Starting a business requires a viable product or service and an initial investment of both time and money. It also requires financial oversight in the form of accurate accounting. Many startup business owners attempt to manage the accounting for their business even if they lack experience.
At CMP, we love working with startup companies to help them succeed, including doing accounting to help maximize profits and minimize tax payments. If you’re planning to start a business or have already done so, we’ve created this guide to accounting for startups, including information on why proper accounting is important and what type of financial records you should maintain to track your growth. Here’s what you need to know.
Accounting Versus Bookkeeping: What is the Difference?
It’s common for startup business owners to confuse accounting and bookkeeping. You’ll need to understand what each term means and what the differences are to ensure that you’re keeping proper financial records.
What is Bookkeeping?
Bookkeeping is the process of tracking daily transactions and is largely an administrative process. It is not typical for a bookkeeper to conduct any analysis of a company’s finances. Their primary job is to record them.
Here are some tasks that fall under the umbrella of basic bookkeeping:
- Record daily transactions and categorize them
- Create invoices and send them to clients
- Mark invoices as paid
- Follow up on unpaid invoices
- Reconcile business bank statements
- Create monthly financial statements
- Process payroll
- Prepare financial statements and tax documents to give to the accountant.
The most important thing about bookkeeping is that anybody can do it. There is no licensing or certification required. That doesn’t mean you should trust just anyone with your books, but the transactional nature of bookkeeping makes it simple to do.
What is Accounting?
Accounting is subjective and analytical, unlike bookkeeping. An accountant must have certification. While it’s possible for an accountant to manage your bookkeeping, the reverse is not true unless the bookkeeper obtains certification.
Here are some of the tasks that an accountant should perform:
- Prepare the adjusting entries to balance the books
- Review and provide analysis of financial statements
- Assess the financial health of your business
- Prepare financial forecasts
- Advise the business owner regarding financial decisions
- Conduct audits
- Prepare and file tax returns
Qualifications for accountants may include a bachelor’s degree in accounting or a Certified Public Accounting designation. As accountants have more training and experience than bookkeepers, you should expect to pay more for a professional accountant than you would for a bookkeeper.
How to Manage Startup Accounting
Startup accounting involves making some decisions about how you will do your accounting and acquiring tools to help you. Here are some things to do.
Open a Business Bank Account
Your first step is to open a dedicated bank account for your business. It’s never wise to commingle your business accounting with your personal expenses.
You may want both a checking and a savings account, but at minimum, you should have a checking account to use to pay your expenses and deposit incoming funds. You may also consider business credit cards for easy purchasing.
Select an Accounting Method
There are two potential accounting methods to choose from, each with its benefits.
- Cash basis accounting. The simplest form of business accounting is cash basis accounting, which tracks income when it is received and expenses when they are paid.
- Accrual basis accounting. The accrual accounting method counts income when it is earned instead of when it is received and records expenses when they are paid. For example, if you execute a contract with a customer, the money would be considered earned as of the date the contract was signed, even if you have not yet been paid.
The accrual method is more complex than the cash basis method, but it provides a more accurate long-term financial picture of your business. For that reason, it’s useful for providing financial information to investors or making decisions related to business growth and scaling.
Establish a Bookkeeping System
In addition to choosing an accounting method, you’ll need to set up a bookkeeping system to track daily transactions. Here are some things to do.
- Buy accounting or bookkeeping software. We suggest QuickBooks, and we’ll go into this more below.
- Create a chart of accounts (COA). Your chart of accounts may include revenue, payroll, cash, supplies, rent, utilities, and accounts payable and receivable.
- Decide on your terms. If you plan to allow customers to buy on credit, you’ll need to decide what terms to offer and include them on your invoices and in customer contracts.
- Set up a bookkeeping maintenance schedule. If you plan to do your own bookkeeping, make sure to stay on top of recording transactions. For many business owners, the easiest option is to record transactions as they occur.
Remember, your bookkeeping system will feed into the work your accountant does.
What Types of Financial Records Should Your Startup Keep?
Maintaining the necessary financial records is a crucial element of startup accounting. There are five reports you’ll need to create and update, so we’ll start with those.
- Balance Sheet. Your balance sheet is a snapshot of your company’s financial status and may be prepared or updated at any time. It should include short-term and long-term assets, liabilities, and equity.
- Profit and Loss Statement. Your profit & loss statement may also be referred to as an income statement. Its purpose is to summarize company revenues and expenditures over a specified period. The profit & loss statement is useful for monitoring business growth. Keep in mind that repeated losses are a red flag for any business.
- Cash Flow Statement. The cash flow statement is a report that may be used to forecast incoming and outgoing cash to predict whether you’ll be able to meet your business's financial obligations. In some cases, you may predict your cash flow for up to three years. Your statement should include both fixed and variable expenses.
- Aging Reports. Aging reports are also referred to as accounts payable and account receivable. They provide detailed information about how many invoices you have outstanding and how long they have been unpaid (accounts receivable) and how much you owe, and to whom (accounts payable). Aging reports are useful because they make it easy to follow up on past-due items and to ensure that you’re paying your bills promptly to maintain a high credit score.
- Tax Returns. You’ll need to complete and file the proper forms, pay all taxes, and maintain records for at least seven years.
In addition to maintaining copies of your tax returns, the following are other documents and records that the Internal Revenue Service asks businesses to retain.
- Gross receipts, including invoices, receipt books, cash register tapes, bank deposit information, and Forms 1099-MISC.
- Purchases, including purchase orders, canceled checks, cash register receipts, invoices, and credit card statements and receipts. You may need multiple documents to substantiate each purchase.
- Expenses, including canceled checks or proof of electronic payment, cash register or credit card receipts, account statements, and invoices. Multiple supporting documents may be required for each expense, and you may need additional documents to substantiate the costs for entertainment, gifts, transportation, and travel. You can read more about these requirements in IRS Publication 463.
- Business assets, including furniture, equipment, and machinery, the purchase price, when and how you required the asset, the cost of any improvements you made to the asset, how you used it, when and how you disposed of it, and the selling price if you sold it. You’ll also need records related to depreciation, including deductions taken for depreciation; other deductions to record include section 179 deductions and deductions you took for casualty losses. Supporting documentation may include closing statements, purchase invoices, sales invoices, or canceled checks/proof of electronic funds transferred.
- Employment taxes are the taxes you pay on behalf of employees, and the IRS has specific rules about record maintenance. You will need to maintain employment tax records for a minimum of four years, and you can find detailed information in IRS Publication 15 and on the IRS page about Recordkeeping for Employers.
If you haven’t given much thought to startup accounting, you might feel overwhelmed looking at this list. However, most of these things are easy to maintain, and you can partner with a professional accountant to help you organize and optimize your records.
Importance of Good Accounting for Startups
Good accounting is essential for every business, but it’s particularly important for startups. There are financial challenges associated with starting a new company, and proper accounting will ensure that you have a clear picture of your financial situation at all times.
Proper accounting can help you build good business habits from the start
Developing good business habits is something that’s easiest when you do it from the beginning. When you start a business, partnering with an experienced accountant can help you create an organized system to track your financial information and maintain proper records.
Proper monitoring of burn rate and cash flow
A lack of cash flow is one of the most common reasons startup companies fail, so it should be no surprise to learn that proper accounting can help you monitor your burn rate (the rate at which you spend money) and cash flow.
While bookkeeping provides you with a list of transactions, an experienced accountant can help you identify cash flow trends, including pinpointing times of the year when cash flow may be lighter or heavier than usual. They can also help you identify areas where you’re overspending and provide guidance to help you reduce your burn rate.
Accounting ensures that you remain compliant and avoid IRS audits
Proper accounting for your startup business can save you from being subjected to an IRS audit or an audit from your state taxing agency. Tax compliance is a complicated thing, and when businesses get audited, it’s usually because there are red flags in their tax returns that indicate potential issues.
Your accountant will prepare your tax documents on behalf of your startup, ensuring that every detail is correct. They’ll understand what’s required to document each deduction and credit and make sure that all necessary forms are attached to your tax return. If you are audited, your accountant can help you through the process, interacting with the auditor and providing all necessary information.
Accounting helps you to identify more tax credits and deductions
Proper accounting isn’t just about keeping accurate records. It’s common for small business owners to overpay both federal and state taxes because they don’t understand the tax codes and which tax credits and deductions they may qualify for.
An experienced accountant can help you review your records and use their knowledge to identify every potential tax deduction or tax credit for your business. As a reminder, tax deductions reduce your taxable income, while tax credits directly decrease the amount of tax you pay. In either case, you can save significant money by taking advantage of both.
Accounting for Startups FAQ
Here are some of the most frequently asked questions about accounting for startups.
What's the best accounting software for a startup?
There are many options for small business accounting software solutions, but ideally, you should choose a system that’s easy to use and intuitive. If you go for something complicated, there’s a risk that you’ll wind up not using it—or at the very least, not using it properly.
We recommend QuickBooks for startup businesses because it offers a lot of functions at an affordable price. The online version, QuickBooks Online, comes with access to a host of resources that explain various features and how to use them. CMP offers QuickBooks consulting as a service, and we’re here to help you take advantage of QuickBooks’ many features.
Do startups need a bookkeeper or an accountant?
We believe that startups need both a bookkeeper and an accountant, although it is possible for one person to do both jobs.
Startup businesses can get by with the owner or a trained employee doing the bookkeeping to make sure that transactions are recorded properly as they occur. If you can only hire one person to help you with your financials, we recommend hiring an accountant and getting them to help you set up a bookkeeping system that you can maintain.
Should you do your accounting in-house or outsource for your startup?
Startup owners may be tempted to cut corners by managing their accounting personally. However, unless you’re somebody who has accounting and tax experience, we don’t recommend this approach. You should either hire a part-time or full-time accountant or outsource your accounting to a CPA.
Hiring is typically more expensive than outsourcing because you may need to provide benefits to your employee. With outsourcing, you can pay somebody as a contractor to set up your accounting system, analyze your financials, and provide you with guidance about your business and its growth.
We recommend outsourcing for most startups. Not only is it the more affordable option, but it’s always helpful to have a fresh set of eyes on your finances. As a business owner, it’s easy to lose perspective and miss things that would be obvious to a trained accountant.
Let CMP Set Up Your Startup Accounting for Success!
Accounting for startups is crucial because it provides a clear financial picture of your company and gives you the tools you need to choose growth strategies and avoid potential pitfalls. An experienced accountant can help you make important financial decisions, comply with tax and oversight regulations, and save money by taking advantage of all available tax deductions and credits.
Are you in need of an accountant for your startup business? CMP can help! Contact us today to learn about our services and schedule a free consultation.