If the phrase “Mind the GAAP” makes you think of the London Underground, you’re probably a business owner and not an accounting professional who enjoys a good pun. And if you’re reading this article, it’s highly likely you just got off a call with potential investors who dropped the phrase “GAAP accounting” about four or five times, and now you’re thinking, “Great, another accounting to-do on my plate...”
But don’t worry: GAAP won’t give you any grief.
Before we dive in, on behalf of everyone here at inDinero I want to say, CONGRATS!
If you’re hearing questions like these it’s a pretty major indicator that big things are coming your way and we couldn’t be more excited for you and your business.
If you haven’t had a chance to read my previous post on what small businesses should consider when choosing an accounting method, a) it’s been very popular so you totally should, and b) here’s how I’ve explained GAAP accounting, in a nutshell:
“GAAP, or generally accepted accounting principles, is essentially the Magna Carta of accounting in the United States and establishes the standard financial reporting definitions and styles that are uniform across all businesses.”
Basically, these are the rules all accounting and finance professionals agree to play by and the standard measuring stick potential investors follow when comparing one business to another. This is why your potential investors are interested in it; they want to understand your business financials so they can confidently invest in your company.
Overall, your financial statements need to conform to GAAP, and many of your potential sources of capital want to see GAAP-based financial statements to understand your business. But what kind of value does GAAP accounting have for your small business and you as an business owner?
Instead of thinking about GAAP as just another box to check on your way to building your empire, think again, because there are actually many ways that implementing GAAP accounting makes your business stronger and helps you become a better entrepreneur in the process.
GAAP accounting helps you plan ahead
As someone running a company, you’ve learned how important it is to plan. You also definitely know that these plans are determined by more than just your dreams and “gut feelings”; you need to have the capital and the right timing to make things happen. With GAAP you get these insights and so much more:
1. GAAP can be your financial crystal ball
Companies using GAAP must prepare their reports using the same methods and figures every time. This provides a more accurate picture of your revenue so you can identify and predict cash flow trends over time. You’ll find that once you’ve made the switch you can predict patterns you may not have been able to see before. Having an uncanny ability to anticipate your finances for the future is an invaluable tool for building out your business model or planning for operations based on factors like season, department, or client.
2. Recognizing transactions in real time means you can budget in real time
GAAP uses the accrual method of accounting and recognizes all transactions when they are earned, used, or due instead of waiting until payment is procured. Because you can handle your accounting procedures as they happen, you’re less likely to let things fall by the wayside or make plans while overlooking relevant transactions that haven’t been paid for.
3. Tying expenses and assets back to earning capabilities
To provide a more straightforward picture of your company’s performance and profitability, GAAP accounting correlates the costs of products and services you purchase and the revenue from goods or services that you sell. Being this detailed provides a more accurate understanding of how your spending decisions actually affect your bottom line.
Transparency isn’t just for investors, there’s lots for you to learn from GAAP accounting too
Accounting can be a very flexible process for small businesses who haven’t been subject to an audit or had to report to a third party, at which point they will be required to show that the financial statements comply with certain policies. Smaller companies are free to report their finances in their own way internally to fit their specific needs. But, as you can imagine, that doesn’t always paint the most accurate financial profile. Going through the process of switching to GAAP accounting, you’ll see your finances in a new light.
4. Consistently gain accurate, impartial information about your company’s financials
Companies using GAAP must calculate and report their finances based on what’s relevant to people outside the business, using unbiased evidence. Seeing your company’s finances the way other people do can be very eye-opening and bring your attention to activities that makes sense to you but not to your investors.
5. If your investors want to know how you spend your money, shouldn’t you?
You may think you’ve kept track of all the major spending from your company/departments/employees, but some spending may go beyond your line of sight. GAAP gives you a comprehensive view of the costs you’ve accrued in the way your investors and other outsiders will see them. This is your chance to use the same critical eye others will have on how you’re spending your money and if you’re making wise decisions.
GAAP Accounting enforces consistency for all the right reasons
It takes extra work to be consistent, but by adhering to the principles of GAAP you’ll do yourself a favor by putting the right measures in place to keep your company safe.
6. Reduce risks and avoid fraud by looking into the tough stuff
GAAP is what your investors use to hold you accountable for reporting finances responsibly, but this process can also force you to question other things, like why you might not be hitting your sales expectations. GAAP can give you the information you need to diagnose gaps in earning capabilities, collection issues, as well as mistakes you’ve made that need to be cleaned up.
7. Identify Areas for improvement & competitive analysis
Because GAAP levels your financials so they can play on the same field with other companies, you can then compare your overall performance to your competitors and pinpoint where you need to make changes. You can also judge the benefits of different financial decisions based on other companies in your industry or with similar business models. If you see X company’s books line up with yours and they made these decisions and saw growth, you know it’s a safe bet you could see the same results. You also will know what you’re up against compared to other companies your investors have in their portfolios.
If you’ve read through these benefits and want to take a look at other implications such as what switching to GAAP actually looks like, when it’s the right time to get on it, and what the tax implications might be it’s the perfect resource for you!
You can download your copy for free (and thank me later at firstname.lastname@example.org after you’ve impressed your investors with your GAAP knowledge in your next meeting… ka-CHING!)
*Cover photo by Pawel Loj, with edits