In a political context, we talk about liberal and conservative, Democrat and Republican, Bush and Clinton.
In accounting, we talk about aggressive and conservative. The traditional notion was that accounting entries that resulted in understating actual earnings were “conservative” and entries that led to overstating earnings were “aggressive.” The question for entrepreneurs and executives might be, “which is best for maximizing the value of my business?”
The SEC and FASB (the folks who define Generally Accepted Accounting Principles or GAAP) view it as their primary objective to end this discussion in favor of being “simply right.”
For investment bankers, entrepreneurs and executives alike, the import of the discussion revolves around valuation. Entrepreneurs and executives want to maximize value whenever they sell shares or, most importantly, when they sell their businesses.
Entrepreneurs who are selling their businesses, seeking to effect a merger, or otherwise seeking liquidity, want to put their best foot forward.
In confess, I tend to believe the accountants. The value of the business will not be impacted so much by the accounting as by the economics—which are somewhat independent of each other (the FASB and SEC want to fix this too, but I’m not optimistic).
In fact, there is some risk that aggressive accounting could actually reduce the perceived value of the business because the quality and accuracy of the record keeping could be called into question by potential buyers or investors—or even lenders.
Of course, conservative accounting can’t help the valuation, especially if the accounting is wrong.
When a potential acquirer is reviewing the books (doing “due diligence”) prior to making an acquisition or buying a business, the buyer will be focused on understanding the truth. Every departure from Generally Accepted Accounting Principles (GAAP) in the accounting will create more doubt and uncertainty in the buyer’s analysis, reducing the buyer’s perception of the value of the business.
You’ll also want to be sure to have an audit done each year, not only to be sure that the records are kept accurately (which is tough) but also to be sure that the entries conform to GAAP (which is impossible without professional guidance). Having good records can increase your ability to raise equity, borrow money and even increase the value of your business at exit!
Good records will also help you comply with the requirements of Sarbanes-Oxley. Even if you don't intend to take your business public, you'll want to comply in order to help prepare yourself be acquired by a company that is public or hoping to go public. You don't want to exclude potential buyers from the mix.
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