Information Technology (IT) is one of the fastest-growing industries in the United States, with more than 585,000 tech companies operating in the country. While these companies are known for their rapid growth, they also face a number of challenges when it comes to accounting.
Understanding these challenges, following the best accounting practices and partnering with an experienced accountant can help ensure that your IT company enjoys sustainable growth.
The Unique Challenges of Accounting for IT
IT companies face unique challenges when it comes to accounting. Along with the use of non-traditional business models, tech companies must also keep up with an ever-changing business landscape and complex intellectual property rights.
An IT company can provide businesses with a variety of services, such as
- Software (SaaS and one-off) Subscriptions
- Networking
- Databases
- Data storage
- Maintenance and setup
- Hardware manufacturers
- Internet or related services
- VoIP
- Cloud services
- Many others
Some of the many accounting challenges tech companies face include:
Intangible Assets
Tech companies rely heavily on intangible assets, like trademarks, patents and copyrights. It can be challenging to value and account for these assets because laws and market conditions can change at the drop of a dime.
In order to overcome this challenge, IT companies must have a deep understanding of the value of their intangible assets and how to account for them properly.
Revenue Recognition
IT companies often rely on unconventional business models like software-as-a-service (SaaS) or subscription-based models, which can complicate revenue recognition. You also have IT companies that charge one-off for services or software.
Depending upon your chosen accounting method, revenue may need to be recognized when it’s earned rather than received. For example, if a customer pays on January 1 for a year-long subscription, if you’re using accrual accounting, you can’t recognize all of that revenue on January 1.
Make sure you’re properly recognizing your revenue. One mistake could have significant repercussions for the company.
Research and Development Costs
To stay competitive, tech companies invest heavily in research and development. The aim is to innovate and grow as quickly as possible. This approach can present challenges for many reasons.
For starters, research and development costs can be challenging to plan for, as there is no immediate revenue generated from the spending. Costs must be tracked very carefully.
For many tech companies, research and development funding is sourced from private equity funds, debt or venture capitalists. Being heavily reliant on external funding complicates matters even further.
Unconventional Success Indicators
In the tech world, profitability isn’t necessarily a sign of success. In some cases, it can be sign that the company isn’t investing enough in growth. For this reason, IT companies must choose their Key Performance Indicators (KPIs) carefully to illustrate their progress towards their goals.
3 Best Practices for Tech Company Accounting
Accounting as a whole is complex, but it can be especially complicated for tech companies. Following these best practices can help:
1. Adopt GAAP Reporting
Adopting GAAP (Generally Accepted Accounting Principals) financials is always a good practice, particularly if you’re interested in attracting investors.
Typically, investors will require IT companies to become GAAP compliant after reaching a certain point, usually a Series A.
One important aspect of adopting GAAP financials is producing regular financial statements:
- Cash flow statement
- Profit and loss statement
- Balance sheet
These essential financial documents help executives and investors understand the business’s financial performance.
Another key component of GAAP is adopting the accrual accounting method. Adopting this accounting method means that the business must account for revenue when it is earned, which gives leaders a more precise understanding of their future cash flows.
Additionally, accrual accounting can help the company understand its cash burn rate, an essential metric for IT companies.
Bringing an IT company up to GAAP often requires the help of a CFO or an experienced accounting team.
2. Choose Meaningful KPIs
Tech companies must take the time to develop meaningful KPIs. Not every KPI must be a GAAP metric. Selecting the right non-GAAP metrics will help the company understand whether it’s progressing toward its goals.
Here are some common non-GAAP KPIs tech companies focus on:
- Burn rate
- Annual recurring revenue (ARR) or Monthly recurring revenue (MMR)
- Average annual contract value
- Churn rate
- Cash runway
- Number of customers
Every tech company is unique and has its own goals, so it’s important to ensure that your KPIs are relevant to your operations.
3. Consider Outsourcing Your Accounting
Accounting is complicated for IT companies. Intangible assets and non-traditional business models are just a few of the many things that make tech accounting more complex.
Fast-growing companies may not be ready to build their own in-house accounting team, but they still require the expertise and knowledge of an accountant.
In these cases, it often makes more sense to outsource your accounting. Outsourcing will give you access to accounting professionals who know and understand the challenges of your business model. Along with saving your business time, they will also help ensure that your company is compliant and working toward reaching its goals.To learn more about IT accounting or how we can help you with your accounting needs, schedule a consultation now!
