Startup Bookkeeping 101 With Tips from a CPA

Startup Bookkeeping 101 With Tips From a CPA

From product development and hiring to fundraising and market positioning, a founder's responsibilities are endless. However, there's one crucial element that demands your attention from day one: bookkeeping.

Solid financial records form the foundation of any successful business, particularly in the fast-paced world of startups. Whether you're preparing for investor pitches, planning for strategic growth, or simply ensuring day-to-day operations run smoothly, having well-organized books is essential.

This article will cover everything you need to know about startup bookkeeping, from assessing whether you need a dedicated bookkeeper to addressing common financial challenges unique to startups.

Do startups need a bookkeeper?

Many startup founders don't know whether they should hire a bookkeeper. The short answer is it depends on your specific circumstances, but in most cases, professional bookkeeping support is beneficial.

Here are a few factors to consider:

• Stage of your startup: In the very early stages, when transactions are minimal, you might be able to manage basic bookkeeping tasks yourself. However, as your startup grows and finances become more complex, professional help is invaluable.
• Financial expertise: If you don’t have a strong financial background, a bookkeeper can set up and maintain proper financial records for your business.
• Time management: Spending less time on bookkeeping tasks means you can focus on core business activities that drive growth.
• Investor requirements: Looking for more investor funding? Detailed, professional financial records are just what you need.
• Compliance and taxes: A bookkeeper can help ensure you're compliant with tax laws and regulations, potentially saving you from costly mistakes or penalties.

What are the benefits of better bookkeeping for startups?

Investing in professional bookkeeping services for startups can provide long-term benefits that far outweigh the initial costs.

Here are just some of the advantages you’ll come to enjoy with professional bookkeeping:

• Informed decision-making: Better bookkeeping provides a clear, real-time picture of your startup's financial health. This clear view of your finances will help you allocate resources effectively, identify trends in revenue and expenses, and spot potential issues before they become major problems.
• Easier fundraising: Good bookkeeping demonstrates that you’re a good bet for potential investors. It provides the data you need to create compelling financial projections and speeds up the due diligence process during funding rounds.
• Cash flow management: A bookkeeper can help you stay on top of cash flow more effectively. They can identify seasonal trends in cash flow and provide insights for better budgeting and financial planning.
• Tax compliance and optimization: Proper bookkeeping reduces the stress and time associated with tax filing and helps identify all possible tax deductions.
• Audit preparedness: In the event of an audit, having well-maintained books can be the difference between a small inconvenience and a months-long headache for your startup.
• Scalability: As your startup grows, a bookkeeper can help scale your financial processes. They provide the data needed to better understand how much you’ll grow and help identify areas of the business that are ready to expand.
• Better stakeholder relations: With accurate financial records in hand, you can provide investors with timely financial reports, ensure accurate and timely payroll for employees, and pay vendors and suppliers on time.
• Financial health monitoring: Regular bookkeeping can help you keep better tabs on key performance indicators (KPIs) relevant to your industry. You can compare your financial performance against industry benchmarks and identify areas for cost-cutting or increased investment.
• Strategic partnership opportunities: Well-maintained books can open doors to strategic partnerships. They give you the financial data needed for negotiations and demonstrate your startup's financial growth potential.
• Peace of mind: You'll have confidence in your financial data when making important decisions. Gone are the days of financial stress — you’ll have a clear picture of your financial health, and you can focus more on growing your small business.

Which accounting method is best for a startup: Cash vs. accrual accounting

Choosing the right accounting method affects how you record, organize, and understand your financial data. The two primary methods are cash accounting and accrual accounting. Let's explore both to help you determine which is best for your startup.

Cash accounting: Pros and cons

Cash accounting is a method where transactions are recorded only when money changes hands.

Pros:

• It's straightforward and easy to maintain, especially for small startups with simple financial structures.
• It provides a clear picture of how much cash you have on hand at any given time.
• It can offer tax benefits for some startups, allowing you to defer income recognition.

Cons:

• It doesn't provide a complete picture of your financial obligations or future income.
• It can be difficult to track receivables and payables, which can make long-term planning difficult.
• It may not accurately represent your startup's financial health if you have significant accounts receivable or payable.

Accrual accounting: Pros and cons

Accrual accounting records income when it's earned and business expenses when they're incurred, regardless of when cash is exchanged.

Pros:

• It provides a more comprehensive financial view of your startup's financial health over time.
• It allows for more accurate forecasting and budgeting.
• Many investors and potential acquirers prefer this method as it gives a clearer picture of the business's financial position.
• It aligns with Generally Accepted Accounting Principles (GAAP), which may be necessary as your startup grows and is required for public companies.

Cons:

• It's more complex to manage and may require more sophisticated startup accounting software or expertise.
• It doesn't provide an immediate picture of cash flow.
• You may owe taxes on income before you've received payment.

Which method should you choose?

The best method for your startup depends on several factors:

• Business size and complexity: Smaller startups with simple financials might steer toward cash accounting, while more complex businesses often benefit from accrual accounting.
• Growth plans: If you're planning rapid growth or raising funds from investors, accrual accounting may be preferable.
• Industry standards: Some industries have specific accounting method preferences or requirements. For example, construction and real estate companies often prefer accrual accounting, while professional services favor cash.
• Revenue: The IRS requires businesses with annual revenue exceeding $25 million to use accrual accounting.
• Inventory: If your startup sells inventory, the IRS requires you to use accrual accounting for purchases and sales of inventory, even if you use cash accounting for other aspects of your business.
• Financial reporting needs: If you need detailed financial reports for investors or lenders, accrual accounting is often a better pick.

Many startups begin with cash accounting for its simplicity and transition to accrual accounting as their financial needs become more complex. It's also possible to use a hybrid method, where you primarily use cash accounting but choose accrual accounting for specific items like inventory.

What bookkeeping tasks need to get done

Keeping a regular schedule of bookkeeping tasks is important for your startup's financial health and compliance.

Here's a breakdown of essential bookkeeping tasks to keep up with on a weekly, monthly, and annual basis:

Weekly tasks

• Record transactions, including income and expenses.
• Categorize transactions.
• Reconcile petty cash.
• Invoice clients for goods or services provided.
• File receipts and documentation, including invoices and bank statements.

Monthly tasks

• Reconcile bank and credit card statements.
• Review accounts receivable and follow up on outstanding invoices.
• Review accounts payable and ensure all bills are paid on time.
• Process payroll and make sure all related taxes are paid.
• Conduct a physical inventory count and reconcile it with your records.
• Generate financial statements, including income statements, balance sheets, and cash flow statements.
• Analyze financial performance against goals and budgets.

Annual tasks

• Close the books and prepare for the new fiscal year.
• Analyze your startup's financial performance over the past year and compare it to previous years.
• Gather all necessary information and documents for tax returns, including 1099 forms for contractors.
• Review and update the chart of accounts.
• Reconcile loans and investments.
• Update your fixed asset register, recording any new purchases, disposals, or depreciation.
• Review and update financial policies.
• Prepare annual reports for stakeholders, including investors and board members.
• Use your financial data to create budgets and forecasts for the coming year.
• Consider an external review or audit, depending on your startup's size and investor requirements.

Common issues with startup bookkeeping

Think of this section as your financial early warning system. Knowing common pitfalls can help you steer clear of them and keep your startup's financial health in top shape.

If you look at this list and see problems your startup is facing, then maybe it’s time to invest in better bookkeeping practices.

Important records get lost or thrown out

Startups often struggle with document management, which can lead to lost or discarded important financial records. This can cause problems down the road: incomplete financial data, difficulties during tax season, and potential legal issues.

How to fix it

Startups should implement a robust digital document management system and establish clear protocols for record-keeping to help prevent this problem. Another solution is to always keep backups of your financial documents in case of any accidental data loss.

Data entry falls behind

Delayed or backlogged data entry can lead to decisions made with inaccurate financial reports or outdated information.

How to fix it

Regular, systematic data entry practices and automation tools can help startups stay up-to-date with their financial data.

Burn rate gets out of control

Many startups struggle to accurately track and manage their burn rate, the rate at which a company spends its cash reserves. Not knowing or tracking spending patterns can lead to unexpected cash flow crises.

How to fix it

Real-time expense tracking and regular financial reviews can help startups maintain a healthy burn rate and extend their runway.

Bills and invoices get missed

Overlooking bills or failing to send invoices promptly can severely impact a startup's cash flow. Late payments can damage vendor relationships, and delayed invoicing can lead to cash flow gaps.

How to fix it

Setting up systematic processes for accounts payable and receivable, along with automated reminders, can help make sure bills and invoices are always handled in a timely manner.

Tax season becomes overwhelming

Many startups find themselves scrambling when tax season arrives due to poor year-round bookkeeping practices. This can lead to rushed, potentially inaccurate filings and missed deductions.

How to fix it

Maintain organized financial records throughout the year and consider professional tax preparation services so you can alleviate much of the stress associated with tax season.

6 ways for a startup to handle bookkeeping

It's common for startups to change their bookkeeping approach as they grow, often starting with DIY methods and progressing to more sophisticated solutions over time. According to Statista, more than 60% of business owners manage their own books, but many are turning to new software to simplify bookkeeping.

Let's explore the approaches to managing your startup's bookkeeping:

1. DIY bookkeeping

For very early-stage startups with simple finances, founders might choose to handle bookkeeping themselves.

This approach is cost-effective in the short term and provides founders with a deep understanding of their finances. But, it can be time-consuming and may lead to errors if the founder lacks business accounting expertise. As the business grows, this method often becomes unsustainable.

2. Hire an in-house bookkeeper

As your startup grows, you might consider hiring a dedicated in-house bookkeeper who can handle day-to-day financial tasks efficiently.

However, this choice comes with salary and benefits costs, which may not be in the cards for smaller startups. An in-house bookkeeper might also have limited expertise in complex financial matters.

3. Outsource to a bookkeeping service

Professional services provide expertise without full-time employee costs and offer scalable services that can grow with your business.

The drawback of this method is that it often results in less direct control over day-to-day financial operations and can lead to potential communication challenges with your bookkeeping service. Outsourcing can also be more expensive than DIY methods.

4. Use bookkeeping software

Modern bookkeeping software can automate many aspects of financial record-keeping, provide real-time financial data and reports, and integrate with other business tools.

Software can take a lot of time to set up and learn, and may still need human oversight for complex transactions. Subscription costs for software can also add up over time.

5. Fractional CFO services

For startups needing high-level financial strategy, fractional CFO services offer part-time executive-level financial management.

While more cost-effective than a full-time CFO, it may be overkill for very early-stage startups and offers less hands-on involvement with day-to-day bookkeeping tasks.

6. Get the winning combination with Digits

Digits offers a unique approach to bookkeeping and accounting that combines cutting-edge technology with professional financial expertise. It does this through advanced AI-powered financial analysis and integrations with your financial accounts so you get real-time visibility and insights into your startup's finances.

Combine all of this with smart features like AI Bill Pay, advanced reporting, and bank-grade security, and you have a cost-effective bookkeeping and accounting solution perfect for tech-forward startups.

Bookkeeping made for startups

Traditional bookkeeping methods often fall short for startups. That's where Digits comes in, an AI-powered bookkeeping platform designed specifically with startups in mind. Digits' AI bookkeeping provides real-time visibility and categorizes transactions instantly.

Ready to take the next step? Schedule a demo to learn more about how Digits can help your startup continue to grow.