The core components of accounting systems for climate startups

Climate tech companies have a razor-thin margin for error when it comes to accounting. But with a complex capital stack, you could be juggling grant reporting with investor diligence and compliance with government contracts. Keeping on top of these demands means you can’t treat accounting as an afterthought – you’ll need to set up an infallible foundation from day one. 

To learn more about the fundamentals of accounting for climate startups, we sat down with our own Abdul Hannan, who leads accounting operations for multiple climate and sustainability-focused ventures and helps founders establish DCAA-compliant, audit-ready systems from day one.

Why these fundamentals matter

The risks of letting accounting slip

Climate startups often rely on complex funding streams that span grants, equity, debt, tax credits, and carbon markets. These diverse capital providers will each have unique and convoluted requirements, whether that’s justifying how you’ve spent every dollar of a federal grant, demonstrating your unit economics to an investor, or navigating the intricate rules around tax credits.

This is a lot to balance, and if you don’t have solid systems from the get-go, it’s all too easy to lose track of obligations, misreport financials, or fail to meet compliance standards like DCAA. The penalties, lost trust, and operational headaches that these mistakes can incur will significantly derail your growth. 

Accounting fundamentals set you up for growth

As well as preventing expensive and painful mistakes, a bulletproof accounting system will build your credibility with investors, auditors, and regulators. This is particularly true when you’re taking funds from public or mission-driven sources, where scrutiny can be intense. But if you can earn trust by showing you have a meticulous, reliable system, you’ll turn compliance into a competitive advantage.

Plus, a rigorous accounting system will give you true visibility into your burn, runway, and impact. These insights will inform critical decisions, from when it’s the right time to hire, to your path to scale. 

Six core fundamentals

1. Keeping compliant

Segmented accounting
Every source of capital comes with its own rulebook. Mix them up, and you risk violating loan agreements or losing your eligibility for tax credits. To avoid this possibility, separate your funding streams to ensure you don’t blur the lines and have clear oversight over each one.

For example, say you’re a battery manufacturing company with multiple funding sources. These will need to be tracked separately, using distinct charts of accounts, classes, or business units. This will allow you to clearly differentiate between grants for R&D, investor funds for operations, and loans for equipment, therefore ensuring compliance, transparency, and accurate financial reporting.

Grant reporting
If you’ve been awarded a grant, you’ll need to build detailed schedules that reconcile your grant draws with actual project spend, proving every dollar was spent for the right reasons. You’ll also need to provide a record showing how you’ve met all matching funds or co-funding requirements – or face brutal clawbacks.

To illustrate, let’s take a circular economy startup that uses detailed tracking to match each grant draw with actual project expenses, ensuring every dollar is spent as approved and reported accurately to the funding agency. This is done by setting up project-specific accounts or classes in the accounting system and linking each expense directly to the corresponding grant activity.

Donor/investor restrictions
As with grant reporting, you’ll need a system that tracks not only your own matching contributions, but also how funding is spent. You’ll also need systems that let you easily meet reporting deadlines and demonstrate your progress on the metrics your funders care about most.

For example, let’s say an impact investor funds a solar project with restrictions around the use of funds. The startup will therefore need to track this spending separately and provide progress reports that demonstrate funds are being used as intended. To achieve this, they’ll either use a dedicated bank account for the project or maintain separate bookkeeping within the accounting system.

2. R&D and tax credit tracking

You’ll need to systematically track your qualifying R&D spend to unlock tax credits. This includes clearly distinguishing between eligible and ineligible costs, as an overlooked expense in the wrong place could jeopardize your entire claim. 

For instance, an innovative materials company will need to record qualifying R&D costs like lab testing and researcher hours – apart from general expenses – under a separate heading on the Profit and Loss statement. As a result, they’ll produce accurate tax credit claims and audit-ready documentation.

3. Carbon credit accounting

If you’re monetizing your climate impact through carbon or other environmental credits, you’ll need watertight processes for recognizing, valuing, and reporting these revenue streams – or face serious compliance issues. To avoid getting ahead of yourself and misreporting revenue, ensure you align recognition with the terms laid out in your contract.

For instance, say a climate startup records revenue only when the credits they sell are verified and delivered. If credits are sold in advance, the proceeds will need to be recorded as deferred revenue (a liability) until the credits are verified and transferred to the buyer.

4. CapEx vs. OpEx discipline

A lot of climate hardware startups fall into the trap of misclassifying pilot and demo costs. Getting this right is crucial for understanding depreciation timelines, ensuring your eligibility for grant reimbursement, and cementing your fundraising credibility.

Under US GAAP, the classification of costs as either capital expenditures (CapEx) or operating expenses (OpEx) is guided by whether the cost is for a long-term asset, or a short-term expense:

• Pilot equipment (CapEx): Costs associated with pilot equipment are capitalized if the equipment has an alternative future use beyond the specific project. These costs will then depreciate over the asset's useful life.
• Testing costs (OpEx): Costs incurred for testing can be expensed as long as you gained insights but not a tangible, reusable asset.

This approach keeps your financials clean and compliant, so you can meet grant reimbursement requirements with minimal stress. 

5. DCAA-compliant systems, where relevant

If you’re taking funds from DOE, NSF, or DoD, you’re not just accountable to the DCAA (Defense Contract Audit Agency), you’re also bound by FAR (Federal Acquisition Regulation). FAR governs cost allowability, disclosure requirements, and other small print you’ll need to follow to the letter. 

Keeping compliant means incorporating:

• Timekeeping: Daily, auditable timesheets that tie your teams’ hours to specific projects. 
• Cost allowability: Following FAR Part 31 rules around which costs can and can’t be billed (lobbying is not allowed, for example).
• Disclosure statements: If you hit certain thresholds, you’ll need to file a CASB (Cost Accounting Standards Board) disclosure statement detailing your accounting practices.
• Audit readiness: Your books and policies need to align with both FAR and DCAA requirements.
• Internal controls and documentation: Including establishing clear internal processes for spending approvals, and accounting policies for expense recognition, capitalization, and cost allocation.

If your startup is receiving federal funds, these steps will help you stay on the right side of federal cost principles, secure reimbursements, and be ready for anything an audit might throw at you.

6. Impact-linked financial reporting

In the climate space, the entities that fund you will often be looking for more than just financial return. This means your accounting will need to go beyond the numbers and pair financial outcomes with climate or impact-related KPIs, such as GHGs reduced, waste diverted, or acres restored.

Don't wait

Laying down this groundwork early on will both save you from future fires and free you up to focus on what really matters: scaling your solution and tackling climate challenges. Plus, the more you prepare your business with dependable, airtight accounting systems, the easier it will be to convince funders and regulators that your startup is here for the long run.