Tech companies often adopt a project-based approach for accounting due to the nature of their operations and rightfully so.
Most software houses and I.T firms engage in different projects, like developing new software, launching a product, or undertaking a research initiative, each with its own budget, timeline, and deliverables.
The following blog post will cover the basics of project accounting and the key performance indicators that must be tracked by tech companies to assess project profitability, manage cash flow, ensure compliance with accounting standards, and secure more projects.
Project Accounting vs Traditional Accounting: What’s the Difference?
Project accounting and traditional accounting have different focuses. Traditional accounting looks at a company's overall financial picture, in that it summarizes all income and expenses.
In contrast, project accounting breaks down financial data by individual projects and shows the profitability and resource use of each.
Moreover, traditional accounting might show that a company is profitable, but project accounting reveals whether a specific project is over budget, even if the company's finances appear healthy. Thus, project-level detail helps businesses make informed decisions, find areas to improve, and manage resources accordingly.
Project Accounting Fundamentals for Tech Companies
Tech companies thrive on new projects. These projects, whether it's building new software or creating a new app, need careful financial management. Project accounting helps with this.
Let's look at the key elements of project accounting for tech companies.
1. Budgeting and Forecasting
Perhaps your company is making a new mobile game application. Your budget will include salaries for game developers, costs for design tools, money for music and sound effects, and testing expenses. You’ll also need to plan for things that might go wrong.
Forecasting goes hand in hand with budgeting. You predict how much money (if at all) the project will bring in and when. For example, your company needs to forecast how many people will download the application to see if the project makes financial sense.
2. Expense Tracking
Tracking expenses is an essential aspect of project accounting. It’s exactly how it sounds: carefully recording every cost, no matter how big or small, from salaries and materials to office rent and marketing ad spend. Picture a tech startup building a new gadget. Now their accountants need to track the cost of hardware parts, factory labor, shipping, and promotional campaigns.
Recording and monitoring expenses as they happen is also important. It shows where the money is going and if costs are getting too high. Project managers can use this information to make changes early and stop projects from going over budget.
3. Revenue Recognition
Counting revenue for tech projects is a bit different than traditional accounting.
Instead of counting all the money when a sale is made, project accounting often counts money as the project moves forward. For example, a company building a new website for someone might count some money after finishing the design, more after finishing the coding, and the rest after the website goes live. This gives a better idea of how the project is doing financially at any point in time.
4. Resource Management
Tech projects often have many people with different skills working together, so it's important to allocate resources in a way that their man-hours are utilized fully and there’s no productivity leakage.
Project accounting tracks how many hours people work, how digital tools and other infrastructure are used, and what all can be done to keep things running smoothly and finishing the project on time.
5. Project Financial Reporting
Project accounting ends with reports that show how the project did financially. These reports might cover profit and loss statements, cash flow predictions, and comparisons of the budget to what was actually spent.
For example, a tech company that launched a new app can use these reports to see how much it cost to make the app, how much money it made, and if it was a good investment. These reports are useful for making decisions about future projects.
6. Risk Mitigation
Tech projects are rarely without risks. Unexpected technical problems, scope creep, changes in the market, or delays are common and can affect a project's finances.
Project accounting helps keep the risks to a minimum by including a contingency budget to cover unexpected costs or problems that may arise during the project. It also has well-laid-out plans to handle sudden eventualities without disrupting the pace of the project. For example, a tech company making a new computer chip might set aside some money in case there are problems procuring the raw materials.
7. Performance Measurement
After a project is completed, it's time to assess its financial performance. Project accounting evaluates key factors such as total revenue, profit margins, and how actual expenses aligned with the initial budget. By analyzing these insights, tech companies can determine whether a project met financial expectations, spot cost inefficiencies, and apply lessons for future endeavors.
For example, a tech company that launched a new online store can review sales data, operational costs, and return on investment to assess whether it was a sound financial decision from the start.
Key Performance Indicators and Financial Metrics for Tech Companies
The tech industry is a multifaceted ecosystem and has several verticals: software development, electronics manufacturing, IT service provision, and more. Each of these business models has unique characteristics and, therefore, requires tailored key performance indicators (KPIs) and financial metrics to benchmark success. While some metrics are universally applicable, others are bespoke to the specific business model.
This section will unpack the essential KPIs and financial metrics for various tech companies, and give a clear understanding of what moves the needle in this dynamic sector.
Software Companies
Software companies lean on recurring revenue to survive. Therefore, several key metrics are mission-critical for evaluating their performance:
Monthly Recurring Revenue (MRR): This is a key metric for subscription-based businesses, such as SaaS companies, as it helps track financial stability, growth trends, and revenue forecasting.
Annual Recurring Revenue (ARR): This is the annualized version of MRR and gives a long-term view of recurring revenue. It's calculated by multiplying MRR by 12.
Customer Acquisition Cost (CAC): CAC measures the expense of acquiring a new customer. It covers all sales and marketing costs associated with customer acquisition.
CAC Payback Period: This metric indicates the time it takes to recoup the CAC from the revenue generated by a new customer.
Churn Rate: This is the percentage of customers who cancel their subscriptions within a given period. A high churn rate flags potential issues with the product or customer satisfaction.
Customer Lifetime Value (CLV): CLV estimates the total revenue a company can expect from a single customer over their entire relationship. It helps understand the long-term value of acquiring and retaining customers.
Customer Retention Rate: This metric measures the percentage of customers who continue their subscriptions over a given period. It's the inverse of the churn rate.
Burn Rate: This metric shows how quickly a company is spending its cash. It's essential for startups and early-stage companies to monitor their burn rate to make sure they have enough runway to achieve profitability.
Burn Multiple: This metric is calculated by dividing the burn rate by the company's current cash balance. It indicates how many months the company can survive with its current cash reserves.
Electronics Companies
Electronics companies, conversely, are more concerned with manufacturing costs, efficiency, and inventory management. Key metrics for this vertical are:
Revenue per Employee: This metric measures the productivity of a company's workforce.
Revenue Growth Rate: This metric tracks the growth of a company's revenue over a specific period.
Gross Margin: This metric represents the percentage of revenue remaining after deducting the cost of goods sold (COGS). It indicates the profitability of a company's core operations.
Days Sales Outstanding (DSO): This metric measures the average number of days it takes a company to collect payment after a sale. A lower DSO = faster collections.
Days Payable Outstanding (DPO): This metric measures the average number of days it takes a company to pay its suppliers. A higher DPO can bolster cash flow because it allows a company to hold onto its cash longer before paying suppliers.
Cash Conversion Cycle (CCC): This metric measures the time it takes a company to convert its inventory into cash. A shorter CCC suggests efficient inventory management.
Inventory Turnover: This metric measures how many times a company sells and replaces its inventory within a given period. A higher turnover indicates efficient inventory management.
Asset Turnover: This metric measures how effectively a company uses its assets to generate revenue.
Current Ratio: This metric gauges a company's ability to meet its short-term obligations.
Working Capital: This metric represents the difference between a company's current assets and current liabilities. It indicates the cash available for operations.
Net Income (Loss): This metric represents a company's profit or loss after all expenses have been deducted from revenue.
Net Income (Loss) Before Taxes: This metric represents a company's profit or loss before income taxes are deducted.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): This metric measures a company's profitability before considering interest, taxes, depreciation, and amortization. It's often used to compare the profitability of different companies.
Return on Equity (ROE): This metric measures how effectively a company generates profits using its shareholders' investments.
Return on Investment (ROI): This metric measures the profitability of an investment.
IT Services Companies
IT services companies emphasize customer satisfaction and efficient service delivery. Below are a few key metrics for this vertical:
Customer Satisfaction (CSAT): This metric measures how satisfied customers are with the services rendered.
Average First Response Time: This metric measures the average time it takes for a company to respond to a customer's inquiry.
Average Resolution Time: This metric measures the average time it takes to resolve a customer's issue.
Average First Assign Time: This metric measures the average time it takes to assign a technician to a customer's issue.
First Contact Resolution: This metric measures the percentage of customer issues resolved during the first contact.
Resolution SLA Percentage: This metric measures the percentage of customer issues resolved within the agreed-upon service level agreement (SLA).
First Response SLA Response: This metric measures the percentage of first responses delivered within the agreed-upon SLA.
Contact Oblique Consult
Smart tech founders know that a solid and scalable accounting and finance function is essential for any business to survive today’s cutthroat competition. It's indispensable for high-growth tech companies that are looking for venture capital to fund their next stages of growth.
That said, building a financial infrastructure is also not easy, especially for founders focused on product development or sales. Successful tech accounting demands skilled professionals, established processes, and relevant experience.
This is why most tech companies outsource their accounting to firms like Oblique Consult.
We shift accounting from a reactive task to a proactive driver of value, help tech companies unlock their full potential, and position them for sustained growth and market leadership.
Our team understands the unique challenges and opportunities facing tech businesses in the region and can help you develop a tailored financial strategy to achieve your goals. We also keep a pulse on all the relevant KPIs and financial metrics, provide valuable insights into their performance, identify areas for improvement, and make data-driven decisions that fuel growth and profitability.
