Working with startups (plus building and managing a few of our own)  has taught us that founders and business owners continuously struggle to stay on top of their financial management responsibilities — the most time consuming and important of which is bookkeeping. Your books are the baseline financial record for your business, from which you will draw all insights needed to make strategic decisions. Because of this, your books need to be 100% accurate.

“Because of this, your books need to be 100% accurate.” 

Most startup businesses will outsource bookkeeping tasks by hiring a part-time bookkeeper or working with a finance firm. The problem with going that route is that it leads to heavy fragmentation, where you’re now managing multiple platforms and have to communicate across several channels just to get a simple answer.

As such, we’ve experienced these pains first hand:

• The current process is very manual and human intensive, requiring founders to spend a lot of time and energy managing their company’s finances. For example, to check in on your financials, you must log into any number of different accounts to see the latest balances and statements. Then you must figure out a system for organizing and understanding how the various datasets stack up to provide insights into your company’s overall financial health.
• Even when you outsource bookkeeping, you still have to double check your bookkeeper’s work every month. Because even when this process is outsourced, the books are never 100% accurate, given the varying levels of experience, insight, and attention to detail the individuals managing your company’s bookkeeping bring to the table.
• If your company’s metrics change drastically — such as its operating expenses or burn rate — you won’t know until the month’s books are delivered (which usually happens at least two to three weeks into the next month, putting you indefinitely behind). And when you do get the numbers, you’re unable to derive the cause of changes from the Excel spreadsheet you just received. You can see that your burn rate has increased, but now you need someone to pour over the books and interpret the data to tell you why it has increased.
• It’s tax time, and the CPA you deal with roughly once a year suggests further revisions to your books. Because this is a transactional relationship, and not an ongoing partnership, your taxes are never optimized for your business because the tax accountant does not have deep insights into your business.

In order to solve these pain-points, we created a list of four things a modern bookkeeping system and, more generally, a complete financial management system ought to do.

1. Have a system in place to keep your books 100% accurate throughout the year (making it easier to do things such as prepare investor packages, be audit ready, and file your year-end tax return).
2. Bundle all data from various financial accounts into one easy to navigate finance dashboard where the most important insights for your business are available 24/7.
3. Utilize a fast and efficient system to manage receipts, invoicing, bill pay, and other financial functions.
4. Proactively communicate important financial insights in real-time, allowing you to identify and take action on changes to your finances as quickly as possible.

In this article, we’ll cover the basics of startup bookkeeping and explore the most common ways startups handle their books.

The Basics of Startup Bookkeeping

You may not need (or want) a refresher on bookkeeping basics. If not, go ahead and jump to our section on how most startups tackle bookkeeping (and how this process can be improved). Otherwise, keep on reading.

What Is Bookkeeping?

Bookkeeping is tracking all financial transactions as they pertain to your business. It is different than accounting, though the two are sometimes conflated. Accounting is the interpretation of data, whereas bookkeeping is simply recording data. ‍

Startup bookkeeping is different because startups are often more agile and quick to change. They can grow in a short amount of time from a small business with four employees to a mid-size company with a staff of 50+ full-time employees — half of which are now taking advantage of your new company-wide benefits. Plus, many startups have unique business models when compared to more traditional small businesses such as restaurants, law offices, or retail stores. For startups, otherwise mundane bookkeeping details (such as using the proper chart of accounts to categorize expenses and revenue correctly) are not trivial.

Cash vs. Accrual Accounting

One of the more common (and easiest to answer) questions we are asked is: Should my startup use cash or accrual accounting?

The quick and straightforward answer is to choose the accrual accounting method.

Here’s the difference:

• Cash accounting tracks expenses or finances when the money hits the bank.
• Accrual accounting tracks money regardless of cash inflows or outflows but in terms of when it is earned or due.

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And here’s why we recommend the accrual accounting method: It gives you a more accurate overview of your business’s financial health and allows you to continue making strategic business decisions.

Say you complete a project in February. Then you invoice the client. Because it’s February’s work, the expenses for it are coming out of February. You want to record the revenue in February as well, but the client pays you anywhere between 30-60 days of receiving your invoice. Using cash accounting in this example would show a significant loss in February (the expenses without the revenue) and an unexplained gain in March (or whenever you finally received your paid invoice).‍

Plus, the IRS requires any business earning $5 million a year in revenue to use accrual accounting. Since startups are almost by definition built to scale, we find it best practice to start using accrual accounting for your startup sooner rather than later.

Establishing Your Chart of Accounts

A chart of accounts (COA) is how your financial transactions are categorized and tracked within your accounting software.

There are standard categories, including:

• Assets
• Liabilities
• Owner’s equity
• Revenue
• Expenses.‍

But a chart of accounts can do a lot more for your startup when it’s created with intention. A thought-out COA can serve as a mirror for your business, both for how it exists now and how it’ll exist in the future. Yet almost every time we’ve looked at a startup’s books, we saw that their COA wasn’t designed to be reflective of their present business needs or the ways in which their business will grow. And trust us, changing your COA three years into your business isn’t fun or easy.

You want your COA matched to your business needs and goals. For example, a startup COA may bucket salaries in two ways: administrative (non-consultative) salaries and consultative salaries. This division will make it easier to see where your money is going and if the ratio of consultative to non-consultative salaries is working well for your business. Another example: meals and entertainment. Instead of just using that broad category, break it up into smaller buckets, such as coffee, office meals, and off-site lunches. Those are three distinctly different activities, and your startup may want to know if most of your meals and entertainment costs are focused on coffee runs or team-building, off-site lunches.

A COA also directly impacts your end-of-year taxes. If you don’t have separate categories for meals purchased at the office and meals purchased when traveling for work, then you aren’t getting the appropriate write-off.

Source: https://www.zeni.ai/blog/startup-bookkeeping