Many startup founders and entrepreneurs are concerned about managing their startup accounting and the books from the start. And creating and running a business venture can be quite hard at times, wearing many hats in the beginning, a need to keep on top of your company’s bookkeeping and financials can be a little overwhelming. And many bootstrapped young startups are often faced with the dilemma, should they try to manage it themselves or hire a startup CPA or outsourced bookkeeping service.
Scalable hyper-growth startups need to have accurate, up-to-date financial statements that you can use to manage your business’ growth and cash flow. Having accurate financials is especially important when you’re an early stage startup that is preparing to take on an initial seed investment or a Series A funding, as well as having the proper tax due diligence materials.
If you have been down the troublesome rabbit hole of accounting woes, it could be about time to look for some startup accounting services, to get on the right financial bookkeeping track.
Here are some items to consider when managing your finances and looking to possibly outsource your startup accounting needs.
Some of The Most Common Startup
Accounting Problems and bookkeeping Issues
Setting Up Financial Goals
If you want your startup to succeed and you want to pitch investors and be taken seriously, then you need proper financial projections along with data that supports it. If you don’t have the data to back up your claims, you may run into some issues getting investors to cut you a check to grow your business. Setting up financial goals also helps to establish customer acquisition and revenue goals. In the beginning it might be hard to accurately set reasonable and achievable goal targets, but by at least setting up one to two year milestones to aim for, can help keep you on track to growth and profitability one day.
Time and Quality Management
As startup founder or manager, one of the most important things is your time, and many startups approach finances from a naive or cautious standpoint. And if you are wasting a bunch of time trying to learn how to manage the books, you are doing your company a disservice by not delegating this task and using your valuable time for more productive parts of the business such as sales or product development.
Cash Flow Management Problems
Say your business idea has turned into a startup company that produces a product or service that is making money and turning a profit. If you have not already been tracking your expenses, sales and revenue, now is the time to set that up. One common theme I hear from growing startups is that the cash flow looks healthy, but the profit margin looks weak. This may mean money is being overspent in a certain area and that area needs to be found. Many startups struggle with managing cash flow, whether it’s overspending on marketing / hiring or dealing with unexpected losses. This is the reason why it is so crucial for startups to make accurate accounting a priority from the start. Having a well planned budget helps your startup hit its goals without prematurely running out of cash. For most early-stage startups, the biggest part of burning cash is headcount. You never want to be in the position where you fear not being able to pay your bills or making payroll.
Choosing an Accounting Method: Accrual Accounting vs. Cash Accounting
Sometimes it can be a little confusing which accounting method is best for your company, especially in the beginning stages of your startup. Of course there are advantages and disadvantages to each method, along with different business requirements. So as an example, in general the accrual accounting method can provide clearer long-term visibility into your business, where the cash accounting method gives you insights into your ‘real-time’ cash flow situation.
Here is another way of describing it:
- Cash accounting – tracks expenses or finances when the money hits the bank.
- Accrual accounting – tracks money regardless of cash inflows or outflows but in terms of when it is earned or due.
According to an article in Zeni.AI “the IRS requires any business earning $5 million a year in revenue to use accrual accounting.” Since startups are almost by definition built to scale, it can be a best practice to start using accrual accounting for your startup sooner rather than later.
But it is recommended that you consult a tax advisor further to make sure you are using the right accounting method to maximize your growth and meet your goals.
Preparing financial statements
The information a bookkeeper manages is also used to file taxes, do VC due diligence, secure debt financing or business loans, and outline the overall financial health of the company. When the data is accurate and clear, the business owner can then look at those figures and make informed decisions.
If your startup has raised a funding investment from VCs, then each month your company’s investors, board members and management team will want to see 3 important financial statements which are:
- Income Statement: The Income Statement or also known as The Profit & Loss statement, outlines your revenue, costs and expenses over a period of time. These statements use financial data to give business leaders and investors an idea of the company’s ability to generate profit.
- Balance Sheet: The balance sheet outlines your company’s current financial position, reflecting the company’s assets, liabilities and shareholder equity at a specific point in time. It helps you understand how much your business is currently worth.
- Cash Flow Statement: The cash flow statement documents how much cash is flowing into and out of your business during a period of time. Simply put, it tells you how much cash you actually have on-hand.
Often early stage startup companies raise their next round of venture capital based on their revenue growth. According to an article by Kruze Consulting states that “many early-stage CEOs use a variety of dashboards to visualize their revenue.” The article went on to say “smart VCs will check to see what the difference is between the CEO’s revenue number and the actual financial statements recognized revenue.”
Correct accounting relies on more than just data feeds and dashboards; it also requires more informational input from the CEO to make GAAP revenue.
Growing startups that raise venture capital need to have accurate books – in fact, a company’s executive team often promise recurring delivery of accurate financial records to venture investors in the funding documents. And reconciliation is a crucial aspect in bookkeeping. This process involves when a bookkeeper checks and makes sure that the different records balance, and that the money leaving an account (like your company’s bank account) matches the actual money spent.
Reconciliation is an especially important part of bookkeeping for venture capital funded companies, since investors (and potential acquirer) expect accrual accounting and financials that are close to GAAP.
Your company is expanding, you have raised a large amount of funding and you see a need to deploy your capital and increase your spending. Now in times of growth it’s even more important to manage your cash properly. This might be time to consult with an experienced finance professional such as outsourced CFO or controller that can help guide your decisions.
Useful Startup Accounting Metrics
- Gross Margin – gross margin is a percentage that demonstrates the total revenue of your business after subtracting the costs associated with creating and selling your business’ products. It is a helpful metric to identify how your revenue compares to your costs, allowing you to make changes accordingly.
- Average Cash Burn – average cash burn is the rate at which your business’ cash balance is going down on average each month over a specified time period. A negative burn is a good sign because it indicates that your business is generating cash and growing its cash reserves.
- Cash Runway – if your business is operating at a loss, analyzing your cash runway helps you estimate how many months you can continue before your business exhausts its cash reserves. Similar to your cash burn, a negative runway is a good sign that your business is growing its cash reserves.
- Outstanding Accounts Payable – outstanding accounts payable (A/P) shows the balance of cash you currently owe to your suppliers.
5 Tips to get your startup’s accounting systems setup for financial success
(image credit: Robinhood)
Startup expense tracking
Set up a system to help with expense tracking. You can even do this before you incorporate or set up a business bank account. Make a clear distinction between your personal account and your business account from day one in order to save a lot of time, money and complexity later. You want to make sure you have everything tracked properly in case you are audited by the IRS.
Look for an automated Expenses Management system that can: document the paper trail of expenses for IRS audit purposes, help keep founder and businesses expenses cleanly separate, and easily integrate with your accounting system. The best expense management tools have a mobile app for scanning receipts on the go, accept invoices and payment records via email and have a killer web app for managing your records.
Startup payroll systems
How to choose the best payroll system for your startup? The moment when you begin hiring employees is a key point in any startup’s life. For founders, picking a payroll system presents an important decision that will matter a lot over time.
Huckabee CPA has helped dozens of early stage startups set up their first payroll, so have experience with what is important business owners as they take this step. While there are many factors to consider, above all you need a payroll system that:
- Supports your team (since few things tick employees off like getting paid late, or not at all)
- Allows for growth as your business needs it; and
- Ensures that your company stays compliant with all tax laws (since few things tick the IRS off like not receiving payroll taxes when they’re due).
Choosing the right payroll system from the start will ensure that all three of these needs get met, and will save you a world of time and hassle as your company grows. Huckabee CPA does not offer separate payroll services, but rather as a package for clients who also need tax and accounting services as well.
Startup accounting system
Now that I have briefly covered expense tracking and payroll, the next step is to set up an accounting system to help ensure accurate tracking and financial planning. Is your company ready for an accounting system?
Here a few ways to know:
- You are spending too much time on financial record keeping.
- When your investors ask for your Income Statement, Balance Sheet and Cash Flow Statement you don’t have one to send.
- Your financial records don’t tie to your bank account, so you run the risk of vendors taking advantage of you, or even fraud.
At Huckabee CPA we usually recommend QuickBooks Online or Xero. QBO is great because of its reliability, upgrade options and excellent customer service. Although Xero will work while you’re a Seed Stage company. Startups should plan to update financials weekly, or at least monthly, and look for trends that you can use in financial planning.
Tax compliance deadlines
Keep up to date with tax compliance. In addition to using the best software tools to run your business, we want to make sure you’re keeping on top of taxes. Missing tax deadlines can cost $10,000 or more in penalties. You will want to research deadlines relevant for your business and set calendar reminders. Keep in mind this year in 2020 the Covid-19 crisis postponed certain tax deadlines this year. Every startup is different and so are its tax compliance needs. Consult with a tax professional about your specific needs.
Startup financial models
Startups create financial models to; quantify (and then validate) their business plan and business model, raise investment capital, sell to an acquirer or to manage the company’s budget. What is a financial model?
A financial model is the numerical expression of your startup’s goals:
- how many customers you’ll have
- how many people you’ll hire
- how your margins will improve
The creation of a financial model should test out the key metrics and assumptions that you will test as you execute your business plan. The best startup financial projection models are usually not “right” – but the differences between the projections and the actual results can drive insight into the company’s potential and the targeted industry’s dynamics. Understanding the difference between your projections and your actual results can also help your executive team make important business decisions. There are several different types of financial models that you can build. The CPA firm called Kruze Consulting created a helpful financial modeling article that has some modeling spreadsheet templates such as:
- Cash flow models
- Startup budget models
- SAAS income projection models
- Depreciation scheduling models
- Customer acquisition cost models
- Projecting working capital
So if you have a startup that has built a team and product and you want to put together a financial model to figure out if you can raise capital, or how long you can last with your existing investment. The Kruze consulting article suggest that you should start with a couple of questions such as;
- How big is the market, and if you capture a small amount of it, do you have enough revenue to have a real business?
- How many people do you need on the team to get to your first milestones?
- What are your product’s unit economics? How much will your clients pay, and what will your costs to deliver it be at first, then at scale?
The management consulting firm EY put together a comprehensive guide on financial modeling for startups that is useful to check out. It discusses the two major approaches to modeling; Top down forecasting and Bottom up forecasting.
So when does a funded startup exactly need to think about setting up proper bookkeeping and accounting systems? If your startup has not been keeping track of your books by the time you raise your first outside investment capital, you need to get your books in order yesterday. When a startup takes outside investor money, they need to have a firm understanding of their financials (books), since investors usually demand transparency. But early stage startups need more than a robot bookkeeper to simply reconcile the accounts, they need a trusted financial advisor who can interpret complex data and identify liabilities or other problem areas that may need to be addressed to reach a path to strategic growth. If, say your company is considering a fundraise, an experienced CPA firm would be able to give you a heads up on whether or not investors might consider you to be a viable candidate.
If you are a small business or startup founder that has any questions feel free to reach out to Huckabee CPA for a free consultation.