Accounting for Tech Companies: Overview and Best Practices

Tech companies include software developers, electronics manufacturers, fintech companies, and IT service providers with extraordinarily fast growth plans and potential. Technology companies provide needed solutions to big problems in return for impressive future revenue streams. 

Seed capital from angel investors, followed by venture capital rounds from Silicon Valley and other tech meccas, often fund these promising companies. But sometimes, tech companies begin as garage startups and avoid obtaining venture capital financing.  

Understanding and implementing proper accounting for tech companies is essential to cash flow management, effective back-office operations, financial reporting, and metrics to aid decision-making, obtain financing, and inform stakeholders.

The Unique Accounting Challenges for Tech Companies

Tech company accounting must address R&D accounting, patents and intangibles, M&A goodwill impairment checks, stock options, and cash management, among other accounting issues such as obsolete inventory and proper inventory valuation. 

GAAP (generally accepted accounting principles), which apply to tech companies, are included in the FASB (Financial Accounting Standards Board) Accounting Standards Codification as numbered ASC sections by topic. Publicly traded companies must also follow SEC accounting guidelines for reporting, financial disclosures, and required SEC filings. 

Your public accounting firm will conduct audits or review the company’s financial statements to ensure they materially adhere to GAAP, although they can’t provide outsourced accounting services for bookkeeping purposes. Consistently preparing GAAP financial statements will prepare tech companies for an eventual sale through M&A or an IPO. Before a planned IPO, ensure that the CFO and Controller are (or will become) familiar with SEC reporting rules. 

For effective business management, the accounting system should provide real-time trends in key financial and non-financial metrics and KPIs and use AI-assisted tools for business intelligence. It should give you visibility on business spending to help you discover ways to reduce the cost structure. 

Key Performance Indicators and Financial Metrics for Tech Companies

In the tech industry, different metrics and KPIs (key performance indicators) are used for software companies, electronics companies, and  IT service organizations. These financial performance metrics may be supplemented with non-financial indicators. 

Software Company Financial and Non-financial Metrics

Software metrics to monitor include:

• MRR (monthly recurring revenue) and ARR (annual recurring revenue)
• Customer acquisition cost (CAC) and CAC payback period
• Churn rate
• Customer lifetime value (CLV)
• Customer retention rate
• Burn rate and burn multiple (burn rate divided by current cash balance)

The churn rate is the percentage of customers discontinuing SaaS subscriptions for a measured period, like monthly, quarterly, or annually.

Burn rate is a cash flow analysis of how fast your company uses cash. It is compared to the company’s cash balance as the burn multiple. Burn rate is an essential metric for VC-financed tech business startups and early-stage small businesses to compute. 

The gross burn rate is the company’s total monthly spending, determined in accounting for technology companies. The net burn rate calculation considers revenues minus cost of goods sold (COGS) and spending (the gross burn rate) in the burn rate formula. The burn rate should be calculated monthly as part of your accounting cycle and your company should forecast the projected burn rate in its planning process. 

Electronics Tech Company Financial Metrics

• Revenue per employee
• Revenue increase %
• Gross margin % 
• Days sales outstanding (DSO) for accounts receivable
• Days payable outstanding (DPO) for accounts payable
• Cash conversion cycle (CCC)
• Inventory turnover and asset turnover
• Current ratio and working capital
• Net income (loss) and net income (loss) before taxes
• EBITDA (earnings before interest, taxes, depreciation, and amortization) 
• ROE (return on equity) and ROI (return on investment)

The most useful Return on Equity calculation uses the DuPont method formula which considers operating efficiency as net profit margin, asset turnover, and the equity multiplier for financial leverage. Return on investment is another important financial metric calculation that can help you make spending decisions and measure results.  

Strategic tech industry buyers and private equity firms use a multiple of adjusted EBITDA as one method, among others, like using competitors’ average P/E ratio, for the valuation of targeted companies for M&A deals. Their due diligence may reveal any required adjustments to the financial data. 

IT Services Company Performance Metrics

According to a blog recap of the Freshworks Service Management Benchmark Report 2022, IT services company performance metrics include:

• Customer satisfaction (CSAT)
• Average first response time
• Average resolution time
• Average first assign time
• First contact resolution
• Resolution SLA percent 
• First response SLA response

SLA is the service level agreement. IT accounting software and some specialized operations software can calculate financial metrics and these performance metrics. 

Best Accounting Practices for Tech Companies 

Tech companies must use the best ERP systems or accounting software and consider accounting best practices to function effectively and avoid common accounting problems. Tech accounting systems should be enhanced with third-party add-on accounting API integrations (or CSV integrations) for digitized finance automation to manage their back-office business processes more efficiently and effectively. To the extent possible, tech companies should use AI accounting processes. 

Best practices in accounting for technology companies include:

• Accrual accounting 
• Revenue recognition
• Research & development (R&D)
• Intangible assets and amortization
• Inventory accounting and control
• Accounting for stock options
• Cash management

Accrual Accounting under GAAP

Tech companies in the U.S. should generally follow GAAP accounting standards like accrual accounting when preparing their financial statements. However, some startups may use cash-basis accounting instead of GAAP-mandated accrual accounting for tax reasons and then recast them to GAAP financial statements later for comparability. 

Revenue Recognition 

Software companies within the tech umbrella often sell products with SaaS pricing plans, requiring compliance with GAAP revenue recognition policies. Proper revenue recognition means that software revenue is recognized monthly as the SaaS software is used instead of all at once when cash is collected upfront under an annual contract. 

Accounting for software companies requires accounting or ERP software to perform these billing and revenue recognition tasks. Revenue recognition for all software licensing requires contract performance obligations to be completed before being recognized as revenue. 

This revenue recognition rule also applies to other types of companies. Tech companies selling electronics must properly time revenue recognition using GAAP accounting standards. Similarly, accounting for IT companies must be GAAP-adherent. 

Your tech company’s ERP system should provide functionality to properly handle revenue recognition in accounting. (Startups and their business owners sometimes begin with QuickBooks Online or similar accounting software with third-party app integration before switching to a more robust system with greater functionality.)

Research & Development (R&D)

Tech companies incur R&D costs to create and significantly improve products developed by engineers for electronics and by software developers and R&D for services. GAAP covers (1) accounting for R&D costs (codified in ASC 730-10) and (2) how the parties paying and receiving funds handle accounting for an R&D funding arrangement (ASC 730-20). U.S. income tax laws offer an R&D tax credit for increasing research activities.

KPMG provides a downloadable online Handbook: Research and Development that covers accounting for R&D costs, including development costs and intangible assets acquired through M&A. It also covers R&D funding arrangements. Your company’s CPA firm may offer a comparable document. 

Intangible Assets and Amortization 

Tech companies need patents, which are a type of intangible asset, to protect their revenue streams. They also have trademarks, copyrights, and perhaps goodwill from M&A purchases and other intangible assets. 

Patent, trademark, and copyright costs are initially capitalized on the balance sheet as intangible assets and then amortized over the asset’s useful life using automated recurring month-end close process journal entries. 

The current GAAP treatment of goodwill is to assess the amount annually to check whether a goodwill impairment charge needs to be recorded when the value of the acquired goodwill is less than the goodwill amount recorded as of the purchase date. Tech companies must also understand how to account for all aspects of M&A purchases to record the deals upon closing. 

Inventory Accounting and Control

Obsolete inventory write-offs and lower of cost or net realizable value (an adjusted market selling price) are accounting concepts relating to inventory accounting. Net realizable value is computed as ordinary selling cost less the costs of completion, selling, and transportation. 

Inventory should be physically secured for internal control to prevent theft or damage, and issuance should be documented in the warehouse and accounting records. Accounting team members reconcile the annual physical inventory and periodic cycle counts, and they make approved journal entry adjustments in the books when required. 

Accounting for Stock Options 

Tech company employees often receive incentive compensation as stock options that could become extremely valuable compensation when milestones are accomplished that lead to an eventual exit event like an IPO or M&A deal for the sale of the company. These employees may receive lower salaries than prevailing compensation norms in startups when they can get an equity stake in the company through the eventual vesting of stock options or share grants. 

Under ASC 718 for GAAP accounting, companies recognize compensation expense at fair value for each stock option award or other type of equity-based award as of the date granted. Later, when stock options are exercised, the company debits Cash for the amount received upon exercise and credits Common Stock at par value and Additional Paid-in Capital to balance the entry using double-entry bookkeeping. 

If you look at public company financial statements, you’ll often see a reconciliation of GAAP vs. non-GAAP net income, with employee compensation often featured as a line item because it represents a significant amount that’s not directly associated with operating a company but affects earnings per share. Financial analysts covering public tech companies often prepare EPS estimates using non-GAAP accounting. 

Cash Management

Startups and early-stage companies that are either garage startups or venture capital financed need excellent cash flow management control for survival. These tech companies must wisely allocate funding to their spending needs during the rapid growth phase after product launch. Cash management is an important financial management aspect that is often provided as a feature in the best accounting software and ERP systems. 

Leveraging Automation for Accounting Efficiency

An ERP system has functionality and efficiency gaps that can be bridged through ERP integration with third-party AP automation and other finance automation solutions. 

AP automation software from Tipalti:

• Integrates with your ERP system or accounting software
• Adds self-service supplier onboarding
• Captures invoice data digitally as headers and line items with OCR and AI technology
• Streamlines and automates routine payables processes, including supplier validation, 26,000+ automated payment rules to flag exceptions and reduce errors by 66%, matching to POs and receivers, and using generative AI for automated general ledger account coding 
• Simplifies invoice approvals, supplier tax compliance, global regulatory compliance, and global batch payments
• Gives payees a larger choice of EFTs as global payment methods in 196 countries and 120 currencies
• Provides 80% payables and payment time reduction for cost savings from efficiency and reduced hiring needs 
• Gives your staff more time for strategic work to improve business results
• Provides real-time, multi-entity cash flow requirements and categorized spend visibility (with integration to a real-time, multi-entity ERP)
• Includes Ask Tipalti AIâ„  queries for business intelligence 

Chat GPT is a generative AI tool for accounting and other functionality, including automated GL expense coding and making chatbot inquiries. 

Your tech company will save money from efficiency and the ability to take supplier early payment discounts on time with efficient invoice processing verification, matching, approvals, and global payments. Your company’s hiring needs will be reduced. 

Besides its AP automation software, Tipalti offers employee expense automation software (Expenses) that works in combination with its AP automation software. Other Tipalti products are advanced FX products (Multi-FX and FX Hedging), and Mass Payments for payouts to creatives, publisher networks, affiliates, and independent contractors. Tipalti also offers finance automation Procurement software for purchase requisition intake, approval processes, and automatic purchase order creation. 

Tipalti’s cloud finance and accounting automation software platform provides an audit trail and enterprise-grade security. Tipalti AP automation software can speed up your financial close by 25% because it prepares real-time, automated payment reconciliation for global batches that use multiple payment methods. 

Preparing for Growth and Scalability

First, your tech company needs the best multi-entity ERP or accounting system that fits its needs and budget. If your tech company is venture capital financed, ask the VCs or members of their other portfolio companies which ERP system they recommend. 

If your financial systems can’t handle GAAP accounting and analysis with business intelligence,  you may not be able to answer questions about the financial statements properly. And you’ll possibly have a lot of rework to do before an IPO.

Financial management, including the tech company CFO and Controller, must proactively seek modern finance automation systems. Efficient finance automation software applies digital transformation to accounting and finance processes like accounts payable. These robust automation systems let your finance team cut costs and make informed decisions about spending. 

Tipalti finance automation products are scalable for business growth through expansion and volume increases. Learn more about Tipalti’s finance and accounting solutions for the technology industry.