But, as a Y Combinator funded company and referral partner, we’ve noticed a pattern: promising startups regularly fail because of poor financial management. 

In this article, we’ll explore the essentials of tech startup accounting, including best practices, common mistakes, and the accounting software we think will make your life easier. 

The Importance of Accounting for Tech Startups

Accounting is about more than compliance. Startups that hope to attract venture capital need to be able to provide high-level financial statements to investors. Not only does it speed up their due diligence, but founders who practice good financial hygiene are better equipped to make informed decisions, manage cash flow, and demonstrate the discipline that builds confidence among investors. 

Good accounting also helps avoid costly mistakes: misfiled taxes, underreported equity, or mismanaged cash flow can snowball into major problems.

Important: Startup funding deals fall apart all the time because of this oversight. Don’t make this mistake.
When distributing equity, file an 83(b) election.  Doing so informs the IRS you’d like to be taxed on the date the equity is granted rather than when it vests. 

What’s Unique About Tech Startup Accounting?

Conventional companies and startups are different enough, but tech startups come with an added layer of complexity that’s important to consider. Let’s explore what makes tech startup accounting unique. 

Revenue Recognition Timing: Cash vs. Accrual

This is one of the more common reasons startups come to us for help.  If you run a SaaS business model, revenue recognition is trickier than just recording money when it lands in your account. Since customers often pay upfront for long-term subscriptions, you need to defer revenue across the length of the service. 

The key is the difference between cash and accrual accounting. 

You’re already familiar with cash accounting; it’s how people manage household budgets, where transactions count when money physically changes hands. Accrual accounting is a bit trickier. This method recognizes revenue and expenses at the time the service is provided, irrespective of when money changes hands. 

Accrual accounting is better suited for tech startups. It requires more sophisticated accounting but is more accurate and, if applied strategically, can even save a company money on taxes. 

How to Value Intellectual Property?

Intellectual property is often the crown jewel of a tech startup. Whether it’s software, a proprietary algorithm, or a patent, your IP might be a key driver of investor valuation. But accounting for IP isn’t as simple as listing it as an asset.

There are multiple valuation methods to consider, and you’ll need to decide whether the costs associated with development should be capitalized (spread over time) or expensed immediately. Each approach has tradeoffs, but regardless, there are also regulatory requirements to be wary of when listing IP as an asset. 

This guide will walk you through the essential steps to develop a budget that supports growth and helps make a strong business case for prospective investors.

Budgeting Benefits

Whether you’re pre-seed or have raised a Series-A funding round, budgets are crucial. They help allocate resources, predict cash flow, and attract investors by demonstrating effective planning. 

For example, once you’re in the revenue stage and working toward profitability, your budget is a navigation tool. Comparing prior budgets against present spending and revenue clarifies investments that are paying off and where cuts need to be made.

Other benefits include:

• Estimating break-even points and cash runway.
• Predicting surpluses, allowing you time to plan investments in advance.
• Generating financial statements, balance sheets, and income statements to share with investors and lenders.
• Improving expense management and cost control.
• Simplifying tax preparation and compliance.

Budgeting Strategies for Startups

Financial planning is undoubtedly math-heavy, but there’s an element of creativity as well. Budgeting should be approached based on your startup’s unique circumstances and goals. After all, pre-revenue, growth stage, and mature startups operate completely differently, as should their budgeting process. 

Here are a handful of approaches startups commonly employ:

Historical budgeting uses past data as a baseline for the future. Brand new startups don’t have the luxury of historical budgeting, but those that have been in operation for some time can make reasonable estimates based on recent experience. 

Zero-based budgeting involves rebuilding the budget from scratch for each new period; expenses are analyzed and justified on a case-by-case basis. The approach takes more time than using historical budgeting, but can also prove more economical. 

Rolling budgets are updated monthly or quarterly, rather than annually. Regular adjustments are ideal for startups in unpredictable markets or going through rapid change.

Percent of revenue budgeting allocates funds based on fixed proportions of projected revenue. This method may seem attractive, as it allows new founders to use industry norms to benchmark their investments. However, budgeting using fixed percentages rather than realistic needs assessments is potentially unproductive. 

Project-based budgeting allots money on a case-by-case basis, allowing you to precisely allocate resources according to the specific needs and returns of a project.

Scenario-based budgeting plans for scenarios ranging from conservative to optimistic.  By forcing you to decide in advance where you would place scarce or surplus funds, you can react more rapidly to an evolving business environment. 

Step by Step: Creating an Effective Startup Budget

You don’t have to track every penny or make perfectly accurate estimates to have a useful budget. It’s normal to forecast revenues and expenses based on well-informed assumptions. 

The key is to approach your assumptions and projections cautiously; it’s wise to underestimate revenue and overestimate expenses rather than the other way around.

Step 1: Gather Your Tools and Decide on a System

Depending on your circumstances, you may start with anything from a simple spreadsheet to DIY payroll software or indinero outsourced accounting services. 

Regardless of your decision, budgeting isn’t a one-time activity; it’s a dynamic process that should be revisited regularly. You never want to be in a position where you’re digging through emails for receipts and invoices; designing a systematic process for tracking cash flow is key to budget hygiene. 

At minimum, your budgeting system should avoid commingling personal and business funds. Additionally, it should centralize record-keeping so that you’re never scrambling for information and include regular bank reconciliations, expense, and revenue reviews. 

Step 2: Identify Initial Startup Costs

These investments must be made before officially launching, covering everything from registering an LLC to purchasing equipment, office space, and vehicles. 

When planning, don’t group expenses into vague categories like “website costs” or “marketing.” Instead, break each down into component parts. The more detailed you are, the better you can estimate costs, identify where to cut, and avoid surprises. 

Or perhaps you’re building an MVP and scrapping for revenue. Your idea has potential, but you have to diligently manage resources until you can raise seed funding.

Regardless of where you are in your journey, cash flow management for your startup will be crucial. In this article, we’ll cover the fundamentals, the single most important KPI you can track, and how cash flow differs from funding stage to funding stage.

Fundamental Financial Hygiene 

Startup founders are often visionaries who like to move fast and break things, not accounting majors with a penchant for the nitty gritty. But when it’s time to develop a budget for your startup or present progress to investors, you’ll need two foundational pieces:

• A bulletproof bookkeeping system
• A three-statement financial model 

Collectively, the income statement, balance sheet, and cash flow statement show your revenue, expenses, debt, equity, and cash flow over time. This three-statement model is your bird’s eye view of startup finances. Keeping track of where money goes from day to day – bookkeeping – is the basis of a three-statement model. You can’t have one without the other.  

Clean books reflect well to investors, allow you to make informed strategic decisions, and optimize your accounts payable and accounts receivable systems. Building a system to track this information will pay dividends in the future. 

The Startup Cash Flow Statement

On balance, what does a good startup cash flow statement look like? 

When accountants build cash flow statements, they break them into three sections:

• Operational: Funds from core business activities, such as sales, marketing, and overhead.
• Investing: Expenses that will pay dividends over the long term.
• Financing: Capital coming into the company from either equity or loans. 

If you’ve raised a Series A, you’ll be flush with cash from financing and have plenty of money to invest. You’re in a growth stage, so while profitability is important in the long term, your investors will be more concerned with bottom-line revenue figures. What remains is balancing operational and investing flows.

On an ideal cash flow statement, operational flows are net neutral, and you’re aggressively investing. In other words, if you stopped making long-term investments today, your short-term costs and revenues would break even, and the company would be indefinitely sustainable. 

Aiming for operational neutrality is a solid benchmark but not a one-size-fits-all approach. Startups make tradeoffs between growth and profitability all the time, where short-term losses and high burn rates are acceptable while acquiring market share. Some industries, such as manufacturing, are capital-intensive. They’ll need longer timelines before they’re net neutral. 

Seed Stage Cash Flow Management

Your current priorities should be building an MVP, testing your revenue model, and achieving product-market fit. Funds come from friends and family, personal savings, or if you’re lucky, an angel investor. Cash flow from revenue will be inconsistent or nonexistent, so the goal is to stretch every dollar you have while building a compelling business case.

You should regularly monitor your burn rate and financial runway. Focus on optimizing expenses and reducing unnecessary costs.  If you need specialized expertise, it can be more cost-effective to hire a freelancer than a full-time employee.

Where to Invest After a Series A?

Finding quality talent will be one of your biggest challenges and most important investments. Tech and SaaS companies dominate the startup industry; without quality engineers, they’d never succeed. Beyond startups, the largest expense for nearly every company is payroll. Investing in people is key. 

Luckily, startups are uniquely positioned to incentivize prospective employees. Between equity compensation and the promise of working on innovative projects that can impact the world, many young top-tier candidates are attracted to the industry. 

After investing in employees, startup wisdom often diverges into two camps: improve your product or spend more on sales and marketing.

Balancing Operational Expenses and Revenues

The number of data points you could track is overwhelming, but not all KPIs are created equal. If you’re short on time, there’s just one ratio to watch: customer acquisition cost (CAC) vs lifetime customer value (CLTV).  

Nearly every critical piece of information for a startup eventually funnels here. Conventionally, a 3:1 ratio is considered a healthy CLTV to CAC ratio, and mismatches signal both inefficiencies and opportunities. If the ratio is too low, you spend more money acquiring customers than they’re worth. If the ratio is high, it means you have an opportunity to scale while remaining profitable.