Many founders are surprised at the total cost of accounting and tax preparation.
While there are a lot of reasons, the biggest cost contributors are related to two things:
For both of the situations mentioned above, preparing accrual financial statements and sharing metrics that investors will trust requires significant additional effort from accounting personnel.
So what goes into preparing financial statements and metrics for a company?
There is also an underestimated hidden cost: the time and effort required for a founder or business operations leader to coordinate and compile all the necessary information if there are shortcomings in the information included in the software.
The biggest contributor to how many hours it takes is the complexity of the business and the decision to prepare cash vs. accrual financial statements. A cash accounting basis recognizes money when it is received, while accrual accounting recognizes revenue when it is earned. Since it is expensive to go back and prepare accruals later, startups that plan to generate meaningful revenue or raise capital from day one often choose to do accrual financials.
The bulk of bookkeeping hours relates to calculating the adjustments required to prepare accrual financials. As one example of the type of adjustments that are required, consider the accrual accounting process for revenue. For illustration, assume a customer pays you $1,200 upfront for an annual plan at a price of $100 per month. In accrual accounting, you can only recognize $100 of revenue per month for delivering the service. Initially, this would be considered “deferred revenue” (on the balance sheet), and each month you have to add $100 of revenue, and subtract $100 from the deferred revenue balance. Most companies track various accrual schedules in Excel because current SMB accounting software does not natively support accruals.
Fundamentally, the purpose of accounting is to answer two questions:
(1) are all of the transactions in the system (i.e. are financials complete)? Accounting systems and personnel accomplish this through a series of reviews and reconciliations.
(2) are all of the transactions categorized the right way (i.e. are financials accurate)? Accounting systems and personnel accomplish this through creating a robust chart of accounts (i.e. the relevant categories for accounting purposes) and making sure all the transactions are properly categorized and tagged.
Let’s look at a hypothetical but realistic scenario to illustrate how the considerations above translate into the total cost of accounting. A founder and four employees just raised a seed round. They are building a product and not yet generating revenue. They rent space at a WeWork and have some monthly expenses such as lunches and software. They use industry best practices for startups to select a business bank account such as Mercury or SVB, a payroll provider such as Gusto or Rippling, and a dedicated company card such as Brex or Ramp.
While this can vary, it typically takes about 5-10 hours per month once everything is set up to complete the bookkeeping process. At an hourly rate of $80 (which is low for some bookkeepers), that means about $400 to $800 per month for non-revenue generating, simple startups with no additional questions or support needed. You can see some pricing here for well known startup bookkeepers here and here.
So, if we assume a bookkeeping expense of $650 per month, that is $7,800 annually plus an estimated $2,000 for simple federal tax preparation (don’t forget state or local taxes and filings), for a total of about $10,000 per year. The cost can get even higher as you prepare aging reports for accounts payable, accounts receivable (typical fee of $125-$170/hr), revenue recognition (typical fee of $150-$200/hr), and financial modeling (typical fee of $400/hr). In our next post, we’ll look at ways to minimize the cost of accounting while still remaining compliant.