and loss statements, and cash flow statements.
Conveying Information to Investors
Before a venture capitalist, angel investor, or any other type of investor deploys money into your startup, they need a clear understanding of your startup’s financial position, business growth projections, and cash flow. In fact, even after you secure funding for your startup, you will need these numbers to report the financial performance of your company to investors.
Tax Filing and Compliance Help
Accounting information is used to communicate with the IRS. Plus, it can save you money on your taxes when you file your yearly income tax return. It is important that all financial information submitted to the IRS is accurate. Effective startup accounting helps ensure that your business stays tax-compliant.
How to Do Accounting for Your Startup
1. Choose a Business Structure
If you haven't already, the first step to accounting for startups is to choose a business structure and register your business. The most commonly used business structures are:
- Corporation/C Corp (most common for startups)
- Limited Liability Company
- S Corp
- Sole Proprietorship
The type of business entity you choose for your startup is hugely important. To learn more about business structures and determine the right one for your startup, check out our guide on How to Choose a Business Structure.
2. Select an Accounting Method
There are two types of standard accounting methods: cash basis accounting and accrual basis accounting. Keep in mind that some states require businesses to use the accrual accounting method, check with your state to make sure you are compliant.
Cash Basis Accounting
Cash basis accounting involves recording revenue when cash is received for a sale and expenses when they are paid. This is the easiest of the two methods; however, it doesn’t always provide the most in-depth or accurate representation of the company’s financial position. Furthermore, it is not recommended for businesses with staff or plans for expansion.
Accrual Basis Accounting
Accrual accounting involves recording revenue when a sale is made, not necessarily when cash is received, and expenses when they are incurred, not necessarily when paid. Accrual accounting is the most accurate accounting method because it factors in how much money is spent and earned and is recommended for use by mid-to-large sized businesses, businesses with funding, or businesses with growth plans.
3. Choose an Accounting System
There are three types of accounting systems: manual, automated, and enterprise resource planning (ERP). The most commonly used accounting system for small businesses is automated through accounting software while larger companies may opt to use the ERP accounting system that encompasses the entirety of business operations.
Manual accounting requires inputting all financial transactions into a spreadsheet or tracking method. This is not recommended for businesses with more than a few expense or income statements to document.
4. Document Financial Transactions in a General Ledger
A general ledger is a compilation of entries detailing each of your business's financial transactions. If you are using software, your statements will be added automatically when you create an invoice or make a payment.
However, if you choose to do your startup accounting manually, you will need to record all transactions in the general ledger. This includes income, expenses, deductions, and any other transactions or financial records.
5. Reconcile Your Bank Accounts
Most accounting software for startups will automatically compare bank accounts with general ledger entries. If you aren't using software, you need to match your bank account statements with the entries in the general ledger to ensure they line up.
6. Create and Issue Financial Statements
Once you've determined that all transactions are accounted for and accurate, you can prepare and issue financial statements. There are three financial statements businesses are required to issue: balance sheet, cash flow statement, and profit and loss statement.
These financial statements also provide invaluable insight into the financial health of your startup, help you communicate effectively with investors and stakeholders, and allow you to track your business growth. If you are using a startup accounting software, these documents will be created for you.
Best Accounting Software for Startups
The best rule of thumb for startup accounting is to hire a professional accountant to help you manage your business’s finances. However, there are several accounting software options available to help you manage your startup finances whether or not you choose to hire an accountant.
QuickBooks accounting software makes tracking financial documents easy. On the platform, you can manage bills, track expenses, calculate tax deductions, assess project costs, view and manage inventory, and manage invoices and payments — all on one platform. Plus, QuickBooks makes it easy to integrate with your payroll and time-tracking software, giving you a holistic view of your business’s financial position and performance.
Freshbooks accounting software features bookkeeping and accounting tools to help you manage your startup finances. On the FreshBooks platform, you can create invoices, utilize accounting tools, make payments, track expenses, and manage time tracking and project costs. Better yet, Freshbooks offers a variety of plans dedicated to businesses at every stage of their startup journey.
Zoho accounting software is part of the suite of products for businesses offered by Zoho. The platform allows users to manage finances, create invoices, make payments, track inventory, manage business banking, monitor time tracking and project expenses, and view in-depth reports. Additionally, Zoho’s accounting software offers a variety of tax features to ensure your business stays tax-compliant.
What do startups use for accounting?
Startups can either do their accounting themselves, hire an accountant, or utilize accounting software depending on the business needs, size of the company, and length of time in business.
How much should a startup pay for accounting?
The Bureau of Labor Statistics states that accounts are paid $78,000 annually or $37.50 per hour on average.
What is the best accounting method for startups?
The accrual accounting method is the best for startups. Compared to cash basis accounting, the accrual method provides a more accurate view of the company’s financial position as well as income and expenses. Plus, there are some states that require businesses to use the accrual method for their accounting.
How to do bookkeeping for a startup?
Bookkeeping entails keeping track of all financial documents and transactions relevant to your startup. This may include receipts, tax forms and returns, bank and credit card statements, and proof of payments. You can do bookkeeping manually or use software like QuickBooks to help you manage and track your startup’s financial documents.