This article is going to kick off a series of pieces centered around what is and isn’t necessary for a company’s accounting (and finance) based on its stage. I see a lot of companies either over- or under-invest in their accounting operation, but few who do it purposefully to attain the ‘Goldilocks’ or ‘just right’ effect.
Early-stage companies usually fall into two categories, the first being a hypothesis — meaning, a test of an idea. Does the idea that someone has been mulling over in their head have legs? Is there a market need? Can it be monetized? Testing a market hypothesis and acting accordingly is a great way to minimize financial risk and focus efforts on the market need and potential profitability of an idea.
The other early-stage company is a classic bootstrapped company. Maybe a single-shingle business someone created to serve as their source of income. A “solopreneur” so to speak. Both of these cases have very similar financial and accounting needs, so I’m lumping them together.
For early-stage companies, the key financial and accounting issues are all focused on cash flow. Knowing how much cash you have on hand to pay bills, your burn rate (how much you spend per month over what you take in) and your run rate (when you will run out of money based on your burn rate and current cash balance) are the most critical to your company’s success. All other considerations, while maybe important, are not existential at this stage.
Yes, profitability is important. But at this stage, if you are a solopreneur, you are trying to make a go of your own business. You need to first focus on how long you have until you run out of money and how quickly you can get to cash-flow positive since this is your livelihood. For a hypothesis, your main focus is whether or not you are addressing a market need with a viable service or product. Odds are you are spending money and may not even be selling anything, so profitability isn’t even in the picture. This will change in the next stage of the company, but you first have to survive the beginning stage.
Any practice that helps you preserve or maximize positive cash flow is good. All other practices are secondary. What does that mean for GAAP? The CPA in me would want you to be GAAP compliant, regardless of the stage of the company. However, GAAP is ultimately intended to “ensure a company’s financial statements are complete, consistent, and comparable” for an investor. If you are a solopreneur, you are the investor. The books and records need to be of such to help you. Same with a hypothesis test.
This doesn’t mean I completely support cash base accounting for early-stage companies. I think there are some very good GAAP principles that can be helpful to an early-stage company. My focus on accounting is first and foremost, usefulness. If an accounting practice isn’t useful to management and investors, then less emphasis and effort should be applied.
While revenue timing may be overkill in an early-stage company, revenue accruing is very important. From a logistics perspective, if you record accounts receivable (AR), you then have a record and a report of what is owed to you. It is easy to lose track when you are a solopreneur with a ton of distractions. Having and then managing an AR schedule lets you know who owes you what and for how long. It lets you decide if you want to do any future work for someone who hasn’t paid you in a long time. It also is a great reminder when you need to ping someone to pay you.
I’m less concerned with expense matching at this stage and more concerned with keeping track of what is owed. A good AP schedule lets you know who and what you owe them. How you manage your AP is up to you. But it is very hard to monitor cash flow and predict your runway without recording your AP.
At this stage, you really only need a diligent bookkeeper. You don’t need a complex financial forecast or profitability analysis, just someone to record your transactions and reconcile your bank statement.
As you grow, your finance and accounting needs will grow. But for now, your money, time and concentration would be better spent proving out the viability of your company than on robust financial reporting.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
This article was first published on Forbes Finance Council.
