Profit in transit

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ALDIE P. GARCIA

ALDIE P. GARCIA

For the first time in a long time, there is now a strong push and recognition for start-ups in the Philippines. Several incubator groups have sprouted up and even some of the big conglomerates have taken active part in supporting and collaborating with start-ups.

Together, they have started to take on the innovation agenda not only for themselves, but also for the country as a whole.

Start-ups, they say, are 20 percent idea and 80 percent execution. In reality, at the beginning, it is 100 percent promise. Promise of a future product or output; promise of a thriving business; promise of profits, monetary or otherwise. Herein lies the difficulty of pushing beyond the 20 percent into the critical next 80 percent—funding.

While start-up funding is now more plentiful than before, it trickles down in different shapes and sizes. Access is still limited. Investors and banks alike channel funds mostly to the biggest and most established groups of start-ups, for good business reasons. Independent and small-scale start-ups often have limited avenue to pitch to potential investors and resort mostly to conventional banking institutions.


Such is the situation that M&P, a start-up from Western Samar, which conceptualized a brilliant HealthTech product with a surefire rural market fit, has faced. M&P aims to carve a niche in the healthcare market especially in the 2nd and 3rd tier municipalities nationwide for its products. It has spent a good part of the last three years completing its research. It combed countless municipalities for assessing the technical and economic feasibility of its product. It advertised and organized promotional campaigns to stir up awareness of the product and the upcoming launch. A separate company has been duly organized and registered. It has spent considerable amount of money for “start-up costs” and pre-operating expenses. Just months before the planned product launching, however, all its funds and some personal funds of the entrepreneurs, have been depleted. Due to absence of access to potential investors, M&P approached a bank for funding.

As part of the bank’s requirements, M&P sought the help of a friendly neighborhood accountant to prepare the pro-forma financial information. And M&P felt confident that with everything it has done so far, it should be able to prove to the bank not only the feasibility of the product but also the substantial “assets” it was able to put up. A healthy balance sheet is what it was expecting; so it came as a jaw-dropping surprise when the accountant came back a week later showing a rather gloomy state of its financial position. Aside from a few thousand pesos in the bank, there were no other assets reported. M&P asked: Is this correct? How about the product, the output of the research, the impact of the strategic advertising, the significant costs incurred in organizing the company and preparing everything for the product launch? Surely, these should account for something.

Let’s look at M&P’s concerns one by one.

First, the product. At this stage, what M&P has is just the concept of a product. In order for M&P to report an asset, the basic asset recognition criteria under Philippine Accounting Standard (PAS) No. 1, Presentation of Financial Statements, should be satisfied. It requires that (a) it is probable that future economic benefits will flow to the company; and (b) the cost of the asset can be measured reliably. It may have already cracked the formula and have all the right ingredients but until the product goes into production, ramped up and rolled out, technically, there is no product to speak of.

Second, research and advertising costs. No doubt, these are crucial parts of start-up businesses; but PAS No. 38, Intangible Assets, is explicit that all research-related costs are considered as period costs and should be expensed as incurred. Regardless of the favorable output of the research, the related costs can never be reported as part of the assets. Similarly, for advertising expenses, paragraph 29 of PAS No. 38 prohibits the recognition of advertising related expenses as part of assets, precisely because of the difficulty in proving that future economic benefits arise from specific advertisements or promotional campaigns.

Lastly, the start-up costs and pre-operating expenses. For most start-ups, this is where most, if not all, seed money gets burnt. For some, this is launch pad for execution but for others, this simply is the end of the line. This uncertainty is considered in paragraphs 68 and 69 of PAS No. 38 which cite start-up costs and pre-operating expenses as examples of expenditures that should be recognized as an expense and not as an asset.

So now, M&P has a pro-forma financial statement that shows very minimal assets and very significant amount of losses. However, such is the indomitable spirit of the entrepreneurs behind M&P that they went ahead to the bank nonetheless. M&P pitched that start-ups, manned by innovators such as them, are portals that bridge the present to the future and that the value of their company is not limited to backward looking financials, but anchored on a glimpse and promise of the future. The product is brilliant. The business model is sound. So surely, the profit is in transit!

M&P got its much needed funding and are now on their first full year of commercial operations.

Philippine start-ups are beginning to take center stage. Our very own innovators and disruptors are driving real and needed change not only in their chosen industries, but also to our country as a whole. If they are to truly realize their full potential of bridging us to the future, they need all the help they can get. Funding is critical, yes, but so are other areas like legislations, incentives and recognitions. They promise to take us to the future. The least we can do is to take care of them at the present.

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Aldie P. Garcia is a Partner from Assurance, Markets Lead for Priority Targets,Lead Partner for Branch Operations and the PwC Experience Leader of Isla Lipana& Co./PwC Philippines. Email your comments and questions tomarkets@ph.pwc.com. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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