Everything You Need to Know About Accounting for Startups

Good (or bad) accounting can make or break your new business. Accounting for startups is a crucial part of your company’s success. It defines and tracks your vital financial metrics, helps you get organized and wise with money, and positions you for rapid growth.

But there’s a lot you may not know about what effective accounting for startups looks like. So let’s go!

‍Why Is Startup Accounting Important?

90% of startups fail, according to a US Bank study. Of these, 82% of businesses, in general, close up shop due to problems with cash flow.

Accounting is vital for any size business. Of course, it is. But newer businesses face unique challenges like raising capital and deciding where to invest to grow the company.

During this time of uncertainty (but great promise), a relatively small unwise financial decision can have a big impact. It can threaten your company’s financial health and stability (in both the short and long-term).

Knowing the numbers and what they’re saying ensures you can accurately communicate with stakeholders and potential investors alike.

What’s more, when you know your cash flow, you can take steps to increase it. This eliminates the uncertainty. It paves a path forward.

Startup's Unique Financial Factors

There are no two ways about it. Accounting for startups is different. Whether you’re contracting with a fractional CFO or utilizing outsourced accounting services, it’s important to recognize why startup accounting needs specialized expertise and attention.

Heavy Growth Focus

As a business owner, you know your startup must grow to survive. But with growth comes “growing pains.” Like so many startups before you, you find yourself stuck in the in-between.

You’re too small for a full-time CFO and too big for the startup accounting services you started with.

For this reason, it might seem impossible to define the financial positions you need to fill or what you need to do to move forward.

But keep this in mind. Not only do your accounting team and infrastructure need to match where you are. They need to grow with you.

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Fundraising

Startups usually require a mix of funding sources, and their choices here can influence both short-term and long-term stabilities. Funding may come from lines of credit, business loans, personal loans, crowdfunding, and/or venture capital.

Fundraising is the lifeblood of a startup. It not only provides a cash infusion when you need it. Getting new funding can attract attention on the market. Earning investor dollars means they see potential.

It’s vital that your in-house accountant or outsourced financial services team recognize the importance of fundraising for startups.

They must have the skills to not only report accurately. They need to showcase the fabulous ground-floor opportunity investing in your company now represents.

Honestly, this is where many run-of-the-mill accounting services fall short.

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Small Teams

You have a small team of core employees who are already giving their all (and on startup salaries at that). Asking more of them means taking away from where they do their best work.

What’s more, they’re not bookkeepers or accountants.

So alternatively, maybe you do have a bookkeeper or accountant on your team. Or you use an outsourced bookkeeping service.

Even here, they’re only one person. Accounting is a highly specialized field. A startup accountant can’t do everything a startup needs.

Bookkeepers can’t do the job of accountants. CFOs won’t do your bookkeeping.

Thus, the dilemma many startup business owners face. You can’t afford to hire all these positions on a startup budget. But you do have smart options.

First, it’s important to clear up some definitions. What’s the difference between outsourced bookkeeping services and outsourced accounting solutions?

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Bookkeeping vs. Accounting for Startups

Bookkeeping is the logging of financial data day-to-day. It’s completely transactional.

You sell something. They log that sale. Someone returns it. They log the return. Buy something. They log an expense.

They ensure this information stays accurate and up-to-date. That way, you can make decisions based on that information in real-time.

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An accountant’s role is more subjective. They can see what that data is saying about cash flow and your financial health.

They can run and prepare custom financial reports and ensure all of your financial statements are filled out correctly based on the bookkeeping numbers they’ve been given. These reports may be used both internally and externally by auditors and investors. They can help you gain perspective and insights.

Some accountants do bookkeeping before putting on their accountant hat for the accounting side of things. After all, they have to understand the numbers.

However, a bookkeeper is not trained as an accountant. So, they would work beyond their pay grade if they did more than log the numbers.

Each has different skills. And even if they are cross-trained, switching hats not only means you’re paying for a more skilled person to do less skilled tasks. Multitasking makes a person more error-prone.

Errors are something that startups can’t afford. So, accounting for startups and small business accounting must take this into consideration.

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Benefits of Startup Accounting

Startup accounting organizes financials and establishes the metrics you need to track. It puts into place the procedures your accounting team (in-house and/or outsourced) follows to ensure the accuracy and timeliness of financial statements.

In doing so, accounting for startups can help your company:

• Increase cash flow
• Enhance stability and agility, and adaptability
• Plan for growth
• Understand your limits and challenges
• Stay compliant
• Pay the taxes you owe and nothing more
• Make fundraising easier
• Qualify for better terms with loans and venture capitalists
• Streamline accounts receivable, accounts payable, and payroll

As a bonus, because your finances are well organized, you embody financial integrity. With it, you can build and retain healthy relationships with vendors, customers, employees, partners, and other stakeholders.

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Challenges of Startup Accounting

The biggest challenge facing startups trying to do their own accounting is trouble getting organized as they grow. What seems to work when it’s just you or a handful of employees can quickly spiral out of control. But you don’t have the means to hire a whole team to fix it.

This leads to challenges that can become detrimental to your startups future, like:

• Getting behind
• Not recognizing trends, red flags, and opportunities
• Struggling with accounts receivable
• Paying vendors late
• Inaccurately calculating payroll
• Paying employees late
• Lack of financial analysis
• Failed audits
• Back taxes and penalties
• Inability to make your money work for you

Startup Accounting Basics

Many entrepreneurs start a business but lack an understanding of basic accounting principles. Not knowing these basics means recreating the wheel and learning the hard way from your mistakes. That’s not something you can afford to do at this stage.

Financial Modeling

This is a visual representation of business performance over time. It’s an important tool that helps you make wise, data-driven decisions and can reveal the best path forward.

Cohort Analysis

A cohort analysis is a powerful type of customer behavioral analytics. It compiles data into subsets of customers that share similar traits. You then look at each sub-set independently to glean insights.

For example, you could use a cohort study to identify which customers deliver the highest return on investment (ROI). Targeting this subset of customers can increase your profits overall.

Financial Valuation

Financial valuation is the act of determining the value of an asset or your company as a whole. Knowing your valuation (and having the documents to support it) is critical in fundraising negotiations.

Financial Planning & Forecasting

Forecasting allows you to make plans for the future based on the trajectory of your financials.

For example, let’s say you’re forecasting high cash flow one year from now. Then right now, you might want to start evaluating opportunities for vertical, horizontal, geographic, or workforce expansion to grow.

Budgeting

It doesn’t matter who you are or how much startup capital you have. If you’re not budgeting, that money will slip through your fingers.

As a startup, budgeting gives you the solid break-even you need to make wise decisions. Start adjusting the variables to cut costs and increase profit margins.

To create a startup budget:

1. Gather your tools. More on that later.
2. List your startup costs.
3. Identify your fixed costs that you won’t have much control over and that don’t change often (e.g., rent, business insurance, Internet, web hosting).
4. Estimate variable costs (e.g., utilities, materials, shipping costs, customer acquisition costs, travel).
5. Estimate monthly revenues. (That’s where that forecast comes in!).
6. Figure out your break-even.
7. Budget accordingly.
8. Adapt as needed, but only with proper budget analysis

How to Build Your Startup’s Financial Infrastructure

Your financial infrastructure consists of people, technology and procedures that work together to help you meet your financial goals. And it all starts with the people. Without them, the best financial systems won’t work as you planned.

Figuring Out What Roles to Fill

Your plan is for your startup to take off and grow. But as you do, you can outgrow your startup financial infrastructure system fast. So it’s time to adapt because if you don’t, it’s going to hold you back. What roles do you need to fill?

Online bookkeeper:

The person in this role does basic daily data entry. They help you keep your books in order and can use basic financial software to cross-populate financial information and produce out-of-the-box reports. But they’re not qualified to interpret your startup’s financials.

In-house accountant:

They help with basic financial statements by closing month ends. But like the bookkeeper, they have their limits. An in-house accountant can provide some interpretation and analysis of your financial statements.

However, they don’t have the strategic knowledge to help you make informed decisions about your finances. So they can’t manage the whole financial process or provide data-backed recommendations to improve your financial health, profitability, or growth.

Fractional CFOs:

Fractional CFOs are former corporate execs that can help with high-level decisions. But they aren’t hands-on enough to meet a startup’s needs alone.

They can help you evaluate the big picture. But the day-to-day is still on you or those you’ve hired to manage the books.

Major accounting firms:

Similar to the CFO, an accounting firm is knowledgeable about annual filings and audits. But they won’t support your day-to-day accounting.

So, they’ll provide you with insights. But your company is expected to do all the heavy lifting.

Plug-in finance department:

This role covers all aspects of the financial infrastructure. It’s the jack-of-all-trades solution that your startup has been looking for.

Plug-in finance helps you save time and money. It will support you in everything from financial planning to your next capital raise.

A plug-in finance department employs people in all these roles. Together, they fill in the gaps in your financial infrastructure.

This is precisely what so many startups are lacking. It’s why startups can often get from square one to two but then struggle to advance.

Bottom line: startups need the best tech backed by the best people for a cost that works within a startup budget. A plug-in finance department can save you up to 70% off hiring the startup accounting team you need.

What Financial Records Do You Need to Maintain?

Online Statements (Bank and Credit)

Whether we’re talking credit card or banking statements, online banking eliminates the bulky paper statements and makes keeping track easier. But it’s still vital to reconcile statements regularly.

Good financial organization demands that you balance your ledger regularly. Make sure you give yourself a chance to spot any errors, overspending, and anomalies sooner.

Payroll

If you have even one employee, you have payroll. You must ensure you’re properly categorizing contract vs. employee, keeping track of employee records, and accurately calculating payroll taxes and any fringe benefits. Submit accurate payroll statements and forms to employees, contractors, and the IRS.

Invoices

Establish an effective and regular electronic invoicing system. Automate the invoice process as much as possible. It’s horrible for the customer relationship if they go months without getting a bill or don’t know what they owe.

At the same time, your cash flow is suffering. You may struggle to make payroll.

Proof of payment

Proof of payment is vital for the vendor relationship. Let’s say a vendor is saying they haven’t shipped because you haven’t paid or don’t pay on time. You need immediate proof that they received the payment (cashed the check, completed transfer, etc.).

Financial statements

Generally Accepted Accounting Principles (GAAP) outline financial statements every business should keep up-to-date and how to fill them out. These include a profit and loss statement, balance sheet, and cash flow statement.

If you have a reliable setup, you can use accounting software to run this cross-populating information. But you still need to verify it.

Tax Returns

Have tax returns and all of the supporting documentation mentioned above in one place with a backup somewhere else.

How Long Do I Keep Financial Documents?

According to the IRS, generally, you should keep most of these documents for 3 years from the date you filed. Three years is also how many lenders and investors need to see.

After 3 years, the IRS’ “statute of limitations” expires and they will not be able to audit you, except in cases of suspected fraud. So if you’re doing anything “risky”, it’s a good idea to keep records for 7 years.

Startup Accounting Tools

The right tools will save you time and give you peace of mind. They support a more organized and engaged approach to startup accounting. You’ll automate tasks, lowering your risk of mistakes during transfer, billing, and calculations (among others).

Software

• Accounting. Accounting tools encompass bookkeeping. So they help you keep track of your outgoing and incoming liabilities, and assets (along with attached documentation). They can cross-populate financial statements. Then automate out-of-the-box and custom reports you need on a regular basis.
• Invoicing. Invoicing software keeps track of individual customer accounts receivable when they make a payment, the amount due, and any late fees or interest. They can track 30-60-90 days past due and flag accounts to send to your collections company. They can automate the invoicing process. So you collect faster and more efficiently. And you can run reports to learn how many accounts reach past due thresholds to improve your collections process.  
• Payroll. Payroll software manages and automates payroll in compliance with local, state, and federal laws. It can automatically cut checks or initiate direct deposits on a schedule, instilling employee confidence in your company’s long-term stability.

Business bank accounts and credit cards

These accounts should be exclusive to your business. Any commingling of personal and business accounts only makes keeping track and reporting numbers accurately that much harder. Don’t do it!

Many banks provide useful tools for free. So take advantage of them.

These are just as useful for startups as they are for personal finance:

• Auto-drafts and transfers
• Notifications
• Tracking lending rates
• Automatic categorization of expenses
• Budgeting tools

Accountant or Startup Accounting Services

Startup Accounting services include everything a startup needs to keep its finances organized and money working for them. These include:

• Bookkeeping. Always keep your books up-to-date and an accurate reflection of your performance.
• Access to industry-leading tools. Streamline and automate your finances with industry-leading tools like those for accounting, payroll, invoicing, reporting, automation, etc.
• Accounting. Build and work within an organized and robust accounting infrastructure. Understand the data to make wise financial decisions and grow your company.
• Fractional CFO for Startups. Providing big-picture advice on direction and smart investments to meet business goals.

What are the most important financial metrics for startups?

Revenue

Revenue should be tracked in real-time, weekly, monthly, quarterly and year-over-year. Through it, you better understand your revenue trend and can forecast revenue growth.

Profitability

It’s critical to know if you’re actually making money. When you do, you have the power to adjust the variables to increase your profit margins over time.

Cash Flow

Positive cash flow helps businesses weather seasonal and economic downturns because you’re not “just getting by.”

It positions you for growth because you have that money to invest in R&D, new markets, better equipment, and even that online CFO you desperately need.

Burn Rate

This is the rate at which you’re burning through startup capital as you trudge along toward profitability.

It tells you how long you can exist without making a profit. What many forget when tracking burn rate is that you continue to burn through cash after you’re in the black. So this isn’t a zero-sum game.

Your burn rate is more likely to slow gradually as you begin making a profit until your business is fully self-sustaining.

Expenses

How much are you spending in each category? Where can you make adjustments to lower your expenses without sacrificing quality to increase profits?

Frequently Asked Questions

Should I hire an accountant for my startup?

Many startups find themselves in an in-between place where they need more than a bookkeeper. Yet, hiring a full-time accountant wouldn’t make sense, either. What’s more, you may need more than what one accountant can do.

In this instance, it’s much wiser to explore outsourced financial services like a plug-in account service. These provide startups with what they need now: startup CFO services, accounting & bookkeeping, financial modeling, fundraising, and tax compliance.

How do I keep my finances organized as my startup grows?

A plug-in accounting department helps you fill in the gaps in your financial infrastructure to stay organized and effective. They have a team of experienced professionals within each role necessary for a robust financial infrastructure. This infrastructure is designed to grow with you.

What’s the first step in accounting for startups?

Get organized. Figure out the metrics you need to track, the accounting tools you’ll need to do that, and how your accounting infrastructure will help you meet your business goals. If you’re struggling to do this, get a plug-in finance department.

The Bottom Line

The right accounting for startups can make or break a business. And so many watch their financial health deteriorate as they try to grow.

You need startup CFO services that go beyond an outsourced CFO, accounting, bookkeeping, or Mergers and Acquisitions. But you could never justify hiring full-time employees to fill these roles.

When startups are stuck in that in-between and ready to grow through robust accounting infrastructure, they turn to Aquifer—Your next CFO.

You have enough on your plate. Let Aquifer provide you with the equivalent of a whole accounting department but at scale to grow with your business.

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