Accounting Differences and Best Practices for the Technology Industry
Effective accounting is crucial for the success and sustainability of the technology industry. Certain businesses, like technology companies, require a different method than those used for traditional businesses due to factors that affect the industry. Although there are similarities, such as tracking revenue, managing expenses and adhering to Generally Accepted Accounting Principles (GAAP), there are key differences in methods. Technology companies have entirely different revenue models, growth targets and cost structures, which may become complicated due to fundraising plans and complex capitalization tables. Understanding the key accounting differences in the technology industry can help businesses adopt best practices to improve efficiency and grow.
Accounting Differences in the Technology Industry
Revenue Recognition
Recognizing revenue for a technology company can be a complex task, and many companies that offer software-as-a-service (SaaS) or subscription-based services often encounter revenue recognition challenges. Companies that offer SaaS, where the customer receives and consumes the benefits of the service, will be able to recognize revenue over the life of the contract. Whereas subscription-based revenue is referred to as deferred revenue and is only recognized on an accrual basis, meaning revenue is recorded when the value is earned, not when the payment is received.
Cost Structures
Technology companies generally have higher fixed costs compared to the more variable costs that dominate traditional businesses. Usually, most of these costs are related to selling, general and administrative (SG&A) and technology costs, rather than the costs of goods sold. Technology companies that are in the early stages of operations often allocate expenses to Research and Development (R&D) that are used for software development, prototype creation and testing. It’s important that technology companies maintain accurate records of these costs since R&D expenses can lead to better rates from venture capital firms.
Cash Burn
Cash burn measures how quickly a company spends its capital, which is a key factor in a company’s sustainability. While cash burn is important for all technology companies, it’s especially important in startups. Most technology companies strive for rapid growth by using external funding which can complicate cash flow management. Having specialized accounting software that can handle a business’s scalability is essential.
What Are Best Practices for Accounting for Technology Companies?
Due to key differences, such as rapid growth and complex revenue models, technology companies should consider implementing a few best practices to help ensure financial accuracy and sustainable growth. Here are a few best practices that technology companies should keep in mind when managing their accounting:
- Follow GAAP Principles: GAAP is a common set of accounting rules, requirements and practices that are issued by the Financial Accounting Standards Board (FASB) and Governmental Accounting Standards Board (GASB). Technology companies can gain more insight into the financial performance of their company by adopting these principles.
- Adopt Accrual Accounting: Following the accrual accounting method allows technology companies to recognize revenue when it is earned. For technology companies that have long-term contracts, adopting this method enables leaders to have a more accurate understanding of future cash flows.
- Develop Meaningful Key Performance Indicators (KPI): By using KPIs, technology companies can understand how well their company is doing. KPIs include GAAP metrics and non-GAAP metrics such as burn rate, cash flow, net income, customer acquisition cost and more.
By adopting these practices, technology companies can use a scalable accounting system and prioritize transparency while efficiently managing their finances. If you have any questions on accounting best practices for technology companies, please contact a Brown Plus advisor.