4 Signs You Need to Step Up Your Startup’s Bookkeeping

4 Signs You Need to Step Up Your Startup’s Bookkeeping

Written by 
Pilot Team
December 2, 2022
4 Signs You Need to Step Up Your Startup’s Bookkeeping

In the beginning, startup founders wear many hats, one of which is bookkeeping. While most founders are not bookkeepers by trade, they do what they can to keep finances in order.

The problem is, when a startup grows in size and complexity, an Excel spreadsheet and some late nights are no longer enough to keep the books in order. And inefficient bookkeeping practices don’t just spell trouble around tax or audit time. Bad bookkeeping can cause day-to-day headaches as the company scales.

Sub-par bookkeeping can also mean founders are missing out on hidden growth opportunities and ways to improve business results.

So how do you know when it’s time to stop bootstrapping your startup bookkeeping? If the telltale signs below sound familiar, it’s time to get serious about financial management.

Sign 1: You’re Not Keeping Sufficient Financial Records

Good bookkeeping involves maintaining records of all your startup’s financial transactions for at least three years or longer in some cases. Both the IRS and financial auditors will ask you to substantiate — that is, provide evidence for — every transaction on the general ledger. If you can’t, you could miss out on tax deductions.

While investors may not go through your books line by line before funding you, they will ask for your financial statements for the past three years or more. Bare-bones cash-basis bookkeeping in an Excel spreadsheet doesn’t give potential investors the data they need. Oftentimes, founders realize their financial management is subpar right before an investor pitch–not the best time to be scrambling to get your books in order.

Common record keeping problems

There are lots of ways financial record keeping can go awry. For example, let’s say you and your cofounders keep receipts. That’s great, but there’s a problem. The receipts are paper and the bookkeeping is done digitally. When tax season comes around, you’ll have to go through a year’s worth of paper receipts trying to confirm that each expense is posted in the financial statements.

The bigger your startup gets and the more team members you have, the more time you’ll waste on paper-based accounting tasks. It’s a good idea to invest in a financial management infrastructure. That way, you won’t have to hire an accountant to clean up the books. Plus, improving your accounting system will reduce the amount of time you’ll spend on a financial audit or on your business tax return.

What to do about insufficient financial records

Keep all source documents that support income, deductions, or credit on annual tax returns. The IRS has some handy guidelines on this, but basic financial records should include:

  • Receipts
  • Bank statements
  • Payroll records
  • Invoices

If you’re maintaining a paper or manual spreadsheet bookkeeping system, note the details of the expense on the back of the receipt as soon as possible. Also note the name of the client or investor you met, the reason for the meeting, and the date.

We recommend using a tool like Expensify to manage your receipts electronically. With Expensify you can snap a photo of the receipt, upload it, and enter all the relevant info you need to record. This way everything is kept in one place and easily recorded in your books.

Sign 2: You’re Not Performing a Bank Reconciliation Quickly After Month-End

Every business must reconcile the bank statement to the accounting records quickly after month-end, because your bank statement provides third-party validation of your bank activity. We recommend performing a reconciliation as soon as the bank statement is available online.

When you perform a bank reconciliation, you compare each cash account transaction in your accounting records (“the books”) to the bank statement. If the transactions don’t match, you need to find out why. There are several types of common reconciling issues, such as a check that has not posted to the bank account by month-end.

This might not sound like the best use of any founder’s time, but it’s critically important. If you don’t reconcile the books to your bank account in a timely manner, your financial statements may be incorrect.

Moving forward, every business decision you make will be based on flawed information, and the numbers you present to investors (future or present), will be incorrect. If your financial statements are incorrect, your tax return will also have errors. Overall, it’s something you simply want to get right the first time so a negative domino effect doesn’t occur. 

Looking for help with your reconciliation and bookkeeping? Check out Pilot.

Bad bookkeeping can impact day-to-day functioning

Not reconciling the books can also impact your startup’s ability to function day-to-day. For example, let’s say you do the books in Excel spreadsheets. You place an order on December 15th with a vendor and agree to pay $500 in 30 days. You increase accounts payable and post the amount to material expenses. So far, so good.

On January 15th, the vendor emails you and states that the $500 invoice has not been paid. To maintain a good relationship with your supplier, you pay $500 immediately.

Because you haven’t performed the December 31st bank reconciliation, you don’t notice that the invoice was already paid, and that you didn’t post the payment in your accounting records. The books and your bank account are out of balance.

When you perform a bank reconciliation, you’ll find a number of reconciling items: differences between your bank statement and accounting records that you need to address. The longer you put off performing a reconciliation, the more time it will take to make corrections after the fact. In addition, bank reconciliation is the best way to uncover fraudulent transactions, such as an unauthorized debit to your account.

What to do about reconciling items

Bookkeeping software that integrates with your business bank account makes reconciling the books much easier. But if you want to do the monthly bank reconciliation manually, follow these steps:

  1. Verify that each bank transaction is posted to the general ledger.
  2. Gather all the source documents (paper receipts, purchase orders, payment notices, etc.) for the month.
  3. Associate each amount in the source documents to the transactions that you posted in step one.
  4. Next, look for differences between your accounting records and your bank statement for the month. Typical reconciling items include checks that haven’t cleared and transactions that cannot be easily identified.
  5. Once you have reconciled those items, post the updated info to the general ledger.

Finally, make a bank reconciliation statement documenting the changes that you made, and note any outstanding unreconciled items.

Sign 3: You’ve Got Cash Flow Problems

If financial statements show you’re making money, but your bank account is low on funds, there’s a problem with cash flow. Negative cash flow can have various causes, including poorly done bookkeeping.

Whatever the cause, every entrepreneur needs to stay on top of cash flow. Badly managed cash flow can lead to:

  • Miscalculations around burn rate and runway.
  • Inability to make payroll or cover liabilities.
  • Loss of investor interest

What to do about cash flow problems

Start off by reconciling the books, focusing on accounts payable and accounts receivable. If accounts payable is disorganized, you could be making payments multiple times without realizing it. Put a procedure in place to compare the accounts payable detail to cash payments made. This will help you reduce accounts payable each time you pay an outstanding invoice with cash.

Similarly, sloppy accounts receivable work can lead to unpaid invoices hanging around for months. Your business should have a formal cash collections policy. For example, you may email clients when an invoice is 30 days old and call clients if an unpaid bill is 45 days old. This can speed up cash collections.

Once the books are reconciled, consider automating your invoicing system. This reduces invoicing errors and delays, gets invoices out faster, and provides data on who’s paying late. It also makes it easier to collect overdue invoices. We recommend Bill.com to our clients looking to implement an invoicing system in their back office.

It’s good to remember, cash flow problems don’t always stem from bookkeeping problems. If you have stellar bookkeeping but still don’t have cash, then you may have bigger issues with your business model.

Sign 4: You’re Not Using the Chart of Accounts Properly

The chart of accounts is a listing of each account you use in your business, and the corresponding account number. Setting up the accounts correctly is important because they are used to post every accounting transaction, and ultimately, to generate the financial statements.

This might feel like a pointless exercise to entrepreneurs. But categorizing transactions means you’ll be able to aggregate revenues and expenses based on a logical numbering system in the chart of accounts. Not only does this allow you to budget better, but it’s also useful for investors who want to know the strength of your revenue streams and their potential to generate profit.

If you don’t categorize transactions, it’s easy to record them in the wrong accounts, or record them multiple times. You could end up getting fined by the IRS, or having to pay a tax accountant hefty fees to sort the problem out.

What to do about a poorly designed chart of accounts

A good chart of accounts makes sense for the business—a chart of accounts for a SaaS business is fairly different than a chart of accounts for a dentist's office.

When your startup grows in size and complexity, you’ll probably want to consider a more elaborate coding system to group expenses by department.according to type.

Good Bookkeeping is Part of Proactive Business Management

Financial management is vital to understanding your startup’s performance. Whereas you might get away with a simplistic cash-in cash-out spreadsheet at first, any startup dreaming of Series A funding needs to get their books in good shape.

Good financial practices mean you’ll be able to budget, make decisions based on fact rather than error, and create long-term plans. Knowing when to start investing in professional bookkeeping services is part of a proactive business management plan that sets you up for future growth.

Looking for the right bookkeeper for your business? Here’s a handy guide to finding one.

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