Adopt financial models with caution

Adopt the financial models of your industry peers, but don’t blindly accept that their accounts breakdown measures your business' true value.

Few businesses have revolutionary financial models. Most are a slight variation on an existing financial model, or even an exact replica for a different market. A manufacturing business need not reinvent how it will record materials costs because it’s already standard practice to record these under COGS (cost of goods sold). Yet it would not make sense for a manufacturing company to borrow a software company’s financial reports as a template. This would deflate the manufacturing company’s gross profit in unhelpful ways by emphasizing software accounts which are less relevant to manufacturing. Therefore it behooves companies to shape their financial statements after industry peers.

A note of warning about adopting other’s financial standards; it’s only as good as theirs is. The software platform industry has set a high value on two intangible assets: data and network effect. Many Silicon Valley startups have been purchased for hundreds of millions of dollars simply to acquire the data and network that business has accumulated. While the market valuation of data stays high, adopting the software industry’s approach to data valuation will give your financial statements a great boost and make your company appear much more profitable. If data privacy standards like GDPR were implemented in the U.S.; however, your data may become a legal liability. The intangible value of your data may drop overnight. Remember: good accounting describes measurable value. Though you use the balance sheet to monitor health, your health assessment will be skewed. Or you find that, as you use the income statement to refine value creation, you focus your business on the wrong value proposition.

A previous employer claimed the financial information they supply employees is above average for our industry. I believe them. Knowing how poorly the software industry has accounted for its value; however, makes me question companies that do not give even cursory financial information to their employees. Our accounting practices are similar to other software companies, which means that if I understand a publicly traded software company’s accounting style I might grasp the numbers of my current employer.

One aspect that concerns me is that, as an employee, I’m given information only about our business revenue, but no information about expenses or liabilities. Revenue rises and all employees are glad and think we’re doing well, but the missing data might paint a much different story. And this is considered above average financial transparency?

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