All software startups begin with an idea. This idea is nurtured into a business that solves a customer’s problems. Nurturing may include programming a product, seeking funding, and hiring the first employee. After the first paying customers, a tipping point is reached and suddenly the idea becomes a software startup. During this early phase of startup life, accounting and revenue recognition are mostly an afterthought. Most software startups use QuickBooks in the beginning due to its low cost. Although it appears to be cost effective, most software startups do not realize the future revenue recognition challenges with QuickBooks. To help software startups navigate these early waters, we review the accounting decisions within a startup while it progresses from $0 to $1 million in revenue.
Challenges of an early stage software startup
Accounting Decisions within a Startup
The First Customer – For a software startup, there is no greater feeling in the world then landing that first paying customer. A paying customer provides validation that the idea is relevant and that it will solves a customer’s problem. That first paying customer is also a wakeup call to the founders that they need to address the financial management needs of the business.
Usually in the early phase, the founders are also strapped for cash. Since they are following the lean startup methodology, they figure all they need in the beginning is a bookkeeper and simple desktop accounting software like QuickBooks. The decision is made to outsource the bookkeeping to a contractor and use QuickBooks to track the journal entries.
Continued Growth – Due to good management and strong demand, the startup continues to grow. By now, they have multiple customers and are nearing the $1 million in revenue mark. They were also able to pick up some additional capital in the form of an early stage investor.
Of course, with growth come challenges, especially within the accounting department. The bookkeeper has moved from part time to full time and the investor requires monthly GAAP compliant financial statements. The company continues to use QuickBooks but it starts to realize that the system is limited in what it is able to do.
By serving their customers, software startups go from $0 to $1M in revenue
Effects of Accounting Decisions on the Software Startup
Although QuickBooks appears to be a reasonable solution, the founders have actually underestimated the cost of QuickBooks. They believe that it is the cheapest solution because it only requires a small cash expense each month. What they failed to consider were the additional labor costs required to maintain the books due to the revenue recognition challenges with QuickBooks. Since QuickBooks is a bookkeeping software, it does not handle complex transactions like VSOE calculations or deferred revenue. All of this has to be tracked in a spreadsheet outside of QuickBooks. Instead of paying more for a better software solution, they are paying the bookkeeper more to track the revenue calculations in spreadsheets.
In addition, QuickBooks cannot easily produce GAAP compliant financial statements without significant adjustments or outside software. The additional costs of producing these statements are not reflected in the monthly price of QuickBooks but rather in additional time and expense costs within the accounting department.
Revenue Recognition challenges and costs with QuickBooks creates added complexity
Conclusion
For early stage software startups, QuickBooks is an attractive solution since it provides basic bookkeeping functionality. However, once growth starts to accelerate, startups begin to realize the revenue recognition challenges with QuickBooks. If you would like to learn more about other accounting software options, please contact us.
Tomorrow, we’ll talk about moving from $1 million to $10 million in revenue. [subscribe2]
