Accounting may not be one of the top priorities for a startup to consider.
However, it can prove to be one of the most important aspects of a startup. It is important for firms to choose the best accounting methods for startups.
Accounting has proven to be an integral aspect of the success of firms and ensures businesses steer forward seamlessly financially.
The type of accounting method a startup chooses has a significant impact on the overall performance. Overall, there are two main accounting methods for startups: cash-based and accrual-based, but every new business needs to choose the most suitable method.
The Importance of Choosing the Right Method of Accounting for Startups
The type of method that a startup chooses can significantly impact its performance. Here are a few reasons it is important to choose the right accounting method for your startup:
- It is important to know that revenue is recognized differently in each accounting method. Therefore, it is important to know which method suits the startup and the way it wishes to calculate the revenue.
- There is also a difference in overall reports, which may impact the overall decision-making of the firm. It is important to choose a compact way of accounting for a startup to get the right reports for your company.
- Apart from the operations, the methods also differ in the ways startup files and claims taxes. It is advisable for startups to determine the method which suits their tax season better.
Without further, let’s look at the accounting methods that startups can explore:
1. Cash-based Accounting
Cash-based accounting is one of the simpler accounting methods that startups can choose. The main component of cash-based accounting is cash itself. With this method, the transactions get recorded each time a business receives cash payments or pays expenses and costs.
Pros of Cash-Based Accounting
Going ahead with cash-based accounting for startups can be an excellent decision. This is because many startups operate based on cash transactions only.
- Going with a cash-based system will help a startup keep an accurate track of the incoming and outgoing money. It also allows the business to save up on the accountant cost since it requires no additional skills to keep track of the finances.
- Another significant advantage of the system is that it allows for a more accurate financial record for the firm. This is possible since it purely records the transactions in cash.
Cons of Cash-based Accounting
While cash-based accounting may seem like an optimum choice, it has plenty of downsides for startups. These include:
- Startups with a cash-based accounting method do not deploy a compact accounting system to improve their workflow. Without any automation, the chances for errors can increase substantially since there is always room for human error with manual accounting.
- Apart from that, it also prevents the startup from examining where they stand in terms of financial position. This method of accounting does not generate reports such as balance sheets and income statements, which are considered core aspects by many expert accountants.
Usage of Cash-based Accounting
There are certain conditions that compel a business to choose the cloud-based methods, which include:
- The startup business is very small with little aim for growth
- The business does not provide credit and needs immediate payments
- Fewer employees working in the business
- Fewer transactions that can easily be recorded manually
- The startup does not require inventory tracking or automated data entry.
2. Accrual-based Accounting
With accrual-based accounting, a business can record expenses and revenue whenever they occur. This is unlike the cash-based system that records transactions after they are initiated.
Irrespective of when the payment is made, the method records all the money that the business has earned, and the costs incurred.
Pros of an Accrual-based Accounting
There are plenty of advantages to this method of accounting for startups. It is one of the widely used methods that is trusted by big names in the corporate world. Let’s look at some notable benefits below:
- The method allows the startup to sell on credit rather than only dealing in cash. Startups are easily able to record the transaction even when they have not received the money.
- Using this method allows the firm to seamlessly record and store transactions. Moreover, it also allows the stakeholders to access the finances from anywhere, anytime.
- One of the main benefits is that it allows the firm to determine its financial position. Startups can create accurate income statements and balance sheets. All these aspects are key to sustainable growth.
Cons of Accrual-based Accounting
This method is not perfect either and possesses a few complications in performing accounting for startups.
- With this method, it is hard to know how much cash you have in hand. This happens since the transactions are not recorded in real-time and are based on projections. The startups may have to wait for the transactions to clear before they can spend it on expenditure.
- The accounting system requires complicated accounting, known as double-entry accounting. Only an expert accountant can perform it, and they will not come cheap. It can be a big problem for startups since they need to spend as little money as possible at first to sustain their business.
Usage of Accrual-based Accounting
On some occasions, this method of accounting may suit the startups:
- The startup is backed by huge funding and has the vision to grow.
- The startup also offers the customers to purchase goods or services on credit.
- The number of employees is high
- Larger and more frequent transactions daily for the firm.
Choosing one of the methods among these two can prove to be a difficult task. However, a startup should match their requirements with the characteristics each method offers to decide easily. While both methods offer plenty of advantages in their own way, a startup should only focus on practicality when choosing.
By comparison, it is evident that the accrual method is better for big startups that have a vision for growth. Meanwhile, cash-based accounting is for those with a lower budget and is striving for survival in the market.