Financial statements are vital to investors. But how do investors use financial statements? Before your meeting, learn what they want to see and why.
November 23, 2020
Every startup must have an effective bookkeeping and accounting system in place. After all, your books are the baseline financial record for your business, used to draw the financial insights necessary to make strategic decisions. Because of this your books need to be 100% accurate and, if you plan to raise capital, take out a loan, be acquired or IPO, you’ll need to follow GAAP accounting standards.
Generally Accepted Accounting Principles (GAAP) is a set of accounting rules, guidelines, and regulations to standardize business accounting methods across industries. The purpose of GAAP is to create transparency and consistency in financial reporting from one organization to the next.
All publicly traded and regulated companies are required by the United States Securities and Exchange Commission (SEC) to follow GAAP financial reporting standards. Because startups are private companies, GAAP compliance is not a requirement; however, if you’re looking to raise venture capital funding or take out a loan for your business, financial institutions will require your startup’s financial reports to be in GAAP.
The GAAP guidelines were developed by the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA), and are updated regularly.
You might be wondering, “If it’s not required, why should my startup prioritize GAAP accounting?” At Zeni, we believe following GAAP accounting principles has several benefits for your startup that go beyond future-proofing your financial infrastructure. Read on to learn how your business could benefit from adopting GAAP accounting principles, why some startups put it off, and how Zeni can update and keep your startup’s financials GAAP compliant.
Startups aren’t required to follow GAAP accounting principles, but the benefits of taking this approach from an early stage can bring great value to ambitious, fast-growing businesses.
Fundamental to GAAP, the accrual accounting method tracks money in terms of when it's earned or due (as opposed to the cash method which tracks money in terms of when it hits the bank).
This is a benefit for startups because it gives you a more accurate overview of your business’s financial health, allowing you to make strategic business decisions based on easily comparable financial accounting records.
Furthermore, the IRS requires any business earning $5 million a year in revenue to use accrual accounting. Since startups are (literally) built to scale, we find it best practice to use accrual accounting for your startup sooner rather than later to avoid costly and time-consuming restatement of your financials down the line.
Accrual based accounting through GAAP requires revenue to be recognized on a company’s Profit & Loss or Income Statement when it is realized or earned — which is not necessarily when payment is received.
The value of this approach is best illustrated with an example. Say you’re running a SaaS business and customers pay you upfront for 12-months of service. Your accountant will record the payment as deferred revenue upon receipt, and go on to apply portions of the payment over the course of 12 months as customers ‘consume’ your services.
This revenue recognition process paints a more realistic picture for how your business is earning revenue over a given time period, as compared to reporting large lump sums sporadically upon receipt. The latter does not give a business leader any perspective or insights on ongoing performance, which may lead to cash shortages and runway issues down the line.
A good financial model gives startups the data they need to make strategic decisions and convince potential investors to back their business. Forecasting and financial models leverage your business’s actual revenue and expenses to predict your future financial performance. When following GAAP your financial activity is recorded in a consistent and comparable manner, which lends itself to more accurate and reliable forecasting and financial modeling.
Investors, board members, bankers, and auditors will use GAAP as the benchmark to evaluate and compare your company’s finances. If you aren’t following GAAP standards, the fundraising, audit, and/or due diligence process will require additional time to restate your startup’s financials in order to evaluate your business finances against a common set of standards.
By maintaining your financials in accordance with GAAP, these important business processes will not take up any more time than necessary, meaning funding won’t be delayed or audits strung out across multiple months. Plus, once you’ve secured funding your VC will expect to receive GAAP financial statements (P&L or Income Statement, Balance Sheet and Cash Flow Statement) as part of your reporting requirements.
While following GAAP accounting makes a lot of sense for most startups, there are some perceived disadvantages of startup’s adopting GAAP principles.
GAAP compliance requires knowledge of the general and industry-specific rules and principles that apply to your business. This makes it much harder to manage without the help of a certified finance expert, requiring startups to hire an experienced accountant or finance firm rather than founders or business owners trying to do it themselves.
Maintaining GAAP standards in your ongoing bookkeeping and accounting requires more time and expertise from your accountant, which may result in more expensive monthly accounting fees if you’re paying your accounting partner by the hour.
*However, this is not always the case. At Zeni we charge our customers a flat monthly fee based on their monthly expenses to maintain GAAP compliant bookkeeping and accounting.
Whether you’re in the earliest stages of building your startup or preparing your business for future growth, having a solid, GAAP-compliant accounting system in place can help you grow and scale with grace.
Zeni is a full-service finance firm that provides bookkeeping, accounting, and CFO services for startups and small businesses. GAAP compliance comes standard for all Zeni customers, regardless of which Zeni Plan you’re subscribed to (plans start at $299/month).
Startups who work with Zeni get accurate, up-to-date GAAP compliant books, and a service that is 10 times faster than other startup accounting options thanks to Zeni’s AI-powered processes. The Zeni dashboard gives you 24/7 access to real-time financial data and key startup metrics, including your net burn, cash on hand, and cash zero date, so you can get the insights you need instantly and at no extra cost.
Many accountants and finance firms charge for services based on an hourly rate, which can end up being an expensive surprise each month. With Zeni, you’ll pay a set monthly fee based on the amount you spend to run your business, so it’s easier to budget for your bookkeeping and accounting costs, even as your business grows.