5 Accounting Musts for Early-Stage Startups
Accounting is the language of business — it communicates information crucial for owners, executives, managers, and investors to make decisions. Companies need accurate information to rely on and to determine what is working and what is not. Investors will not provide funding if they are not confident that the information provided to them is accurate. While a majority of early stage startups do not have an accountant on staff, these five accounting tips can help a founder stay on top of his or her business!
1. Save and organize all supporting business documentation.
Setting up a record-keeping system is an important aspect of accounting. Realistically, the likelihood of remembering a one off transaction or expense several months later is extremely low. This is why it is important to document everything. Save receipts, invoices, contracts, legal documentation, and important correspondence in an organized way. Back up all of this data. In the unfortunate chance you are audited and questioned about a specific transaction, having adequate supporting business documentation that you can easily find may save the company from paying a penalty.
2. Use the accrual basis method of accounting.
They say cash is king, especially for capital-strapped startups. However, cash basis of accounting is not allowed under GAAP (Generally Accepted Accounting Principles). Cash basis accounting recognizes expenses when they are paid in cash and revenues when cash is received. The FASB (Financial Accounting Standards Board) issues GAAP to improve the transparency in financial statements. Accrual basis complies with GAAP. It recognizes expenses in the period incurred, not paid, and revenues when earned, not received. This follows the matching principle, which allows the financial statements to reflect all of the revenues and expenses for a specific accounting period. This enables companies to more easily measure and analyze KPI’s (Key Performance Indicators) with revenues and expenses in the correct period. This added consistency and predictability also simplifies budgeting and forecasting. Banks and investors may not accept financial statements in the cash basis and may require using the accrual basis. Therefore, it makes finding financing a little easier if you are already using the accrual basis.
3. Implement internal controls.
Internal controls aren’t just for major corporations. There are many controls that are attainable with a smaller staff that can be put in place as the company scales. Clearly define who is responsible for what and communicate that. Put in place physical controls to protect company resources, such as having passwords on computers and accounts or checks in a locked drawer. Put modest spending limits on all company cards. Review and approve expenses before they are reimbursed and bills before paid by another member of your management team. Conduct a bank reconciliation every month and be able to explain the differences between the book and the bank statement balance. Internal controls will help prevent and identify errors, while protecting the company from fraud.
4. Categorize expenses.
Categorizing costs enables an understanding of how much is spent on various related items. Identifying the right categories depends on the company. When deciding how to categorize expenses, do it in a way that will allow you to make the most effective business decisions. Putting in thought about this at an early stage, will set you up for long-term success. To get the biggest bang for your buck, you need to know where money is being spent and why. Evaluating KPI’s on a regular basis is important and categorizing costs makes this easier. Some costs, such as Sales and Marketing, have a direct impact on revenue generated. This will help you know what to budget for different areas of cost based on your revenue targets.
5. Understand legal documentation.
The way you set up your company from a legal standpoint affects accounting, especially from a tax perspective. It is important to save all of these documents and review them to have an understanding of how the company is structured. These documents can affect who you need to register your business with at the appropriate federal, state, and local government agencies. In addition, filing the correct forms with those agencies. Also be aware of what those agencies can do for you. Many offer various credits for startups that can be hugely beneficial, such as the credit for increasing research activities. For more information about the federal research and development credit, please see https://www.irs.gov/forms-pubs/about-form-6765-credit-for-increasing-research-activities.
Handling all this internally can be burdensome. Fortunately, there are affordable accounting outsourcing options that can provide a lot of support in the areas above. There are many additional things that should be done from an accounting standpoint, but by building off of these, your company will be in a lot better shape!
High Alpha is a venture studio pioneering a new model for entrepreneurship that unites company building and venture capital. To learn more, visit highalpha.com or subscribe to our newsletter.