Many startups and small businesses wait too long to set up their accounting and financial systems. However, as a study from Stanford Business School revealed, this short-sighted thinking will actually hurt a company in the long-run.
This study by Antonio Davila and George Foster showed that the companies which took the time and effort to setup early financial monitoring systems actually grew faster in sales and in other key metrics:
“They [the authors] found firms that acted quickly to institute formal mechanisms such as operation budgets, cash budgets, and financial monitoring systems (tools that measure profitability, customer acquisition costs, variance from actual budget, and so forth) had higher growth rates in terms of revenues and head count. They also had greater and more rapid increases in valuation at successive rounds of venture capital funding.”
The study offered several possibilities as to why establishing an accounting and financial system provided benefits to startups. One key reason stated is:
"Control systems are critical for providing executives with data they can use for their managerial decision making," said one of the co-authors. “It's generally true that managers of early-stage companies are unlikely to predict accurately exactly when growth will occur.”
In our experience providing outsourced CFO services to startups and small businesses in the San Francisco Bay area, establishing the appropriate accounting and financial systems are critical and should not be delayed. Equally important is establishing streamlined business processes (e.g, Accounts Receivable, Accounts Payable, budgeting, etc.), which drive the accounting system and not the other way around.
Here are some other key quotes from the study:
“One key factor driving the timing of when financial management systems are adopted is when a chief financial officer is hired, according to [the co-authors]. ‘We call this the 'import-in' approach to establishing control systems… Companies look for what's missing in their organization and hire people who have skills in those areas. Bringing on a senior financial officer typically fast tracks establishing financial planning and monitoring systems. It's generally more effective and economical than trying to create something from scratch within an organization.’”
“The study also reveals that venture capital-backed companies tend to establish operating and cash budgets sooner than individually funded startups. ‘Often managers want to be sure that the funding will not be abused, so they are eager to set up controls as soon as they can,’ [a co-author said]. ‘VCs also understand the importance of good financial management and encourage the use of these systems.’ Companies with more experienced CEOs adopt planning systems earlier than those with greener leaders at the helm, as well. ‘More experienced executives recognize the importance of formalized decision-making mechanisms and are quicker to implement them.’”