This article is third in a series of pieces centered around the necessities of a company’s accounting (and finance) based on its stage of development.
Many companies either over- or under-invest in their accounting operations, but there are a few that do it purposefully to attain the “just right” effect.
For purposes of this article, I’m defining a late-stage private company as a company that is fully operational, fully capitalized and aiming for an exit. This can happen through either purchase or going public. By this point in time, the company should have revenue, a customer base and ideally be profitable, or close to it. Late-stage private companies’ reporting, analytics and accounting operational needs are drastically different and more complex than earlier stage companies’—even those with institutional investors.
Unlike earlier stage and Series A companies, late-stage companies should have their cash flow needs already met. The companies are usually profitable, or close enough to it that daily cost isn’t as much of a focus. Furthermore, clean, auditable financials are assumed at this stage.
Instead, analysis takes the front seat. Budgets, forecasts, business scenarios and profitability analyses are where most of the finance and accounting attention is spent. You need to set up the process and data infrastructure to support these new functions and a team that is focused on the business, not just their tasks.
The accounting practices and operations become more serious and important as a company grows. At a minimum, you must be GAAP (generally accepted accounting principles) compliant. You must also be operationally efficient and timely in your financial statements, and you must possess robust analytics.
Being GAAP compliant is mandatory. Odds are, you are being audited, or are about to be, so not only must you be GAAP compliant, but you also need to be “audit ready.” This means you need to be able to explain the financial statements, why the numbers are what they are and quickly provide the supporting information for any number or journal entry. You must be able to provide the income statement, all of the balances on the balance sheet, information regarding shareholders’ equity and the statement of cash flows. You will have to state the rationale for your accounting practices (e.g., accounting memos). These memos could cover revenue recognition, capitalization, stock compensation and depreciation.
Supporting GAAP compliance requires upgrading to your accounting operations. While you can spend a significant amount of time and resources becoming and remaining GAAP compliant, the following items are the most important:
• Revenue recognition: This is especially important if you have a subscription service or a combination of hardware and software.
• Expense matching: This often involves matching the expense to the revenue it generated (e.g., cost of goods sold and commissions).
• Capitalization and depreciation schedules: This involves tracking each asset, its purchase price and its depreciation, as well as a justification for the depreciation and useful life (normally written in a memo). For software capitalization, you need to have a clear justification for everything capitalized along with the backup data since it will be audited.
• Equity capitalization table management: This ensures you have a clean record of who owns how many shares of the company, including all securities that can turn into equity (e.g., options, convertible debt, warrants, SAFE notes).
As you grow in size, you will need to deploy fintech to manage these processes automatically. For instance, a robust general ledger should have your revenue recognition rules (including the revenue waterfall schedules) automatically programmed. Manual processes will make audits longer and more work intensive, impeding your data analysis.
This now becomes the main focus of the finance team. Financial and operating metrics must be accurate, relevant and timely, and so must its analysis. This requires extensive processes, infrastructure and technical support. The finance and accounting team will need technology resources to manage its own tech stack and data. This will create its own host of problems since most technology resources are generally focused on product support because it directly supports revenue.
If the finance team cannot get the dedicated and timely IT support it requires, it may have to hire technology resources into its own team. That comes with another set of problems (mainly excess expenses and political turf wars with IT).
At a minimum, you’ll need a full-stack accounting team, including a controller. You’ll also need a financial planning and analysis team with a good sense of how to interact with and extract insights from data.
Rounding out the team is the head of finance, normally a CFO. The size and experience level of each of these teams depends on the complexity and amount of work. The skill set of the team will shift from being scrappy and willing to learn on the job, to one of industry expertise, process management and strategic thinking.
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.
