Prepayments and Accruals for Biotech Startups: Practical Month-End Steps and Examples

How to Record Prepayments for Large Upfront Costs

For a biotech startup, a predictable burn rate is not just a helpful metric; it is a critical signal of operational control to investors and grant committees. However, large annual payments for essentials like Directors & Officers (D&O) insurance or milestone-based invoices from a contract research organization (CRO) can make your monthly financials look erratic. One month your burn seems dangerously high, the next artificially low. This financial whiplash makes runway projections unreliable and obscures the true cost of your R&D progress. The solution lies in correctly implementing two fundamental accounting concepts: prepaid expenses and accrued expenses. Learning how to record prepayments and accruals in your biotech startup transforms your financial reporting from a lumpy, unpredictable report into a smooth, accurate reflection of your company's monthly performance.

Many early-stage companies face a common question: if we just paid a $30,000 annual D&O insurance premium, did our company really ‘lose’ $30,000 this month? From a cash perspective, yes, the money left your bank account. But from an operational perspective, you have purchased a service you will benefit from over the next twelve months. This is a classic prepaid expense.

A prepaid expense is an asset on your balance sheet. It represents a future economic benefit you have paid for but not yet consumed. Instead of recognizing the entire cost in the month of payment, you spread it evenly over the service period. This process is called amortization, and it is a core tenet of biotech finance basics.

A Practical Biotech Startup Accounting Example: D&O Insurance

Consider this common scenario for a growing biotech.

• The Scenario: Your startup pays a $30,000 annual D&O insurance premium on January 1st.
• The Incorrect (Cash-Based) Method: Your January profit and loss (P&L) statement shows a $30,000 insurance expense. This single payment drastically inflates your January burn rate, making it appear as if the company had a terrible month. Your burn rate for February through December then looks artificially low, as no insurance expense is recorded.
• The Correct (Accrual-Based) Method: When you make the payment, you record the $30,000 not as an immediate expense, but as an asset called “Prepaid Expenses” on your balance sheet. Each month, you then recognize a fraction of that cost. The amortization schedule for a 12-month prepayment is 1/12th of the cost each month. For a $30,000 premium, the example monthly expense is $2,500. This $2,500 is recorded as an expense on your P&L each month for 12 months, and the Prepaid Expenses asset on your balance sheet decreases by the same amount. The result is a smooth, predictable burn rate that accurately reflects your true operating costs.

This same logic applies to other large upfront payments common in biotech, such as annual software licenses, prepaid lab supplies, or rent paid quarterly in advance.

Managing Accrued Expenses for Milestone-Based R&D

Now, let us examine the opposite situation. Your CRO is making steady progress on a critical pre-clinical study, but you will not receive the next $250,000 milestone invoice for another two months. How do you account for the valuable work they are doing right now? This is where managing accrued expenses becomes essential.

An accrued expense is an expense that has been incurred, meaning the work has been performed, but for which no invoice has been received or paid. For R&D-heavy biotech companies, failing to accrue for work in progress is a significant error in expense recognition. In fact, a 2022 Deloitte report noted that improper expense recognition is a top reason for financial restatements in the life sciences sector.

Accruing properly ensures your financials reflect the true cost of your research as it happens, not just when invoices arrive. This is vital for accurate budget tracking, grant reporting, and showing investors you have a firm grasp on your R&D expenditures.

A Step-by-Step Example of How to Record an R&D Accrual

Here is a step-by-step example of how to record an accrual for a typical CRO project.

• The Scenario: Your startup has a $500,000 total contract with a CRO. The work is ongoing, but payments are tied to specific milestones.
• The Problem: If you only record expenses when you pay an invoice, your R&D costs will show zero for months at a time, followed by a huge spike. This does not reflect the continuous effort and resources being consumed.
• The Solution (Accrual Method): At the end of each month, you estimate the value of the work completed during that period. This often requires a quick check-in with your scientific lead or the CRO project manager to determine the percentage of completion.

Let's assume the project progress is as follows:

• End of Month 1: The CRO has completed 30% of the total project. You accrue an expense of 30% of $500,000, which is $150,000.
• End of Month 2: The CRO has now completed 40% of the total project. This means 10% of the work was done in Month 2. Your example monthly accrual calculation is 10% of total project value, or $50,000 for Month 2.

In your accounting software, such as QuickBooks for US companies or Xero for UK startups, you would book a journal entry each month. The entry for Month 2 would debit R&D Expense for $50,000 and credit a liability account called “Accrued Expenses” or “Accrued Liabilities” for $50,000. When the $250,000 milestone invoice eventually arrives, you reverse the accumulated accruals against the invoice to ensure the expense is not counted twice. This approach provides a far more accurate picture of your monthly R&D investment.

Your Repeatable 5-Step Month-End Process

Knowing the theory is one thing, but implementing it consistently is another. For a founder or operations lead handling the books, the process needs to be simple and repeatable. You do not need a perfect, by-the-book accounting process; you need a defensible one that gives you and your stakeholders an accurate view of the business. What founders find actually works is establishing a simple checklist for managing prepayments and accruals at the end of every month.

This process is one of the most valuable startup bookkeeping tips for maintaining financial hygiene without a dedicated finance department.

1. Review Large Payments: Scan your bank and credit card statements for all significant cash payments made during the month. A good rule of thumb is to set a threshold for reviewing potential prepayments: large payments greater than $5,000 should be flagged. If a payment over this amount covers a service period of more than one month, set it up as a prepaid expense.
2. Update Prepayment Schedule: Maintain a simple spreadsheet that lists all your prepaid expenses. For any new prepayments identified in step 1, add them to the schedule. For all existing prepayments, calculate the monthly amortization amount and prepare the corresponding journal entry.
3. Check In on Major Projects: Communicate with your scientific or operational leads. Ask for a simple percentage-of-completion estimate for major ongoing projects, especially with CROs or key suppliers. This does not need to be exact; a reasonable, good-faith estimate is sufficient for booking your accrual.
4. Book Journal Entries: In your accounting software, create and post the necessary journal entries. This will typically involve two main entries: one to recognize the monthly portion of your prepaid expenses (debiting the expense, crediting the prepaid asset) and one to recognize your accrued expenses (debiting the expense, crediting accrued liabilities).
5. Reconcile and Reverse: As part of your ongoing process, when an invoice arrives for an expense you have previously accrued, you must reverse the accrual entry to avoid double-counting. Similarly, when a prepaid asset has been fully amortized, double-check that its balance on your spreadsheet and in your accounting system is zero. This prevents errors from accumulating over time.

Practical Takeaways for Biotech Founders

Correctly handling prepayments and accruals is fundamental to sound financial management for any biotech startup. It smooths your burn rate, provides an accurate view of R&D progress, and builds investor confidence. The distinction is simple: prepayments account for cash paid before a service is used, while accruals account for a service used before cash is paid. Together, they shift your perspective from a volatile cash-based view to a stable, insightful accrual-based view.

Whether you operate in the US under US GAAP or in the UK following FRS 102, these principles of matching expenses to the period in which they deliver value are universal. For most early-stage startups, a simple, well-maintained spreadsheet can be your most powerful tool for tracking these items.

To start, create a shared spreadsheet for tracking prepaid expenses with the following columns:

• Vendor Name
• Service Description (e.g., D&O Insurance)
• Total Amount Paid
• Payment Date
• Service Start Date
• Service End Date
• Monthly Amortization Expense
• A column for each month of the year to track the remaining asset balance.

This simple tool, combined with the 5-step month-end process, will give you the control and clarity needed to navigate the long R&D cycles inherent to biotech. See the Cash vs. Accruals hub for broader guidance.

Frequently Asked Questions

Q: What is the difference between amortization and depreciation?
A: Both are non-cash expenses that spread the cost of an asset over its useful life. Amortization is used for intangible assets, like prepaid insurance or a patent, while depreciation is used for tangible assets, such as lab equipment or a company vehicle. The underlying accounting principle is the same.

Q: How accurate do my monthly R&D accrual estimates need to be?
A: Your estimates should be made in good faith based on the best available information, such as project updates from your CRO. They do not need to be perfect. The goal is to create a reasonable reflection of monthly activity, which is far more accurate than recording no expense at all until an invoice arrives.

Q: Do I need to accrue for small, recurring monthly expenses like utilities?
A: Generally, no. Accruals are most important for large, material expenses that would otherwise distort your monthly financials, such as significant CRO or manufacturing costs. For small, predictable monthly costs, it is often practical to record them when paid, as the impact on your burn rate is minimal.