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(This story originally appeared on CFO.com.)
By Eric Segal
The recent bankruptcy of FTX, one of the world’s largest cryptocurrency exchanges, underscores the need for companies in the fintech/crypto industry to develop and install robust internal controls and finance processes.
FTX, led by 30-year-old Sam Bankman-Fried who has since resigned, was once valued at $32 billion, before its financial collapse and bankruptcy filing. It doesn’t appear that the company had a chief financial officer (CFO) on its leadership team.
Bloomberg News’ Matt Levine, who has covered the FTX debacle, hits it head-on for crypto and fintech companies when he wonders: “do they have hard-won expertise, built up over many years, in accounting controls and business processes for running a giant organization? Are they excited about making sure all the paperwork is correct?”
Many boards and management teams hire CFOs or engage consultants to provide that expertise. We are often given the explicit mandate to build out solid accounting and finance teams along with internal controls, policies, procedures, and forecast models.
To the next batch of successful fintech and crypto companies, here are a few items to help ensure you don’t find yourself overextended and short on cash:
Create A Forecast Model Aligned With the Strategic Plan
Crypto and fintech companies should develop a financial model based on assumptions that are reasonable, well-articulated and pressure-tested so investors, bankers and other partners will feel comfortable that it represents a fair forecast.
Key questions to answer in the model are: What are the revenues and costs associated with each element of the plan? What infrastructure is needed to support operations? How many employees will you need, and how fast will you hire them? With a model, you can start to granulize the strategy down to specific elements that can be rolled up into financial statements.
Develop A Solid Accounting and Reporting Infrastructure
A financial accounting platform is another must-have. You will need to choose the right accounting system to fit the business plan that will scale with the company’s growth plan. Earlier stage companies can get a lot of value from QuickBooks or a similar “simple” platform. For companies with higher volumes and increased complexity, Oracle’s NetSuite or Microsoft Dynamics 365 may be the answer. Spreadsheet-based accounting and reporting platforms’ usefulness is short-lived because they are error prone and difficult to audit.
Go With The 3 Flows: Cash, Information, and Accounting
When we helped a crypto derivatives exchange obtain regulatory approval from the U.S. Commodity Futures Trading Commission (CFTC), our mandate was to produce auditable financial statements. But before we could create the statements, we had to develop the key accounting and risk management policies and processes that articulate the governance and control of the information in the financial statements. Crypto and fintech companies may face more regulation soon and a focus on the three “flows” will help you keep your financial house in order.
Your accounting system and processes should focus on these critical flows.
Cash flow is the lifeblood of any company. For fintech and crypto companies, it is also important to keep client cash separate from company cash. The best internal control for this type of flow is to reconcile cash transactions to the bank statements on a daily, weekly, or monthly basis depending on volumes and the nature of your business. If you don’t stay on top of that control, your cash position will become very confusing very quickly.
Information flow provides data for accounting entries and management reporting. On fintech and crypto platforms, transactions can take place every second 24/7/365, all while your company is earning revenue, incurring expense and managing cash from every transaction. That information must get booked appropriately and accurately. The transaction system must communicate to the accounting system, the books must properly reflect the transactions, and customer’s funds in the user’s wallet/account must be updated. At the end of the day, you will process a lot of crypto and cash and, you must have these systems in place to know how much and to whom it belongs.
Accounting flows are the series of processes and controls that the accounting department executes to properly represent information from business operations. These include the bank account reconciliations mentioned above, reviews to ensure that the data from operating systems is accurately reflected in the ledgers, and comparison of financial results to the budget or forecast.
Turn Data Into Insight for the C-Suite and Investors
Collecting the data, validating it, and properly accounting for it is extremely important, but it’s not the final piece. How you communicate something is often more important than what you say. Remember that there can be two sides to the coin. For example, staff turnover is disruptive, but it also presents opportunities to upgrade talent and reengineer processes.
When communicating with the C-Suite and the board, use the strategic plan and the budget as the center of your universe. Every material item needs to relate back to those documents, comparing results to expectations. In November, you expected to spend $10 million on technology, but you spent $12.5 million. Why? Well, perhaps you signed a contract with a cloud computing platform sooner than planned and you received a discount that will reduce expenditures by 20% over the life of the contract. This is part of the story you can craft with the numbers.
You will also need a communications strategy to manage investor relations. Investors always seem to want more information. What level of detail strikes the right balance? Who will speak to them on behalf of the company and what briefings does your team require to present the information?
(Eric Segal, who is a partner at CFO Consulting Partners, leads the firm’s Banking and Financial Institutions practice. He is a former CFO and current fractional CFO. He has counselled crypto and fintech companies since 2014.)