Accounting for Startups: What You Need To Know
Startups are ambitious by nature, but you need a strong foundation. This is where understanding the fundamentals of accounting for startups comes into play.
Startups are born from ambitious dreams. Those dreams won’t take flight, however, without the finances to drive them forward. This is where understanding the fundamentals of accounting for startups comes into play. Before you make the startup leap, make sure you have the basics of finance under your belt.
Let’s dive into the basic accounting information you’ll need to know to keep your business on its feet during your first year of operation.
What’s the Difference Between Accounting and Bookkeeping?
Before you bringing someone on to assess your finances, ask yourself: do you want to work with an accountant or a bookkeeper? As it turns out, the two positions do have their differences.
Bookkeeping basics are primarily about tracking your business’s income and expenses over the course of an entire year. This person will do minimal analytical work and will primarily ensure that your business is either in the black or recovering from startup expenses.
Comparatively, an accountant’s position is largely analytical. This person will help you manage and update your financial data, as well as being responsible for developing and maintaining your financial database, if you have one. An accountant, ideally, also provides analysis and advice on relevant financial decisions, like budgeting, and can help keep an eye out for fraud and irregularities. They may also be responsible for helping maintain your back-office, performing tasks such as running payroll, processing payments, as well as a number of other workflows.
As your business grows, you may find that you want both a bookkeeper and an accountant on board. In the first days of your startup, though, a good accountant will help establish best practices, guide you through the process of paying for your business, and help you plan for initial costs and investments.
Breaking Down Your Business Categories
One of the first things you’ll need to do after hiring an accountant, is determine which financial category your startup falls into. What factors contribute to this categorization? You’ll determine where you fall based on:
- Your startup’s size
- Representation via management or an individual
- How you pay your taxes
- How much money you take in over the course of a year
- Your hand in owning the startup
- The legalities for which you are responsible
There are five different, broad categories of business that your startup can fall into, based on the aforementioned factors. These consist of:
- Sole Proprietorship – businesses fall under this category when one person controls the whole of the organization. This means that one person – the owner – will pay the taxes and debts accrued by the business on her own, without corporate assistance. Note that bank loans are not considered corporate assistance.
- Partnerships – if more than one person can claim ownership of a business, and all affiliated individuals have signed the appropriate documents, then the business in question is categorized as a partnership. Everyone who can claim ownership of the business will have to file taxes for the profits they receive, and each member will need to contribute equally to the financial gains and losses of the business.
- C Corporations – when an owner (or owners) partner with a corporation, they’ll be listed as a C Corporation. This means that the business in question will have shareholders, a board of directors, and management representatives. In these circumstances, no one person will submit tax documents. Instead, the business will file corporate taxes when tax season comes to an end. Startups can grow into C Corporations, but they rarely start as C Corporations.
- S Corporations – S Corporations have the same authoritative boards as C Corporations. However, all financial exchanges that can be attributed to the business are considered the responsibility of the shareholders. The shareholders will report their gains and losses on their personal taxes every year. Again, startups can become S Corporations, but they don’t start in this category unless there are shareholders affiliated with the company.
- Limited Liability Corporations – in unique circumstances, a startup owner will choose how she’s taxed and, in turn, how she pays her taxes.
Understanding which you are will help you better plan taxable expenses and what rules do and don’t apply to your business. One important note: if you do plan on taking in external investments, your investor will likely require you to either register or transition into a C-Corporation.
Accounting & Your Financial Records
As your startup finds its footing, you’ll find that the paperwork you have builds up. Bad news: you’re going to need to sort and keep all of that paperwork if you want to stay on top of your finances. Your accountant will help turn disparate forms, paperwork and invoices into crisp and timely financial statements that will help you better understand and describe your business’ financial narrative.
On a tactical level, you need to retain any documentation that details your:
Why? Because these documents will help you and your accountant more accurately submit your taxes when the year comes to an end. The different documentation you’ll want to keep records of includes, but is not limited to:
- Bank statements
- Credit card statements
- Canceled checks
- Proof of payment
- Previous tax returns
- Previously released W2s and 1099 forms
At a minimum, keep these documents on hand for seven years at a time. Once you’ve been in business for a long while, you’ll be able to clear out your files. In the early days of a startup, though, your ability to organize your financial documents can make the difference between success and failure. Platforms like Quickbooks, Xero, and others offer tools and automation to help store these important receipts, invoices, and documents so that way you don’t have to (physically, at least)! Likewise, a good accountant will help you set up a back-office that automates and stores much of this information with very little effort.
Accountants are the navigators of the ship that is your startup. It’s your idea driving the startup forward, but you’ll need an accountant to stay on track, especially if you have investors. Don’t feel intimidated by the numbers! Reach out, ask for help, and you’ll find it’s easier than you thought to make sense of your startup’s standing.