It’s been said before so the argument that GAAP is bulky and pointless is really nothing new but in a WSJ op-ed this morning, guest writer Mike Michalowicz insists that GAAP is wrong… for profits, that is.
The GAAP actually directs us to spend first, then pay ourselves, and call the leftovers profit. How are you going to grow a successful business and accumulate wealth using that method? Generate more revenue, you say? Well, sure. Except that you’re going to spend it. So you’re right back where you started—working with the leftovers, if you have any.
I propose a new type of accounting: Profit First Accounting (PFA). The difference between GAAP and PFA is simple: Deduct profit first, from the top down. On a PFA income statement, the first line item is revenue, followed by a profit deduction, then your salary, followed by cost of goods and all other expenses.
Hey, guess what? We already have an alternative accounting system lurking in the wings. Allegedly IFRS will help companies that spend quite a bit on R&D buff up equity as R&D costs are considered assets, isn’t that an improvement over GAAP? IFRS also allows for financial statements to come together in whatever order, however those preparing the statements feel is most relevant to the entity’s economic picture. So what’s to stop them from slapping them together as the author suggests above?
GAAP is not meant to transform internal accounting departments into psychics and I doubt any U.S. companies use it because they feel it helps construct a useful picture of the entity that can be used for goal-setting and forecasting. That’s just not what it’s there to do and I think we can all agree on that.
Oh and by the way, Mike is the author of The Toilet Paper Entrepreneur, which he will be able to follow up with a sequel if we actually take his suggestion and try this Profit First idea. Yes business is all about profit but I think Mike is forgetting that companies file for the good of investors and regulatory bodies breathing down their necks, not necessarily for their own good or for the good of their almighty profits.