You’ve finally created a commercially viable product. You’re spending late nights chalking out plans to launch and market it. While that definitely is a priority, the other side of forming a business, the boring part that is, is also as essential. That is keeping the books of accounts. Accounting and bookkeeping may not sound as urgent, though, on the forefront as, say, finding funding or figuring out your next market move. But that doesn’t mean it should be ignored. Disregarding accounting might seriously jeopardize the sprouting of your startup. Else how do you think you’ll figure out the cash runway, or budget to hire another specialist?
Accounting has prime importance in all business entities as it is most essential, especially for managing and providing financial reports at the end of the year. Startup accounting helps it to determine its productivity and profit from the initial stages. It provides entrepreneurs a method to retain accounting information. The accounts in your startup will help you keep track of the money spent on business use, separate than for personal use, to help strategize on reducing costs. In the beginning. it is recommended to hire professional accounting and bookkeeping services to maintain books rather than spending on an in-house professional.
If you’re the owner of a budding startup, this article will guide you through the basics of accounting, as well as some unexpectedly profitable benefits of understanding your numbers.
Accounting vs. bookkeeping
Both are related to money, but bookkeeping and accounting are quite different.
Bookkeeping is the process of tracking all financial transactions—primarily income and expenses. While accounting is the process of describing and deciphering those transactions. This enables you to accurately meet several ends. Pay the right amount in taxes, make sound business strategies based on the numbers, facts, and logic.
Good bookkeeping, in a way, forms the base of good accounting. Therefore, both are vital to every business’s success, but as a startup, you need to keep good records specifically. If you are looking for funding, the potential investors will require clear and easy-to-read financial reports, to present to them. Check how bookkeeping is different from accounting here.
When you’re just about to start
Before you can start bookkeeping, you’ll need to first select the structure of your business.
Choose a business entity
The structure of your business determines how you’ll be taxed, how you’ll earn, your liabilities, and more.
The main five business entities are:
- Sole proprietorship
- C corporation
- S corporation
- Limited liability company
Choose an accounting method
To file your first business tax return, you’ll have to choose either of two accounting methods.
- Cash basis accounting
In the simplest form of accounting, under cash basis accounting, income is recorded when it is actually received and expenses recorded when they are actually paid.
- Accrual basis accounting
Accrual basis accounting records money when it’s “earned”, not when it is received (and same for expenses). For instance, if you sign a big contract with a client who pays you some advance. Since the money hasn’t been earned yet, it won’t be filed. This method is rather complex, but it shows the real standing of the business far more accurately—and is especially useful for strategizing and when reporting to investors.
The selection of entity and accounting methods is quite a complicated decision to make having long-term effects. So consulting with a CPA before making final decisions is recommended.
Which financial records should you keep?
Now that an entity and the accounting method have been finalized. You need to know which financial records you need to maintain and keep track of?
You must review all documents in your startup accounting that show any income, expense, deduction, and credit on your tax returns. These may be:
- Bank and credit card statements
- Canceled checks
- Proof of payments
- Four basic financial statements
- Previous tax returns
- W2 and 1099 forms
- Any other documentary evidence in support of income, deduction, or credit shown on your tax return
And remember to keep these items for at least three years and not to be disposed of as soon as returns have been filed. There are some exceptions to this 3-year rule, which you can check in recordkeeping small business.
Startup bookkeeping and accounting checklist
One thing you may be tempted to but must avoid is only updating your startup’s books when you’re forced to—such as when tax deadlines are to be met or for attracting new investments. Here’s a checklist of books that you should keep fresh:
Record all transactions: In your ledger, journal, software, or a simple Excel spreadsheet, whatever you prefer. Even if you use software to integrate your financial accounts, do enter everything else, such as cash transactions.
File or digitize: The receipts and old invoices should be put into proper files, at least weekly. Or you can also electronically preserve them. Else, you might lose them, and won’t be able to prove to the IRS of deductions if you get audited.
Categorize transactions: Was that trip to the mart for office supplies or to pick up a new monitor for your office computer? These two items are to be put into different categories on your tax return, so enter them into different categories as well, from the very start.
Prepare and send invoices: Diligently send invoices as soon as you can.
Reconcile your bank accounts: This step safeguards you against missing any income or expenses. Bank reconciliations can be complicated until you practice.
Pay bills: As soon as you can. Or you might have to pay extra as of late payment interest. Late payments also affect your standing and credit score.
Review outstanding invoices: Review pending payments and follow-up to save your financial situation from suffering.
Review financial standing: Any business must have enough money to keep operating. Reviewing how much cash you have in the bank, and how much finances are expected, will tell you if you need to improvise your invoicing system.
Scheduling a specific time of the day for dedicatedly handling your business’s financials would be better. Entering every transaction and keeping a journal will also make your life much easier when it comes to filing prepaid quarterly or annual taxes for your business.
Startup & benefits of accounting from the start
Presenting estimates: Every startup needs to present its financial estimates to banks, investors, or lenders to obtain funds from them. Accounting helps to make a realistic and reliable business plan for estimated monthly expenditure, economic, rate of growth, and so on.
Determine profitability: Accounting helps a startup to know its future profitability. It helps to monitor the progress as well as change when necessary.
Budget expenses: Records of the cash flow in the business will help you decide about how the capital should be used.
Payroll accounting: Startup accounting will help you record employees’ compensation such as salaries, bonuses, commissions, health insurance premiums, social security taxes, paid holidays. A database essential while filing payroll taxes.
The financial statement in startup accounting will help you making sound decisions using certain metrics and ratios.
Burn rate & runway: Burn rate calculator tells you how much cash you have on hand, how much is spend each month and how long would your finance last.
Profit margin ratio
Or net profit margin ratio tells you how much is the profit earned against each dollar of expense. Are you overspending? Do you need to raise prices or reduce expenses? This ratio shows if you’re truly making a profit or just selling.
Though this information is not put on display in accounting or traditional financial statement, if your books are organized and you strain your eyes a bit further, you may know:
Where is your market: Are most of your customers based in a particular area? You’ll want to make decisions based on such findings. You might run more targeted ad campaigns accordingly.
Who are your biggest customers: Where are most of your deals coming from? Is the buying concentrated to a few clients? This helps in deciding about attracting new ones, retaining the older ones, and expanding.
Your top vendors: Are you buying from one or too many? Have you done your research for suppliers? This data comes in handy while negotiating.
Want a more comprehensive look at how to set up the accounting and finances for your startup? Check out our in-depth guide, Small Business Accounting 101.
And last but not least, with confident knowledge of your books, you’ll be armed to make good financial decisions on behalf of your startup.
To begin on the journey that’ll be your business, you may ask yourself a few questions. And their answers will show you the method you want to apply to set up accounts for your startup, the right track for you, and your entity.
What and how much should you be withholding? What kind of expenses are deductible and what is the capping? When and how to file the business income return? What happens in case of an audit by the IRS? What if you don’t have a receipt for an expense you deducted? What does your company need to do to comply with IRS regulations? How to get the accounts to track to the appropriate location on the financial statements? Is accounting software suited for your startup? If yes, which one?
Startup accounting: DIY or outsource?
As a startup owner, you should choose early on whether to spend your valuable time and efforts on updating accounting and bookkeeping or to outsource these tasks. Let’s explore:
Consult early: Even if you choose to DIY, an accountant will tell you what accounting method to use or which expenses can be written off, etc.
And help you out during taxes, avail maximum business tax deductions, and protect you from the IRS audits.
DIY is better if you have time: With a tight budget, you may want to manage the books yourself. This move will also allow you to understand better how money flows in and out of your business. This knowledge will make you feel more confident about your financial standing and decide conveniently.
Outsourcing: If the startup is calling for time and effort, or you are not into accounting, or if you’d just rather hire a skilled bookkeeping service.
How outsourcing would help
With AutoFilings, you get a team of human experts to do your books. Human experts mean you get sound advice based on the situation, your industry, etc. You get answers to all your questions, not a list of pre-fixed questions. With us, you have all-time access to your updated books and monthly financial statements. Easy to file your taxes without a million back and forth emails.
Outsourcing would help in:
Tax specialization: Taxation is the area that a startup might find too expensive besides fundraising and finance. This is the area that CPAs train in and are useful in the growth of the Startup. A trained professional who knows the tax laws, inside out, will help put the business transactions on track.
Focus on business: An accountant helps by letting you focus on the product and sales part than worrying about the financial situation. The entrepreneur will get valuable information about the business to make it grow and earn. An accountant will also help in reducing the expenses.
Valuable partner: Outsourcing firms have a wide range of expertise under their belt. Knowledge of various sectors, industries, levels, raising funds, financial planning, financial reporting, and much more. Their assistance could prevent taking wrong decisions concerning accounting and the startup.
FREQUENTLY ASKED QUESTIONS
What should be the structure of my startup?
One of the most significant decisions you need to make when starting your business is choosing its structure. The entity you choose will impact taxes, liability, your control, and your revenues.
The entities most popular are sole proprietorship, partnership, limited liability company (LLC), C-corporation, or S-Corporation. The larger entities are typically more complicated to manage than others and need significant
filing and reporting requirements To decide, plan your goals, and consider the pros and cons of each.
How to record transactions?
One of the first decisions to set up your startup accounting is deciding how you will record transactions. You can record transactions by hand yourself, hire an accountant, or use accounting software.
Recording transactions by yourself would be the least expensive but time-consuming method.
There may be common accounting errors, such as miscalculating or failing to balance statements.
Hiring an accountant would be the most expensive and least time-consuming. With an accountant, you won’t need to manage your books. You may hire an in-house person or outsource to a professional agency.
Lastly, you may go for accounting software to manage your books. Though the software will let you track incoming & outgoing, organize your books, and automate your recordkeeping responsibilities. You will still need an expert person for the more complicated requirements, such as tax preparation.
Do I need a separate business bank account?
If your business is a separate legal entity or operates under a “doing business as” name, you must open a separate business bank account. And even when you may not be legally required, for certain entities, separating your personal and business funds would be a wise decision. Mixing personal and business funds may cause mistakes while filing taxes or overspending.
Should I use the cash-basis or accrual method?
A cash-based accounting method is a simplistic way to manage the books. Transactions are only recorded when you make or receive a physical payment.
With accrual accounting, transactions are recorded whenever the exchange takes place, even if you don’t give or receive physical money. Two entries are recorded for each transaction in a
double-entry accounting system. Accrual accounting is better if you plan to offer credit to customers.
Certain businesses are required to use accrual accounting by the government. Such as if you make over $5 million in annual gross sales or $1 million in gross receipts for inventory sales.
Accrual accounting is a must for a C corporation.
What are the common financing options for startups?
To borrow funds, you can apply for a business line of credit, credit card, general bank loan, or Small Business Administration loan. You may need to offer collateral in certain cases. If you want to attract investors, you may have to offer them business equity or control. You may seek funding from venture capitalists or angel investors. Another option is to crowdfund. Crowdfunding is where you ask for investments or donations, generally from a large group of people. And offer an incentive in return. Taking loans from friends and family is another option for small businesses.