In spite of the challenges brought on by the ongoing pandemic, more startups are gaining traction and getting attention from VCs and investors, especially in Southeast Asia (SEA).
However, having a good idea is just the first step.
With the surge in market saturation, startups are facing incredibly stiff competition. Having a strong financial foundation has never been more important in gaining an edge during fundraising, and it will go a long way to inspire greater confidence from potential investors.
Past examples such as Theranos, WeWork, and even industry giants such as Wirecard showed that size and funding is not the ‘be all end all’.
True long-term success is made up of a multitude of factors, and we need to pay attention to the smaller details in order to avoid the mistakes made by our predecessors.
Having said that, below are five common ones and how you can avoid them.
Mistake 1: Recognising revenue and expenses on a cash basis
Cash basis refers to an accounting method that recognizes revenues and expenses at the time cash is received or paid out. This contrasts accrual accounting, which recognises revenue when a service is performed or goods sold; and records expenses when the obligation to pay is incurred regardless of when cash is received or paid.
Cash accounting can misrepresent a startup’s actual health and growth. For example, the startup might record growth in sales due to customers’ payment of invoices rather than the actual act of performing a service.
Accrual Accounting should be adopted in practice over Cash accounting as it represents a more accurate picture of the startup’s business performance and financial health.
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Mistake 2: Inconsistent accounting policies
A consistent accounting policy means that once an accounting method is adopted for use (e.g. recognition of inventory), the business does not change the method from period to period. The purpose of having a consistent accounting policy is to ensure that transactions or events are recorded in the same way or manner over time.
This allows easier and more accurate comparison of performance over time. An example of this is when a startup recognises inventory using the ‘First-In-First-Out’ method starting out but ends up switching to the ‘Last-In-First-Out’ method during the latter years of expansion.
Therefore, it is important for the startup to plan out and formalise their accounting policies from day one, to ensure consistent and comparable financials in the long term.
Mistake 3: Disorganised accounting practices
The Chart of Accounts classifies and organises all assets, liabilities, equity, revenues, and expenses accounts that help to form the foundation of a startup’s operations and financials.
While it might seem minute, a properly structured chart of accounts is pivotal for an accurate and detailed presentation of the startup’s financials used for analysis, budgeting and cost management.
Mistake 4: Labelling capital expenditure as operating expense
Capital expenditure refers to the purchase of long-term assets such as office equipment, furniture, vehicles and more.
Oftentimes, inexperienced startups can recognise capital expenditure as operating expense, which will skew their income statement as these purchases are only made once every few years, making it more challenging to accurately assess a startup’s true performance.
Mistake 5: Inconsistent bank reconciliation
Bank reconciliation refers to the process of matching the startup’s cash balance to that of the bank statement. This helps to explain any discrepancies or differences between the balance on the bank statement and the startup’s cash account.
The monthly bank reconciliation is important as it helps to prevent fraud and identifies any accounting errors (such as incorrect or duplicate accounting entries) and outstanding cash balances.
While not the most exciting thing to pay attention to, these fundamentals are crucial to the long-term financial success of any startup. Thankfully, these issues can be easily addressed if identified early, be it through hiring an experienced financial team, or by partnering with a reliable service provider.
The article is co-authored by Charles Phan, Project Lead and Darrell Su, Senior Analyst, Capital Advisory at Paloe
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