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​In Pursuit of Profit

Read our expert article below or sign up to get articles sent to your inbox.​

1/12/2020

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Unique Accounting Services Requirements for Startups

 
Unique Accounting Services  Requirements for Startups
Upon creation startups have numerous hurdles to overcome, including accounting for their unique financial situations.  
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Unlike more established companies, startups do not yet have substantial cash flow reserves to fund business purchases. An accountant can ensure that tax planning, forecasting, budgeting, and spending are all approached with an eye on generating and retaining cash as effectively as possible.  
Startups will likely also have more difficulty determining a fair market value to grant equity in the business to investors and make attractive offer packages for new hires. These more complicated payment arrangements require the expertise of an accountant to ensure all federal regulations are being met to keep the business in good standing.

Furthermore, startups that have not yet determined how they will recognize revenue in a way that works with their business model will find enlisting the help of a professional accountant especially valuable. Service providers, in particular, should utilize a third-party accountant to oversee their contracts in order to find an advantageous revenue recognition model.
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Success for startups is contingent upon being aware of these kinds of unique accounting considerations and actively managing them on a day-to-day basis.

Cash Flow Management

Cash is the lifeblood of any startup. Without cash a startup will fail no matter how sound the concept, which is why accounting functions should ruthlessly prioritize cash flow management. Tax planning should be geared towards retaining as much cash as possible right away to give the startup the funds it needs to invest in employees, equipment, technology, raw goods, marketing, and everything else needed to get the business of the ground. Additionally, an accountant should ensure that forecasting, budgeting, and spending are working together to keep cash in the business for as long as possible. 
Conservative Forecasting
Be realistic with financial forecasting by taking a conservative approach to estimating unknowns like materials costs and revenue projections. For ultimate flexibility, create multiple forecasts depending on various market scenarios and use these to guide budgeting efforts.

Create a Budget
Develop a company-wide budget and measure spending against it frequently. As the company grows, departmental budgets can be used to guide individual aspects like marketing expenses. Do not forget to list an owner salary in the overall budget. While this can be a very modest sum at first, it should be included nonetheless so that as revenue and profitability increase, owner investment can expand appropriately. This allows for timely and fair compensation as well as more predictable cash flow throughout the growth cycle of the business.

Track Spending
Rely on accounting software to accurately track expenses by automatically adding, logging, and categorizing receipts. Be meticulous about tracking spending and require the same standard for every employee to avoid budget waste and reduce the risk of fraud.
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Limit Expenses
Defer fixed expenses for as long as possible to avoid large cash outflows. Search for budget-friendly alternatives to planned expenses like renting equipment and property instead of buying. 
Equity Calculation

Startups are prone to giving equity to owners, partners, and investors to get the business off the ground. However, granting equity has significant tax implications, so entrepreneurs should consult with an accountant to understand these elements before issuing equity. Working with a professional can help business owners to follow the most advantageous path to granting equity, as well as meet all applicable requirements while doing so. 
Fair Market Value
Equity cannot be granted without an accurate fair market value (FMV) calculation. For more established companies, past and current financial statements serve as a basis for the FMV. However, startups do not have this same sort of historical information to use as a basis, complicating this vital step in issuing equity. However, estimating FMV is not an option.  An inaccurate FMV can result in additional tax payments being owed as well as IRS penalties. Subsequently, a third-party valuation is strongly recommended for startups.  
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Stock Options
All businesses must expense stock options at their fair market value (FMV). The expense is then recognized over the period when stock options are vesting. This is not difficult for publicly traded companies, but this is much trickier for private companies, especially startups. Again, the FMV calculation is integral for equity-based decisions. Working with a professional accountant will ensure that stock options are accounted for correctly on financial records and reports, keeping the business in compliance with governing regulations. 
Hiring Employees
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Startups often rely on creative compensation tactics like granting stock, warrants, and convertible debt to attract top talent into key business roles. Additional compensation tactics allow startups to compete with larger, more established competitors. 
Stock
Before stock can be granted, an IRS-compliant valuation methodology must be used to determine valuation. A financial professional can spearhead this process to ensure the business is following applicable industry guidelines and best practices.

Unlike stock options, stock is not an employee benefit or perk. Stock is used as part of the compensation package for an employee, and as such must be recorded as an expense and reported to the IRS as taxable income. Stock can also have stated restrictions. For instance, stock may only vest over a set period (like while the employee stays with the company) or vest once certain conditions are met (like once the company becomes profitable).
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Warrants
Startups may also grant warrants, which give employees the opportunity to buy stock at a set price. Like stock, they must be valued at the FMV and are expensed by the business over time.
Recognizing Revenue

All companies hope to recognize revenue as quickly as possible, but this is vital for startups that are looking to secure funding or bring on investors because it makes the business look less risky. However, startups tend to get tripped up by revenue recognition more frequently than established businesses because they are more likely to engage in creative business deals to bring in early revenue. Creative sales strategies may include product discounts, longer payment terms, or increased support offerings.
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For revenue to be recognized it must be earned and then realized. Typically, this means there is an agreed upon contract with fixed pricing, all obligations related to the sale have been fulfilled, and the ability to collect payment is reasonably likely. However, post-contract support and digital delivery can complicate accurate revenue recognition. 
Contracts and Support
Because contracts can vary so significantly from one company to another and even from one customer to another, revenue recognition must be considered when putting the contract together. Before the contract is ever presented to the customer, the business must know how it will recognize the revenue from the sale. A professional accountant should oversee all contracts (especially large deals) to advise on pricing structures and payment terms to aid in efficient revenue recognition.
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A contract that includes post-contract support like premier help desk access must include a set value for each service component to aid in accurate revenue recognition. At this stage multi element accounting is necessary to determine the value of individual offering components. This post-contract support must have its FMV recognized over the entire duration of the support. In some cases, all or part of revenue recognition may need to be deferred until these supporting service obligations are fulfilled.

Delivery of Goods
Proof of delivery is needed to recognize revenue, which is why keeping detailed records of tracking information on shipments is so crucial. However, proof of delivery for nontangible goods is less straightforward. For these types of items, a download, access of a digital good, or start of a subscription service is considered delivery of that offering. 
Due Diligence

Startups that are seeking funding, looking to go public, or are the potential target of an acquisition or merger will have due diligence done on them. An experienced accountant can keep balance sheets, cash flow statements, P&L statements, and statements of shareholders’ equity in order to prepare for close inspection from potential investors. If additional information is requested during this process, an accountant can procure these items as well as help negotiate terms of a potential deal.
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Whether you are in in the beginning stages of planning or well into a startup project, take a moment to contact Eric or Todd. The ASP team is very enthusiastic about supporting startups and understand the excitement of possibilities while staying practical with the accounting practices.
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