A lot of startup companies are buying Treasuries directly through services like Treasure Fi, Arc, Meow, and other online services. After the recent banking crisis, startups are seeking ways to protect their financial reserves and, ideally, earn some yield on those funds. These debt securities are becoming increasingly popular among startups.
What is a Short-Term Treasury?
These securities are called different names, but short-term Treasuries refers to Treasury Bills. These are short-term bonds issued by the US government that mature between four and 52 weeks. A short-term Treasury is a debt obligation that is very low-risk. You can buy them directly through the services we just mentioned as well as services offered by Mercury, JP Morgan, and other financial providers. The accounting treatment for these debt securities is straightforward due to their short-term nature.
It’s a very popular form of cash management since the best credit in the world is the United States government, and they’re paying pretty high yields for short-term securities – as high as 5% currently. The fair value of these securities is often close to their purchase price due to their short duration.
Treasuries Should be Treated as Cash Equivalents
Fundamentally, Treasuries are very liquid and that’s part of the reason why they should be treated as cash equivalents. They are also called short-term marketable securities, meaning you can get out of them easily and there will be very little loss if you have to sell them. Therefore, yes, short-term Treasuries should be treated as cash equivalents on the balance sheet. The accounting treatment for these securities often involves recognizing interest income and accrued interest.
These Treasuries need to be included in your burn rate and runway calculations. Your runway calculation is your startup’s total cash divided by the average burn rate over the last three to six months. If you don’t include your Treasuries in your runway, it will start to look alarmingly short and your VCs might start to panic! This is especially true for SaaS companies, AI companies, biotech companies and other startups that need to manage their capital efficiently.
OK, so we’ve discussed that treasuries and short-term, yield bearing assets should be considered cash equivalents on your startup’s balance sheet and presented to investors as cash equivalents, thus increasing your runway. Now let’s discuss how you should account for treasury bills.
Treasury bills accounting treatment
Treasuries and short-term, yield-bearing assets should be considered cash equivalents on your startup’s balance sheet and presented to investors as cash equivalents, thus increasing your runway.
How should a startup account for short term treasuries held on the balance sheet to generate yield for excess cash?
For a startup accounting for short-term treasuries held on the balance sheet to generate yield for excess cash, there are several important considerations and best practices to follow. Here’s a comprehensive guide on how to approach this:
Classification and valuation
1. Classify as short-term investments:
- Short-term treasuries should typically be classified as “short-term investments” on the balance sheet. This is because they are:
- Highly liquid.
- Intended to be held for less than one year.
- Used primarily for cash management purposes.
2. Choose the appropriate accounting method:
- There are three potential methods for accounting for these investments:
-
Held-to-maturity (HTM):
- Use if the startup intends to hold the treasuries until they mature.
- Record at amortized cost.
- Changes in market value are not reflected on the balance sheet.
-
Trading securities:
- Use if the startup actively buys and sells these securities.
- Record at fair market value.
- Changes in value are reflected in the income statement.
-
Available-for-sale (AFS):
- A middle ground between HTM and trading.
- Record at fair market value.
- Changes in value are reflected in other comprehensive income (OCI).
-
Held-to-maturity (HTM):
- For most startups, the HTM or AFS methods are typically most appropriate.
Accounting entries and reporting
3. Initial purchase:
- When purchasing treasuries:
- Debit: Short-term investments.
- Credit: Cash.
4. Interest income:
- As interest accrues:
- Debit: Interest receivable.
- Credit: Interest income.
- When interest is received:
- Debit: Cash.
- Credit: Interest receivable.
5. Maturity or sale:
- When the treasury matures or is sold:
- Debit: Cash.
- Credit: Short-term investments.
- Record any gain or loss if applicable.
6. Disclosure requirements:
- In the financial statements:
- Disclose the nature and amount of these investments.
- If material, provide details on maturity dates, interest rates, and fair value.
Best practices and considerations
7. Liquidity management:
- Ensure the maturity dates align with the startup’s cash flow needs.
- Maintain a balanced portfolio to ensure sufficient liquidity.
8. Risk assessment:
- Consider interest rate risk and its potential impact on the value of the treasuries.
- Assess counterparty risk, even though it’s minimal with U.S. treasuries.
9. Regular monitoring:
- Regularly review the investment portfolio.
- Ensure it aligns with the startup’s cash management strategy.
10. Tax implications:
- Be aware of the tax treatment of interest income.
- Consider any state-specific tax implications.
11. Internal controls:
- Implement proper controls over the purchase, sale, and custody of these securities.
- Ensure segregation of duties in managing and accounting for these investments.
Accounting treatment for zero-coupon debt held to generate yield for a startup
Zero-coupon notes, also known as zero-coupon bonds or simply “zeros,” are a type of debt security that doesn’t pay periodic interest (coupons) throughout its life. Instead, these securities are sold at a significant discount to their face value, and the investor receives the full face value when the note matures. The difference between the purchase price and the face value represents the interest earned over the life of the security.
For example, a zero-coupon Treasury note with a face value of $1,000,000 maturing in one year might be sold for $980,000. The $20,000 difference is effectively the interest earned by the investor when the note matures and pays out the full $1,000,000. These instruments are popular among investors who want to lock in a guaranteed return and don’t need regular interest payments. They’re also useful for financial planning purposes, as the future value is known with certainty.
Accounting treatment
Initial purchase:
- Debit: Short-term investments (at purchase price).
Accrual of interest:
- The difference between the purchase price and the face value is considered interest income, which should be accrued over the life of the security using the effective interest method.
- Periodically (e.g., monthly):
- Debit: Short-term investments (for the accrued interest).
At maturity:
- Debit: Cash (for the face value).
Example
Using the $1 million zero-coupon note purchased for $980,000 with a 1-year maturity:
At purchase:
- Debit: Short-term investments $980,000.
Monthly interest accrual (simplified straight-line method for illustration):
- Monthly interest = ($1,000,000 - $980,000) / 12 months = $1,666.67.
- Debit: Short-term investments $1,666.67.
At maturity:
- Debit: Cash $1,000,000.
Key considerations for accounting zero-coupon notes
When accounting for zero-coupon notes, startups should be aware of several important factors:
1. Effective interest method:
The effective interest method should be employed for accruing interest in practice. This method results in a slightly increasing amount of interest recognized each period, more accurately reflecting the time value of money compared to the simplified straight-line method used in our example.
2. Materiality:
The materiality of these investments in relation to the startup’s overall financials is another crucial consideration. If the amounts involved are relatively small, a simpler accounting approach might be deemed acceptable. This is where many Kruze clients end up - venture investors usually want simpler accounting for early-stage companies. However, it’s essential to consult with an accountant (like us) to determine what constitutes “material” in the context of your specific financial situation.
3. Transparency:
Transparency is key in financial reporting, and as such, the nature of these investments and the accounting policy used should be clearly disclosed in the notes to the financial statements. This ensures that stakeholders have a complete understanding of the company’s financial position and investment strategies.
4. Tax implications:
Startups must be mindful of the tax implications associated with zero-coupon notes. Typically, the accrued interest is taxable as it accrues, even though the actual cash isn’t received until maturity. This can create a discrepancy between book income and taxable income, which needs to be carefully managed and accounted for in tax planning and reporting.
By taking these considerations into account, startups can ensure accurate, compliant, and transparent accounting for their zero-coupon note investments, providing a clear picture of their financial health to investors, regulators, and other stakeholders.
Treasuries Are Important Cash Management Tools
The recent banking crisis has made startups acutely aware of the limitations of FDIC coverage for their cash reserves. Many are now developing investment policies that include Treasuries as part of their cash management plan, and they are investing their cash reserves in low-risk Treasuries or government money market funds. All of the best startup banks can help you allocate your reserve cash into financial products that can help protect your funds and earn some yield. The fair value of these investments is often reflected in the financial statements.
If you have any questions on balance sheets, valuations, startup investing, startup accounting, taxes, or venture capital please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!
