#003: Startup Accounting Mistakes That Kill

In late 2023, Macy’s discovered that one of its employees had hidden $154 million in expenses from its financial records. This oversight delayed the company’s Q3 earnings report and raised serious concerns among investors. The news spread like wildfire and shook Macy’s trust in the eyes of investors. Investment firms weren’t confident about Macy’s handling their finances correctly. Being a mammoth of a brand, Macy’s was able to recover from this news in a couple of months.

While Macy’s had the resources to recover, startups might not be so fortunate. For founders, a single accounting mistake – deliberate or accidental, can be the difference between scaling successfully or shutting down for good. Imagine your startup losing credibility with investors or burning through cash because of unaccounted expenses.

Accounting errors don’t just happen in billion-dollar companies. They happen in startups too, often because the right systems and processes aren’t in place. And when they do happen, the consequences can be catastrophic.

Below, you will find the top 10 accounting mistakes that startups make and how to avoid them. 

1. Miscalculating burn rate and runway

If you’re a founder, you must know how to track burn rate and runway like the back of your hand. That’s because tracking both of these metrics helps you know how much money and time you’re left with to invest in your startup’s growth, raise more money, or reach breakeven. Miscalculating any of the two can lead to a cash crunch, forcing you to downsize your team and put a stop to your startup’s growth. In fact, cash management is one of the top killers of startups. 

When it comes to burn rate, founders often rely just on how much cash they burned in the last 1 month, which might lead to inaccuracies in calculating your burn. Instead, what you should do is – analyze the average burn rate from the last 3 months. You can also create a detailed cash flow forecast to analyze fluctuations in expenses to get a more reliable picture.

With runway, one big mistake startup founders make is confusing runway calculations with cash flow forecasting. 

Runway is your cash balance over your average monthly burn rate. Cash flow forecasting, however, includes expected inflows like open invoices or new investments, offering a more dynamic view of your financials. While forecasts can complement runway analyses, you should never include cash that hasn’t yet hit your bank account in runway calculations.

For example, a startup founder might estimate a runway (say for 8 months) based on expected receivables and an anticipated $1 million investment. When in reality, the company had only $100,000 in cash and a $100,000 per month burn rate, leaving it with just 1 month of runway.

Another oversight is failing to account for rising costs as your startup scales. Salaries, operational expenses, and marketing budgets often grow over time, shrinking the runway faster than anticipated.

To prevent such problems:

• Track the startup’s burn rate monthly to monitor how quickly you’re using cash.
• Forecast expenses realistically; account for fixed costs, variable expenses, and potential unexpected outflows.
• Review spending patterns regularly to spot and eliminate unnecessary costs.

2. Failing to separate personal and business finances

Processing all your business transactions from your personal bank account might seem harmless at the beginning. However, it’s a nightmare as your startup starts to grow. 

When you combine personal and business finances, you will have a hard time tracking expenses and creating accurate financial reports for your business. This is a big red flag for investors. Financial reports are what they analyze to decide if your startup is investment-worthy. Imagine what impression you might have on investors when your business transactions read like – spent $1,000 in a Nike store or sent David $250 for a weekend getaway.

Not separating your personal and business finances doesn’t just affect funding. It also makes it harder for you to identify deductible expenses. This can cost you money or lead to compliance issues during tax season.

The solution to this problem is to open a dedicated business bank account from the day you get your company registered. Whenever you want to spend or receive money that’s startup-related, use your business credit card only. Stay away from using your business credit card for personal transactions; this is a small mistake that can cost you both professionally and personally.

When you get approval from the bank to own a business credit card, you agree to the terms and conditions that come with it. Most business credit card providers have a condition that you must agree on – you’re not allowed to use the credit card for personal expenses. If you break this rule, it might lead to cancellation of your business credit card.

Here’s an example of the terms and conditions for The Business Platinum Card from American Express:

“By submitting this application, you are representing that all card(s) issued on the account will only be used for commercial or business purposes.”

But what’s more concerning when you make this mistake is – if your business structure is such that it doesn't provide a clear separation between personal and business liabilities (like sole proprietorship or LLC), mixing your personal and business finance could make you personally liable for any business debt.

Lastly, if you think using business credit cards for personal purchases might help you build your consumer credit score, you’re wrong. That’s because most business credit cards only report to business credit bureaus. Any gains you make on your business credit score likely won’t transfer to your consumer credit score.

3. Neglecting to reconcile bank and credit card statements

Reconciliation is an accounting procedure where you compare the ending balance and date on your bank or credit card statement with the corresponding balance in your accounting software to ensure they match. If discrepancies arise, you identify and address any missing or incorrect transactions, ensuring your financial records are accurate and aligned with the actual account activity. Not doing regular reconciliation might lead to a mismatch between the transactions you record and the actual bank statement, affecting financial reports.

Clean financials are a no-brainer for startups trying to raise capital. Because it’s the first thing that a venture capitalist will look at to get an idea of your burn rate, runway, and growth potential. 

Not reconciling your accounts regularly can lead to unresolved discrepancies, like integration errors, banking mistakes, or missed transactions. If left unchecked, these issues can accumulate, making it far more difficult to reconcile and fix discrepancies later, especially if you do reconciliation once per year instead of once per month. 

To handle this problem, set up a monthly reconciliation schedule or get a founder-friendly accounting software that automates reconciliations.

4. Using cash basis instead of accrual basis accounting

Picture a scenario where your startup provides consulting services. In December, you complete a project for a client and send them an invoice for $7,000. The client pays the invoice in January of the following year.

For cash-based accounting, you record the $7,000 as income in January when the payment is received. However, when you leverage accrual basis accounting, you record the $7,000 as income in December, when the service was provided, even though the payment isn’t received until January.

Accrual accounting provides a more accurate financial picture that lets you track financial performance accurately. It also lets you track cash flow by generating a cash flow statement, which shows the inflows and outflows of cash in a given period separately from your revenue and expenses.

Startups often start with cash-based accounting and switch to accrual later, which isn’t wrong, but the switching process is time-consuming and cumbersome. To make the switch, you must re-categorize transactions, adjust records, and adapt to a new system—all while running your startup.

The best way to tackle this accounting mistake is to start with accrual accounting from day one or switch to accrual as early in your startup journey as possible.

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5. Missing tax payment deadlines

You might think missing tax payment deadlines is a small mistake. But hear me out:

The IRS reports a voluntary taxpayer compliance rate of ~83.6%, which means 16.4% of taxpayers either miss deadlines or pay their taxes late.

Here’s another interesting statistic: In 2022, the IRS estimated a tax gap of $696 billion, with $606 billion in unpaid taxes that were not collected. Tax gap is the difference between the total taxes owed to the government and the taxes actually paid on time.

Missing tax deadlines doesn’t just place you in the tax gap bracket; it leads to penalties, enforcement actions, and interest charges that drain your cash reserves and disrupts your startup’s financial health. Falling behind on taxes can also signal poor financial management, increasing your risk of audits and reputational damage.

Here’s a breakdown of how the late fees structure built by IRA works:

Delay in payment

Penalties

Late return filing

Penalty of 5% of the unpaid tax each month or part of the month that the balance remains unpaid

When you file tax return 60 days after the due date

A penalty of 100% tax required to be paid or $ 485, whichever is less. Also an interest of 3% on your balance.

If you fail to file tax return 5 months after the due date

A penalty of 25% of the unpaid tax which continues to accrue (0.5% each month)

Staying compliant with tax deadlines isn’t optional, it’s essential for protecting your startup’s momentum, avoiding costly penalties, and maintaining credibility with stakeholders.

To avoid missing tax payments, set proper reminders. If you’re not confident with doing the due diligence yourself, it's advisable to hire an accountant or look for a software that doesn’t tax payments for you.

6. Improper depreciation and amortization of assets

Depreciation is the gradual decrease in the value of a physical asset (like equipment or a machine) over time. Amortization is the practice of spreading an intangible asset’s cost (like a patent or software license) over that asset’s useful life. To understand your startup finances, you must know what both these terms mean.

Calculating depreciation and amortization for different company assets isn’t everyone’s cup of tea. Overestimate asset value and you might inflate your startup’s profit, underestimate it and you will find yourself paying for unexpected expenses down the road.

Some companies might purposely avoid depreciation costs to inflate their net income so they sound more profitable on paper than they actually are. One popular example of such a scandal is the 1998 Waste Management Inc. scandal.

Waste Management Inc., a leading waste disposal company in the US, was found to have overstated its earnings by $1.7 billion. The company did so by improperly increasing the depreciation time for their property, plant, and equipment on their balance sheet, which minimized depreciation expenses yearly on paper and inflated their profits.

When the Securities and Exchange Commission (SEC) looked into the matter and found the malpractice, they fined Waste Management Inc.’s auditor – Arthur Andersen, over $7 million for their role in this fraud.

To prevent improper depreciation and amortization:

• Classify assets correctly as tangible or intangible.
• Apply proper depreciation schedules based on IRS guidelines.
• Review asset values annually to ensure accuracy.

7. Delaying bookkeeping tasks

Some startups delay bookkeeping until it’s time to file their first tax return. While this might seem like saving time, ‘catch-up’ bookkeeping is a painful, time-consuming process that often leads to errors. Trying to piece together months of transactions under time pressure leaves gaps, creates confusion, and risks non-compliance.

Beyond tax season, delayed bookkeeping prevents you from understanding your startup’s financial health in real-time. Without up-to-date records, you can’t track cash flow, monitor burn rate, or identify overspending. This lack of visibility makes it harder to make informed decisions and leads to financial surprises that catch you off guard.

To avoid being blind-sighted due to catch-up bookkeeping, use software like Firstbase Accounting that handles bookkeeping for you.

Firstbase Accounting simplifies bookkeeping with a blend of AI and human expertise, ensuring accurate financial records. The platform displays essential bookkeeping details like date, description, category, and transaction amount.

It also handles non-cash entries like depreciation or accrued expenses. You can submit documents of non-cash entries, and Firstbase will manage the journal entries for you. 

8. Misclassifying expenses

Misclassifying expenses happens when costs are recorded under the wrong category, like listing office supplies as equipment or personal expenses as business-related. This mistake often occurs due to a lack of accounting expertise or unclear expense categories in your chart of accounts. A Chart of Accounts (COA) is an organized list of all financial accounts used by your startup to record and categorize its financial transactions. You can use COA to organize finances and give investors and shareholders a clear view and understanding of your financial health. 

The category column you see below in the image is the chart of accounts.

For startups, misclassification can distort financial reports, making it hard to understand profitability and cash flow. It also complicates tax filing, as improperly categorized expenses may disqualify you from deductions or send a direct invitation for an audit. Over time, misclassified expenses create a ripple effect, leading to errors in budgets, forecasts, and investor reports.

Expense misclassification can be as simple as recording software subscription costs as capital rather than operating expenses. This inflates asset values while understating ongoing costs, skewing your financial metrics.

A simple way to prevent this mistake is to define clear categories of all expenses in your accounting software.

9. Incorrectly booking deferred wages as tax deductions

Deferred wages are salaries you promise to pay in the future but have not yet paid. A common mistake startups make is attempting to deduct these unpaid salaries on their tax return. However, the IRS only allows wage deductions for amounts that have been actually paid during the tax year, not those that have been deferred.

Improperly claiming deferred wages as a deduction can lead to penalties, interest on unpaid taxes, and audits. This mistake jeopardizes compliance and makes it harder to predict cash flow projections.

10. Forgetting to take advantage of eligible tax credits

Eligible tax credits reduce the amount of tax your startup has to pay, directly impacting your bottom line. These tax credits are offered at both federal and state levels. To claim them, startups must identify eligible expenses, classify them correctly, and file the necessary form with their tax return.

One of the most valuable credits for startups is the R&D tax credit, which rewards businesses for investing in research and development. In the R&D tax credit, you can claim expenses like employee salaries, supplies, and contractor costs related to innovation. 

However, classifying expenses as R&D requires proper amortization, which involves spreading domestic expenses over 5 years or foreign expenses over 15 years. Failure to follow these rules can result in penalties or disqualified claims.

Claiming R&D tax credits isn’t easy as you have to read complex tax regulations, understand eligibility criteria, and compile detailed documentation. But with Firstbase Tax, we take away this hassle and get things done for you in no time. To do so, we only charge 15% of the tax credit you successfully claim.

Most of the accounting mistakes we discussed above can be resolved if you use end-to-end accounting software that helps you automate accounting processes. 

Firstbase Accounting is a full-service solution that can help you with everything from tracking your cash flows to bookkeeping to reconciliation – all done for you. We have a team of reliable bookkeepers who take care of all your accounting needs so you can sit back and track your startup’s financial health. 

Firstbase is a 100% generally accepted accounting principle (GAAP) compliant bookkeeping service. GAAP is a set of accounting rules, standards, and procedures issued and frequently revised by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). The principles are set to ensure consistency, accuracy, and transparency in financial reporting across multiple industries in the United States.

Sign up for Firstbase Accounting now, integrate all your bank accounts, and avoid all the accounting mistakes you’re bound to make in your entrepreneurial journey.

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