Practical Accruals and Prepayments Policy: A One-Page Month-End Guide for Founders

Why Your Bank Balance is a Misleading Indicator of Health

For an early-stage founder, the bank balance is often the primary measure of business health. Yet, that number can be dangerously misleading. A large client payment might mask rising operational costs, or a significant annual software bill can make an otherwise strong month look disastrous. Missing these nuances overstates your cash runway and gives investors a skewed view of your company’s true burn rate. Getting this right is not about complex accounting theory; it is about creating a reliable financial picture to make better decisions. A clear policy on how to handle accruals and prepayments at month end provides the clarity needed to navigate the challenges unique to SaaS, Biotech, and Deeptech startups.

Foundational Concepts: Accruals and Prepayments Explained

Moving from a simple cash-in, cash-out view to a more accurate financial picture relies on understanding two core concepts. These are the foundation of accrual accounting, a system that matches revenues and expenses to the period in which they actually occur, not just when cash changes hands. This principle ensures your financial statements reflect the economic reality of your business each month.

An accrual is an expense your business has incurred for a service or product received but has not yet paid for or been invoiced for. The key is that the value has been consumed. For a SaaS company using a freelance developer in March who sends their invoice in April, that cost belongs on the March profit and loss (P&L) statement. Similarly, a Biotech startup using specialized lab consumables in June should accrue for that cost in June, even if the supplier's invoice arrives in July.

A prepayment is the opposite; it is an expense you have paid for in advance but have not yet fully used or consumed. Think of an E-commerce business paying for its annual Shopify subscription upfront. You pay for 12 months of service, but you only “use” one month of that service in the first month. The remaining 11 months represent an asset on your balance sheet, a resource you own, until it is consumed over time.

Defining Materiality: How to Handle Accruals and Prepayments That Matter

Founders often ask, “How do I avoid spending hours on tiny adjustments while not missing something that could blow up my financials?” The answer is materiality. It is the filter that separates the noise from what truly matters, preventing you from over-engineering minor adjustments or overlooking significant ones. A formal approach to materiality in financial reporting helps you focus your limited time and resources effectively.

Materiality has two sides. The first is quantitative. While large corporations have complex rules, the reality for most pre-seed startups is more pragmatic. A common materiality threshold for internal management accounts is 3-5% of monthly operating expenses. For a startup with $150,000 in monthly operating costs, this means you would focus on accruing for any single un-invoiced item over approximately $4,500 to $7,500. This threshold prevents the finance process from getting bogged down by immaterial items like a $50 software subscription.

The second side, qualitative materiality, is often more important. An adjustment of any size that turns a net profit into a net loss, or vice versa, is always considered material. If your company is on the cusp of breaking even, a $1,000 un-invoiced expense that pushes you from a $500 profit to a $500 loss is highly material. It changes the narrative you present to your board and investors, and it could even impact loan covenants or performance targets. This qualitative test ensures you do not overlook small numbers that have a big impact on your company's story.

Your Period-End Close Checklist: How to Handle Accruals and Prepayments at Month End

For items that clear your materiality threshold, what is the actual process for booking them? A disciplined month-end close process ensures accuracy and consistency. This serves as a lightweight period-end close checklist to get you started on implementing proper finance team cut-off controls.

Step 1: Establish Clear Cut-Off Controls and Timelines

The first step is establishing firm deadlines. A common and effective timeline is for budget owners or department heads to submit their lists of un-invoiced work by business day three of the new month. This gives the person managing the books sufficient time to review, validate, and process the adjusting journal entries. The overall goal is for all period-end adjustments to be posted by business day five, allowing for timely reporting to management and investors.

Step 2: Systematize the Process for Documenting Accruals

For documenting accruals, a simple shared spreadsheet often suffices for a Biotech startup tracking R&D contractor costs or a professional services firm logging subcontractor hours. This central list should include key details to support the final entry and provide an audit trail:

• Vendor Name: The supplier or contractor who provided the service.
• Description of Service: A brief note on the work performed (e.g., "March development work for Project X").
• Service Period: The month the service was delivered (e.g., "March 2024").
• Estimated Cost: The best estimate of the final invoice amount, based on the contract or statement of work.

This list forms the basis for your adjusting journal entries. Each line item translates into a journal entry that debits the relevant expense account (e.g., R&D Contractors) and credits an "Accrued Expenses" liability account on your balance sheet. When the actual invoice arrives later, the entry is reversed, and the invoice is processed normally.

Step 3: Master the Prepayment Accounting Process

For prepayments, the process is systematic. Consider a startup paying a $12,000 annual insurance premium in January. The wrong approach is to expense the full $12,000 in January, crushing that month's P&L and artificially inflating profitability for the rest of the year. The correct prepayment accounting process creates a much smoother and more accurate picture of performance.

First, you record the $12,000 payment to a “Prepaid Expenses” asset account on your balance sheet. Then, you establish a process where these annual expenses are amortized, moving 1/12th of the total cost from the balance sheet to the P&L each month. In accounting software like QuickBooks or Xero, you can set up a recurring journal entry to automatically move $1,000 from “Prepaid Expenses” to “Insurance Expense” every month. This ensures each month bears its fair share of the annual cost.

Scaling Up: When US GAAP vs. UK Rules Start to Matter

If you are expanding across the Atlantic or have international investors, you might ask, “Do I need to worry about different accounting rules?” For early-stage operational accounting, the principles behind accruals and prepayments are largely the same under different regimes. The simple, internal processes you build now are scalable and will serve you well.

However, it is important to know the formal standards that will apply as you grow. In the United States, companies follow US GAAP (Generally Accepted Accounting Principles). In the UK, companies typically follow FRS 102, which is based on a global framework known as IFRS (International Financial Reporting Standards). While the basics are similar, key differences emerge in more complex areas.

A primary area of divergence is revenue recognition, governed by ASC 606 in the US and IFRS 15 internationally. For a B2B SaaS company with multi-year contracts that include setup fees, training, and support services, how and when you recognize that revenue can differ. Similarly, complex areas like lease accounting can diverge. This becomes important for a capital-intensive Deeptech or Biotech firm when signing a multi-year lease on a new lab. The takeaway is that your simple, internal policies will serve you well initially, but expert advice is essential as you encounter these scaling challenges.

Creating Your Startup Accounting Policies: A Simple Template

A consistent approach for how to handle accruals and prepayments at month end is a hallmark of a well-managed startup. Moving this process from an ad-hoc checklist to a simple, one-page document provides clarity for your team and signals financial discipline to investors. Creating clear startup accounting policies is a foundational step toward building a scalable finance function.

This policy does not need to be a 50-page manual. A scenario we repeatedly see is that a simple, clear document is far more effective than a complex one nobody reads. It should act as a practical guide for anyone involved in the month-end process, from department heads to the finance lead.

Here is a mini-template for a one-page policy:

1. Purpose

To ensure the company's financial statements accurately reflect expenses in the period they were incurred and revenue in the period it was earned. This provides a true and fair view of performance and burn rate for management and investors.

2. Materiality Threshold

• Quantitative: Any single un-invoiced expense or multi-period invoice estimated to be over 4% of the trailing three-month average of monthly operating expenses must be adjusted for.
• Qualitative: An adjustment of any size that turns a net profit into a net loss (or vice-versa) is always considered material and must be recorded.

3. Cut-Off Procedure & Timeline

• Accruals: All department heads must submit a list of material services received but not yet invoiced to the finance function by business day 3 of the following month.
• Prepayments: All invoices covering more than one month of service and exceeding the materiality threshold will be recorded as a prepaid asset and amortized systematically over the service period.
• Close: All adjusting journal entries for accruals and prepayments must be posted in QuickBooks (or Xero for UK entities) by the end of business day 5.

Documenting this simple framework builds institutional knowledge, makes financial reporting more reliable, and prepares you for future due diligence or audits. It transforms what is often a chaotic monthly scramble into a predictable, repeatable process.

Conclusion: From Cash View to Strategic Clarity

Adopting a disciplined approach to accruals and prepayments is a crucial milestone for any growing startup. It marks the transition from focusing solely on cash in the bank to understanding the actual financial performance of the business. By defining materiality, establishing a clear month-end timeline, and documenting your process in a simple policy, you create control and clarity. This is not just about satisfying accountants or auditors. It is about giving yourself, your team, and your investors a true picture of the business, enabling smarter decisions about your most critical resource: your runway.

Frequently Asked Questions

Q: What is the difference between an accrual and a provision?
A: An accrual is for a liability that has been incurred where the timing or amount is known with reasonable certainty, like a contractor's invoice for a completed project. A provision is for a liability where the timing or amount is uncertain, such as a future warranty claim or legal settlement.

Q: Do I need to accrue for employee salaries at month-end?
A: Yes, payroll is one of the most common and important accruals. If your month-end falls in the middle of a pay period, you must accrue for the salary expenses earned by employees but not yet paid. This ensures labor costs are correctly matched to the period in which they worked.

Q: How often should we review our materiality threshold?
A: Your materiality threshold should be reviewed at least annually or whenever there is a significant change in your business's operating expense level. As your startup grows and monthly costs increase, a fixed-dollar threshold may become too small, requiring an update to keep the process efficient.

Q: Can my accounting software handle accruals and prepayments automatically?
A: Modern accounting software like QuickBooks and Xero can automate parts of the process. They can memorize recurring journal entries for amortizing prepayments. However, identifying and estimating accruals for un-invoiced services still requires a manual process of communication between department heads and the finance function.