Just when you start to get a handle on all of the formal methods you need to implement to stay on top of your business accounting, we remind you of an even higher standard of accounting you will need to consider. In short, this is GAAP; Generally Accepted Accounting Principles, and it is the highest standard as it comes to accrual based financials. If you are already unsure of what accrual based accounting is, head on over to this article now, and get up to speed. We’ll wait. For those who are still with us, let's dive into what GAAP is, when you need it, and ways it can be implemented, should your business be better off with it.
What is GAAP?
As stated above, GAAP stands for Generally Accepted Accounting Principles - it refers to a common set of accounting principles, standards, and procedures and aims to standardize ways that financials are recorded and reported. These standards are set by the FASB (Financial Accounting Standards Board). We could lay out the ten official principles that the “P” in GAAP refers to, but a quick Google search will satisfy your curiosity, should you be interested.
Accountfully provides accrual based financials to its clients, which means we match revenues to expenses on a month over month basis to understand your business's profitability. This means we are not waiting on a check to clear to record it for that month, or allocate a year’s worth of insurance paid in January, to just that month. We take things into account like cost of goods sold, general administrative costs, marketing expenses, research and development, and match them to their associated revenue monthly. This is a much more cost efficient way to assess a company’s financial health and a better way to predict or analyze trends.
The alternative to accrual based accounting is cash based financials. This is the most basic form of accounting and similar to looking at your checking account statement online.
If these three methods of accounting are on a football field, cash based accounting is at the 20 yard line, accrual accounting is at the 75 yard line, and GAAP accounting is at the 100 yard line. This is because GAAP takes accrual based financials up a notch in the extra layers of policies and procedures required of your accounting team (or department) to adhere to.
Who Needs to Use GAAP?
The majority of Accountfully’s clients are in that 0-3 million dollar revenue range, so a rock solid accrual based method is perfectly acceptable, and the added expense of staying up to GAAP standard is not warranted in most cases. We implement solid systems, standards and procedures that can scale with the business and record things properly so that a business can take it up a notch to GAAP easily, if needed. To best assess if your business is better off using GAAP based accounting, it depends on a few (mostly) external and some internal factors:
- If you are planning to have discerning investors, they will want to see a higher standard to your books that can be easily translated according to an industry standard.
- Similar to the requirements of an investor, many banks will want to see a GAAP focused method to gauge the businesses profitability.
- If you plan on going public/ doing an IPO, you will need to use GAAP to follow more stringent compliance and audit rules or adhere to other government regulations.
- Government entities or non-profits that need to be transparent in their profitability and expense allocation will be best off using GAAP to stay within government regulations.
- If you are dealing with foreign entities or banks, their country may require using GAAP so financial statements are held to a similar standard to their country’s.
- If you are being audited under the GAAP standards, it makes it a lot easier to be reporting to the same standard.
- Internally, if you are in that smaller business range of 0-3 million dollars in yearly revenue, you may want to formalize the accrual accounting process and up your revenue recognition and expense accruing game for your business.
When to Move to GAAP
Based on some of the general reasons listed above, it may make sense for your company to move to a GAAP based method. The biggest challenges depend on how stringent you have been with your accounting up until such a point in time. Speaking of time, this is the biggest part of implementing a GAAP based accounting program into your business. It will take a significant amount of time to create new policies, procedures and to clean up previous year’s books. We all know time = money, so the investment will be large in relation to the time spent upfitting your accounting methods. The good news is that once things are up to par, as long as you are diligent about staying up to date with your new, higher standards, you should be fine.
Things to Consider When Moving to GAAP
The biggest consideration besides the “if” you should move to a GAAP accounting method is the initial bump in time and money it requires. Now is a good time to consider it, before an audit hits, and before you start to actively raise money. Like proper business management (especially on the accounting side), planning ahead and having an implementation game plan is big. Maybe you don't plan on going public or need shrewd investors, maybe you want a higher standard of accounting, which makes sense too.
Step one will be writing and implementing all of the policies and procedures needed to adhere to GAAP. Things like a fixed asset capitalization policy, accrual prepaid policies, and creating monthly schedules for the accounting team to allocate their time to such finite reporting.
You will also need to consider how far back into the years of operation you need to go. How many prior years will need to be brought up to the standard? This will also come with its own time and money challenges. Speaking as your trusty accounting pro at Accountfully - having an outsourced accounting team working on the books, is going to make this transition a lot easier.
Another consideration is how often you need to report your financials. Does it make sense to go month over month, year over year, or meet in the middle at quarterly? This will depend on those external factors mentioned earlier - audit requirements, for example. A bank or investor may want to see things monthly. It also may depend on a specific industry. A state licensed contractor may only need to show yearly reports according to their government agency or state licensing board requirements.
When You’re In Startup Mode - Start Fresh
When you’ve considered where your business is headed and how it may or may not need to be up to the GAAP level of accounting, your best bet is to start fresh and adhere to its higher level from the beginning. You will need to allocate a bit more time and money upfront to lock in quality processes and procedures, but it will be so worth it before running into the challenge of upfitting things after the fact. The big question to ask yourself is this: can I easily go back and redo things after I have implemented my accounting systems? If the answer is no, then start properly and see if you have the extra funding to do it properly. Either way, a solid accrual based method implemented and managed by a quality team is a good first step. That is where Accountfully comes in.
Even if leveling up a notch to a GAAP based method doesn’t make sense for you, we hope this is a good overview of more accounting related standards to think about. Understanding that in order to be successful, understand your business better, and to give it the opportunity to grow properly - whether that is from outside investors or going public, you will need to have a quality standard implemented into your accounting department. For the startup that needs flexibility to implement good systems and grow with the increase in revenue, outsourced accounting is a great first step.