Tech startups face enormous financial challenges in the beginning of their existence, such as limited cash, research & development (R&D) expenditures, rapid hiring requirements, limited recurring revenue, huge tax obligations, and external funding needs. Even though tech entrepreneurs have brilliant ideas and vast intelligence, most of them lack the experience, skill, and time to manage their finances properly.
For these reasons, accounting has become increasingly important as a tech startup grows because it can help the founders overcome these challenges. A professional team of accountants can be there to help tech company leaders make better financial decisions for bigger growth while ensuring they stay compliant with tax laws.
What Is Startup Accounting?
Startup accounting is a financial term referring to the practice of recording, managing, tracking, reporting, and organizing a new company’s financial activities. In other words, it is accounting specifically geared toward helping startup businesses manage the records of their financial transactions and create financial strategies for better growth.
Accounting services should not be confused with bookkeeping services because they are two different financial services. Bookkeeping focuses primarily on recording the daily transactions and financial activities of businesses, such as their sales and expenses. Accounting is a much more complex financial service responsible for the following tasks:
- Recording income and expenditures
- Interpret financial data
- Generate financial statements
- Conduct financial reporting
- File taxes & ensure tax compliance
- Payroll processing
- Budgeting
- Forecast future financial performance
- Create data-driven financial strategies
- Manage internal cash flow
As the operations of startup tech businesses become more complex, it helps to have external financial expertise to assist in the company’s financial management responsibilities. Not only will it help ensure all the financial information is recorded and interpreted accurately, but it will help the founders focus more attention on running the daily operations of their businesses.
Why Accounting for Tech Startups Can Be More Complex
All startup businesses can benefit from hiring accountants to assist them in managing their finances if they want to achieve growth. However, tech startup accounting is even more critical due to the complexities that tech startups often face as they try to grow and prosper. Some of the tech-specific financial considerations that founders usually have to make include the following:
- Software-as-a-Service (SaaS) and subscription revenue
- Securing and protecting intellectual property
- Seeking grants and other funding
- Making external investments
- Managing international customers and currencies
- Quickly hiring qualified employees
- Payroll processing
- Software development expenditures
- Other research & development expenditures
Conventional startup businesses have to hire employees, process payroll, and seek funding, but they don’t typically have to worry about things like R&D expenses, intellectual property, or SaaS revenue management. Tech startups have a bigger responsibility because they must manage these complex financial tasks to avoid future legal or financial problems.
The Financial Numbers Every Tech Founder Should Track
Every tech founder needs to track and understand specific financial numbers to maintain a clear picture of their company’s current financial health. These numbers include the following:
Cash Flow
Revenue is not the same as cash flow. Having available cash matters even when revenue is increasing because it allows businesses to cover expenses and emergencies as soon as they arise. Cash flow management enables tech founders to track when money enters and leaves their businesses to better cover these expenditures and plan future spending.
Burn Rate and Runway
Burn rate refers to how fast a startup company spends its available capital or cash reserves. Runway is an estimate of how long the company can keep spending its capital at this rate until it runs out of cash. Together, these figures allow startups to better manage their spending and figure out when they will need to seek additional funding.
Revenue and Profitability
Increasing revenue may seem encouraging to a tech company founder, but it doesn’t automatically mean their business is profitable yet. All it means is that the company is generating more sales. A company doesn’t become profitable until its total monthly revenue is higher than its total monthly expenditures.
Accounts Receivable and Liabilities
A founder must monitor the money owed to their company (accounts receivable) and all its outstanding financial obligations (liabilities). For instance, a customer with a software subscription owes money to the company each month, which is recorded on the books under “Accounts Receivable.” The founder must ensure the customer completes their payment obligation to the company.
Recurring Revenue
For SaaS businesses, their monthly recurring revenue (MRR) and annual recurring revenue (ARR) can help them predict their future potential income. These figures should be measured consistently so that changes in recurring revenue can be identified and evaluated more accurately.
Accounting and Fundraising: Getting Investor-Ready
Startup tech businesses must often seek venture capital from outside investors to fund their operations and growth. Keeping organized financial records becomes particularly important when raising external capital because investors want to understand the financial health and stability of the company.
Some of the information that investors will want to examine may include:
- Historical accounts
- Revenue and expenditures
- Cash position
- Burn rate and runway
- Liabilities
- Financial forecasts
- Fax position
- Previous funding
Having a reliable accounting team can help a startup organize these financial records so that financial due diligence is more efficient. It will help founders communicate their company’s financial position clearly to investors.
Common Accounting Mistakes Tech Startups Should Avoid
There are good reasons why tech startups should hire professional accountants to manage their finances. When founders attempt to manage their own finances without professional assistance, they usually make some grave mistakes.
Some of the most common accounting mistakes that tech startups make include:
- Mixing personal and business finances
- Delaying bookkeeping duties until tax deadlines
- Failing to monitor burn rate and runway
- Treating all revenue and sales as immediate cash availability
- Waiting until fundraising to organize financial records.
A founder cannot keep accurate financial records if they mix their personal and business finances. Delaying bookkeeping duties can result in inaccurate financial records, which makes financial reporting and tax compliance more difficult to achieve.
Failing to monitor burn rate and runway will increase the likelihood of a cash shortage in the near future. Remember that payments received from customers don’t automatically mean that cash was earned and is now readily available. Expenses must be paid first before making cash available.
Establishing good accounting practices before seeking investment or cash will reduce the pressure of preparing financial records at the last minute.
When Should a Tech Startup Use Professional Accounting Support?
The appropriate level of professional accounting support needed for a tech startup will depend on the company’s business model and financial complexity. You will know when your tech startup needs professional accounting services when it needs to deal with the following circumstances:
- Hiring employees
- Receiving outside investment capital
- Applying for grants or external funding
- Recurring or subscription revenue
- International expansion and growth
- Dealing with more complex tax obligations
- Preparing and measuring financial forecasts
Tech businesses facing these financial circumstances can benefit enormously from accounting for tech startups because their financial reporting, taxation, forecasting, and funding requirements are so much more complex than conventional businesses.
Conclusion: Build Strong Financial Foundations Early
Accounting is more than just some annual tax compliance task. It should be treated as an ongoing part of business management, where you keep accurate and reliable records for better cash flow visibility and more accurate financial forecasting. That way, you can make better financial decisions by using this data to influence those decisions.
Best of all, establishing a strong financial foundation with accounting can make it easier to seek fundraising and external investments to achieve sustainable growth.
