As an Adjunct Instructor at Northwestern University teaching startup accounting, I’m tasked with helping students understand accounting as it relates to startups. Although the foundational mechanics of accounting are the same across all different business types, there are some special considerations for startups. Specifically, startups have to develop and implement accounting policies and procedures that fit the unique needs of their businesses. Because there are no perfectly comparable blue prints to follow, this is especially difficult for startups that are attempting to do something no one has ever done before. As such, the framework that I apply to startups is a cyclical loop of the following components, which we’ll break down further.
Accounting, as a whole, can be inherently complicated. There is a reason Certified Public Accountants undergo years of training and testing, and that is to ensure that they are adequately equipped to navigate the complexities of accounting. The first step in startup accounting is to understand what it is you need to do. For example, many small business owners and startup founders dive head first into launching a business, without taking any time to do some proper planning. They fail to establish a separate business bank account, and instead, they co-mingle business expenses with personal expenses, which is a huge “no-no” from a legal perspective. Another example is that they begin to sell products without realizing that they may be incurring a sales tax requirement in their state, and their failure to charge and remit sales tax can be disastrous for their business down the road. These are just two examples of why the first step in accounting for startups is understanding the tax and accounting related compliance landscape associated with running a business. Make sure to sit down with your CPA prior to launching your business, so you can make sure you’re covering your bases and avoiding any nasty surprises.
After you have a good grasp on what you need to be doing with respect to accounting for your startup, it’s time to start implementing the necessary policies and procedures. This can include (but is not limited to) forming a new legal entity, setting up a separate business bank account, setting up a bookkeeping system, setting up payroll, or developing A/R and A/P processes. Constructing a solid accounting framework from which to grow and scale off of is imperative, and it’s important that the accounting practices you implement for your startup will, ultimately, be scalable.
After your accounting policies, processes, and procedures are implemented, you can’t simply ignore them. You should be continually striving to optimize and make your processes and procedures better. For example, if your company cuts manual checks to pay vendors in its infancy stages, as you grow you may look to move to a more scalable accounts payable system to ease the time burden of such a manual process. Another example is using more powerful and robust budgeting & forecasting tools instead of manually updating your spreadsheets daily. This area of the iterative cycle of startup accounting is perhaps the one that is the most overlooked, but proactive and forward looking founders have discovered untapped operational efficiencies through continual optimization of their accounting functions.
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Perhaps everyone’s least favorite part of startup accounting, tax compliance, is the last component of the loop, but certainly not the least important. If you’ve taken the steps to understand, implement, and optimize sound accounting policies and procedures, complying with your various federal, state, and local tax obligations will be much less of a burden. However, if you’ve largely ignored the first three components of the cycle, you’re likely in for a long, frustrating, and stressful tax season. Regardless, making sure you’re paying all of your tax obligations is crucial for business, as ignoring tax obligations will snowball and can even become criminal in some instances.
The Cycle Continues in Perpetuity
Perhaps the most important thing to understand related to the iterative cycle of startup accounting is that it is continual, and the loop from component to component never ends. This is because each year there are new taxes levied, or the existing tax code is altered, which triggers the requirement to understand once again. What you did last year may not be sufficient for this year, so you must revisit this quadrant of the cycle. You must also responsively implement new accounting policies and procedures, should the circumstances surrounding your business change. For example, if you hire new hourly employees as your business grows, you may need to implement time tracking systems that comply with the new FLSA labor laws. Further, you should always be evaluating existing systems and procedures to optimize them for accuracy, efficiency, and overall effectiveness. This may include evaluating your invoicing processes to eliminate bottlenecks and improve your cash flow gaps. Finally, always be required to comply with your year end obligations, which may have changed either due to new regulation or different circumstances surrounding your business.
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