This is how GAAP works for Start-up Entrepreneurs – GAAP is the acronym for Generally Accepted Accounting Principles. Even though it’s a guideline for accountants in keeping and presenting their accounting information, it has become imperative that young entrepreneurs understand what it is. This is because many start-up young entrepreneurs can’t afford the services of accountants and they have to keep financial records by themselves. This post is to educate them on the common principles and bring out certain accounting information they should keep.
Who is this for?
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As a matter of fact, are you a young and a start-up entrepreneur wishing to keep some business basic accounting records? This is for you. This post will educate you on the basic principles so that you can keep on fine doing your business. It’s also very important for all old entrepreneurs who are still managing their business financial records by themselves. To start with, it’s necessary you click here to read out previous article on business basic accounting
GAAP: This is how GAAP works for Start-up Entrepreneurs
The Generally Accepted Accounting Principles (GAAP) is a set of accounting guidelines. It’s one that all accountants must apply to their accounting practices. Just as a newspaper uses a style guide that outlines a set of standards for its writers and editors. So also the GAAP sets a standard that guides accountants when recording and reporting financial information. Therefore, when all accountants work in accordance with the GAAP, investors and analysts can easily understand their pattern and financial statements.
Lack of good financial records in line with GAAP promotes Bad Business Model and Mismanagement of Funds, To avoid these, GAAP standards were developed by the Financial Accounting Standards Board (FASB) to provide an accurate benchmark to weigh businesses against one another and prevent misleading reporting. In fact, GAAP compliance requires you to perform full accrual-based accounting rather than cash-based.
We are of the opinion that as a young entrepreneur, you must try to understand some of these things. They will help you know how at least to keep basic business records. And, in fact, when your auditors or account officer talks, you can understand.
Example of basic accounting:
The thrust of accounting is Double Entry System. This simply means every transaction will be recorded twice. One as an asset and another as a liability. This is because every liability creates an assets. To illustrate this, if your business borrows N200,000 from Mr. A to buy office furniture. This will be recorded twice. The first one is that Mr. A will be recorded as a creditor on one hand, and the office furniture recorded as an asset on the other hand. In this case the account is balance now. Every transaction must be seen to generate two records like this. That is the double entry system of accounting.
GAAP Compliance: This is how GAAP works for Start-up Entrepreneurs
Furthermore, you must understand that for a business to comply with GAAP, you must include ALL EXPLICIT COSTS of doing your business in the financial statements. These are all operating expenses, depreciation, interest, and taxes. Therefore, you must keep records of all your operations for Employee and Contractor Wages. Other that make up your operating records are Inventory, Raw materials, Transportation, Sales and marketing, Production and Overheads. Just gather all you business expenses in their classes. GAAP compliance gives you the following benefits.
The accrual basis accounting helps you track business trend:
Therefor, fundamental to GAAP, is the accrual accounting method. It helps you track 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,. So, it allows you to make strategic business decisions based on easily comparable financial accounting records.
More accurate profit & loss reporting:
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 accrual revenue recognition process gives 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.
Good & reliable forecasting and financial modeling:
Do you know that a good financial model gives startups the data they need to make strategic decisions? And thus be able to convince potential investors to back their business. In fact, forecasting and financial models leverage your business’s actual revenue and expenses to predict your future financial performance. This is because, if you follow GAAP your financial activity is recorded in a consistent and comparable manner. In fact, this lends itself to more accurate and reliable forecasting and financial modeling.
To attract investors, audit, and due diligence readiness:
These are also what GAAP helps you achieve. GAAP helps investors, board members, bankers, and auditors have a common benchmark to evaluate and compare your company’s finances. If GAAP standards i not followed 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.
GAAP Key Assumptions: This is how GAAP works for Start-up Entrepreneurs
- The first key assumption comprising GAAP is that the business entity is separate and distinct from all others. You must get this sink into your head. Your family expenses is not your business expenses.
- The second key assumption is that the business is a going concern. That is perpatuality concept, meaning that the business is expected to exist for a very long time.
- A third key assumption is that amounts listed in the organization’s financial statements are stated in terms of a stable currency. Inflation and currency devaluation is always a problem to accounting valuations.
- The final key assumption is that the time period stated in financial reporting is accurate.
The Basic Principles:
These basic principles emanate from the understanding and application of GAAP. GAAP’s four basic principles address the matters of costs, revenues, matching and disclosure.
- The cost principle refers to the fact that all listed values are accurate and reflect only actual costs. That is actual values rather than any market value of the cost items. This conforms to the fact that revenue principle of GAAP is that revenue is reported when it is recognized.
- Times of revenue recognition can vary depending on whether the organization uses the cash or accrual method of accounting. But the GAAP principle is that it will be recognized in a timely manner.
- The matching GAAP principle matches revenues with expenses. This means that the expenses of a revenue producing activity are reported when the item is sold, rather than when the organization receives payment for it or when it issues an invoice for it.
- Minimum disclosure – The disclosure principle associated with GAAP requires that information anyone assessing the organization’s financial standing would need is included in the reporting of the organization’s financial status.
GAAP Compliance Constraints:
There are four basic constraints associated with GAAP. These include; objectivity, materiality, consistency and prudence.
- Objectivity includes issues such as auditor independence and that information is verifiable.
- Materiality refers to the completeness of information included in financial reporting and whether information would be valuable/material to outside parties.
- Consistency requires that the organization uses the same accounting methods from year to year. If it chooses to change accounting methods, then it must make that statement in its financial reporting statements.
- Prudence requires that auditors and accountants choose methods that minimize the possibility of overstating either assets or income.
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In conclusion, this is how GAAP works for Start-up Entrepreneurs. Both young start-up and existing entrepreneurs need to understand the principles of GAAP to be able to o their business well. This is because GAAP promotes good Business Model and management of Funds,
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Founder/Managing Partner of Complete Full Marks Consultants Ltd. An Economist turned Chattered Accountant and Tax Practitioner with over 37 years of industrial experience.