Accounting for Startups: Top Challenges and Solutions
This is a guest post from Mike Abelson (see bio at the end) – thanks Mike.
Breaking out of job restrictions and becoming the master of oneself is a great milestone that’s exciting as much as it’s challenging. Any entrepreneur knows that launching a startup will be a long journey to success, with many unforeseen challenges and difficulties. And among those challenges, accounting is one of the most important subjects to pay attention to in a startup, as it’s intimately connected to all aspects of the business.
There’s a lot to accounting for a start-up or a small business, so in this article, we will spotlight the importance of effective accounting methods, some accounting basics to consider, and top accounting challenges with solutions.
Why is Accounting Important for Startups?
Startup accounting refers to the process of keeping and categorizing financial information and employing it for startup growth and expansion. An efficient accounting strategy delivers many benefits to a startup; here are some of the big ones:
Startup funding is the initial capital required to launch a new business venture. Entrepreneurs utilize various fundraising strategies, including bootstrapping, crowdfunding, loans, and private equity firms.
Whether through external or self-funding, accounting plays a critical role in startup-building. By providing essential financial information, accounting helps determine the required working capital, the best financing method, and associated risks. A strong accounting approach will generate the level of confidence investors need to consider moving forward.
Provide Financial Forecasting
Financial forecasting involves analyzing a company’s financial data from the past to make predictions about its future trends. These forecasts can influence key business decisions, such as budgeting, funding, and operations.
Accounting plays a crucial role in financial forecasting, providing historical data, including revenue, expenses, costs, and equity, that can be used to project future outcomes. Bottom line – if you want to know where you’re going, you need solid accounting to make that possible.
Help with Taxation
Taxation significantly impacts a startup’s financial health, especially during the early stages, starting from the initial filing. It is critical to comply with tax regulations and understand the tax system to avoid penalties and fines and to keep track of funds.
Effective accounting strategies can help reduce tax liabilities, ensuring the startup does not pay more than necessary. This can be achieved through good bookkeeping, strategic tax planning, and maximizing tax deductions. Succeeding with a start-up is difficult, paying too much in taxes on top of that can easily make it impossible – good accounting will minimize that risk.
When Should Accounting Be Done?
Accounting processes are pivotal for a startup at all its developing stages; as a result, accounting in the early phase of a startup’s growth is recommended even if the business isn’t rolling along; it provides a better view of the business and puts it on track right from the very beginning. In many cases, entrepreneurs can do the early accounting on their own, as bookkeeping isn’t complex yet, and the budget isn’t flexible.
Whether independently or with the help of a professional, accounting activities should be done weekly, monthly, and annually; however, with different points of focus.
- Weekly bookkeeping should record payments, send invoices, file receipts, analyze cash flow, and prepare financial reports.
- Monthly bookkeeping should reconcile bank accounts, pay vendors, and review financial statements.
- Annual bookkeeping should prepare financial statements and year-end tax returns and review budgets and forecasts.
Accounting Basics to Pay Attention
Accrual Basis Accounting
Accrual accounting is a financial methodology that involves recording revenue before receiving payment and recognizing expenses before they are paid. Although large corporations typically utilize this practice, startups can also benefit from it. Accrual accounting can facilitate effective strategic planning, provide detailed business analysis, and enable better revenue anticipation.
Stepping into the business world, a startup might not know about the tax regulations imposed. However, there’re many tax regulations startups must consider, like income, sales, payroll, and excise taxes. Ignoring these or getting them wrong can be a very costly mistake.
Inventory refers to the raw materials, work in progress, and finished products a company uses for either sale or production. Keeping track of inventory helps minimize waste, manage costs, and save money. It’s also critical for the ability to create future forecasts and determining profitability and pricing.
Accounting Challenges Business Owners Face
New business owners with limited knowledge and experience will face many challenges and hardships. However, it’s okay not to be a master in everything; that’s why entrepreneurs must understand some of the most common accounting challenges and prepare for professionally facing them.
Getting Beyond the Budget
There are many considerations and expenses to consider when putting a company on the right track, such as cash flow, fixed costs, fluctuating costs, profit, and more. Despite how overwhelming it may seem, many startups fall victim to poor financial planning, leading to overspending and accumulating huge debts.
A startup plan is the cornerstone of a business, and getting the business plan right from the start increases growth and expansion chances. That’s one of the reasons why investing in a professional accountant is worth it, as they provide guidance, save time, reduce chances of errors, avoid legal issues, and manage taxes.
Hiring and Retaining Employees
Startups are risky, there’s no guarantee that it will be around after six months, nor if it will generate profit. There aren’t many candidates who will take such a risk. As a result, structuring a team of the highest quality talent for reasonable wages will be a great challenge.
There’re many undiscovered skills and talents in universities and training programs, and they would appreciate a place to nurture their skills and acquire practical experiences. Those are perfect candidates for a startup; they’re knowledgeable and motivated and won’t demand high wages. Good accounting can help things stay on track, hit targets and keep those talented people around.
Inaccurate Growth Estimations
When a startup’s products or services are well received, expected revenues are generated, and conversion rates increase, business owners may believe their startup has gained a foothold. Consequently, they may make optimistic but unrealistic decisions on growth, wasting capital and getting involved in big plans.
It’s easy to get triggered by the positive outcomes of early success. However, business owners must remember that the initial positive or negative results aren’t definitive. Instead, it’s important to track results over a long time scale before making any major jumps in spending.
Starting a business from scratch is a lot of work and challenge, and because finances are the core of any startup, setting up a good accounting system should be the number one priority. It won’t be easy, but a good start and a focus on continuous improvement will have a huge, beneficial impact on the possibility of long term success in your business.
Mike Abelson – Mike is the Editorial Director at Lendza. He enjoys helping entrepreneurs and startups succeed through smart, innovative strategies. He’s partnered with CEOs and executives to grow businesses from the ground up. Before his work at Lendza, Mike was a stock market analyst. When he’s not traveling for work, he enjoys reading adventure and science fiction novels.
Shawn Kinkade Kansas City Business Coach