Accounting for small software and technology companies

Did you know that the UK is ranked fourth most innovative place in the world? If you’re thinking about starting a tech-based business or working as an IT contractor, the UK is an excellent place to call home. Britain’s tech scene is booming and there’ll be plenty of opportunities for you along the way. 

According to recent research, the UK had:

• Seven new unicorn companies in 2020, which takes the total to 80, more than Germany and France combined.
• In 2020 UK tech venture capitalists invested $15 billion, making UK investments third in the world, behind only the USA and China
• In the previous ten years, the AI sector has grown by 145%, with London as the AI European capital.

Throughout your journey, it’s essential to keep a close eye on your finances and make sure you understand the basics of accounting.

Keep reading to learn more about accounting for technology companies. We’ll cover everything you need to know when starting a tech company, in order of how you’ll encounter each one, including:

• Securing funding for your technology business
• Establishing a funding roadmap
• Financial reporting for technology companies
• Revenue recognition for technology companies
• IR35 tax
• R&D tax credits
• Why you need tech-driven accounting software
• How to choose the best accounting software for your technology company

Technology businesses rely on funding to get their idea off the ground, bring a new product to market, and ultimately grow their company, especially since you may not start seeing revenue or sales until after you have a developed product with a defined market fit. 

Tech startups attracted over $13.2 billion in funding in 2019.

If you’re starting out, it’s essential to understand the funding lifecycle and how you can build an investment strategy to attract investors and get the funding you may need to make your vision a reality.

As your company grows, you’ll go through different stages and need different types of funding. While you may be a one-person band now, it’s essential to know about the different stages so you can plan for your future.

When you’re just starting out, you’re likely to be bootstrapped. Bootstrapped companies build from the ground up using owners’ savings and investments from friends or family members.

Once your initial investment runs out, you’ll then need to start fundraising rounds. By this point, you should have a clear idea of your product, understand the wider market, and demonstrate a need for your product. You have probably already started to build your product or, at least, have a plan on how you’ll do so.

Investments will still come from friends and former work colleagues, but you may also get funding from angel investors, incubators or accelerators. You might also secure funding from government grants.

You should have a working prototype at the seed stage, some trial users, and possibly a small amount of sales. You’ll now need to do more extensive funding round to launch your product and drive customer acquisition.

You may attract investments from angel investors and very early-stage VCs (though most tend to focus on Series-A onwards). Crowdfunding may also be a good option if you have a retail-focused product.

Once you reach Series A, you’ll stop being a small startup and start being a serious market competitor. By this stage, you’ll typically have £500,000 or more in revenue and have a team on payroll. The journey doesn’t stop here as you’ll need to continue through series B, C, D and so forth till you eventually exit.

1. Approach funding as a long-term strategy

You need to think about the future as well as your immediate funding round. 

When you’re just getting started, it’s essential to find an investor who understands your business and can offer support and guidance for getting you off the ground.

Investors will want to know about your finances and have a clear record of financial performance at every stage of growth (even in these early days).

You’ll need to decide early on whether to give equity to your first investors. Investors at a later stage will certainly want equity, so you may want to hold onto it at the beginning and avoid giving too much away.

When you start to attract investors, they’ll want to know about your financial performance to date. This includes tracking and reporting your financial performance from the very beginning. Think of it this way, if you get used to financial reporting now, you’ll be able to take on much more complex reporting at a later stage.

Accounting software geared at small technology companies can be a great way to get started and offer you the support you need to make accounting simple. At the same time, you focus on turning your startup into the next unicorn.

Technology companies will need a system for recognising their revenue. Most tech companies use a five-step revenue recognition model to report on their turnover.

The first step to revenue recognition is to make sure you have a contract in place with any customer or client. Even software companies need a contract, which often takes the form of terms and conditions. This contract sets out the framework for engagement and how much you’ll be paid, and when.

Some technology brands may deliver a product or service that’s meant to achieve specific performance obligations. You want to agree on these obligations early on to understand what you need to do to keep your customer happy and ultimately get paid.

When you’re first getting started, you may need to do some market research to determine how much to charge. You’ll need to experiment to find the right price point and ensure your product is profitable in the long run.

Now you can determine the contract’s total value and how much your company will earn from the transaction.

At this final stage, you need to account for the revenue received from delivering the goods or services. Accounting software can make this process super easy.

Technology companies are in a prime position to benefit from R&D tax credits. Research and Development (R&D) tax credits are geared at supporting companies that work on innovative projects in science or technology fields.

Suppose you’re developing a brand new, innovative product that’ll advance your field. In that case, you’ll likely qualify for R&D. R&D can even be claimed for unsuccessful projects, like a new software that never makes it to market or an AI programme that doesn’t quite work as expected.

Small companies with less than 500 employees and a turnover of under €100 million or a balance sheet under €86 million can claim SME R&D relief. 

With SME R&D relief, you can:

• Deduct an extra 130% on qualifying costs from your yearly profit as well as the standard 100% deduction. This gives you a total deduction of 230%.
• If your company runs at a loss, you can claim a tax credit for up to 14.5% of surrenderable losses.

R&D tax relief can give your business some much needed extra support to help through the early bootstrap, pre-seed and seed stages.

When you’re busy building your new product, you don’t want to spend hours crunching numbers or reconciling your accounts. Accounting software can make sure your money is spent wisely (essentially if you’re relying on funds from friends and family), free you up to spend more time on product development and make sure your accounting operations are fully streamlined. 

Accounting software can also automate processes such as revenue recognition, processing payments and filing end of year tax returns. As a small technology business, accounting software can benefit you by:

If you’re still in the bootstrap phase, you’ll want to make sure your funds and personal savings can go as far as possible. This requires keeping a close eye on your cash flow and monitoring any outgoings. Make sure all outgoings are genuinely essential, and you’re not spending money on anything you don’t need.

Accounting software can help you keep up-to-date records, which improves the accuracy of your cash flow and allows you to see when exactly you’ll need to raise funds and find further investment for your tech startup.

If you’re a small, one-person technology business in the early startup stages, you’ll need to spend your time wisely. There’s a lot to do, including building and finding customers for your product. Automating your accounting can save you up to an hour every day, which you can then focus on your product.

When you have investors, even if they’re family and friends, you’ll need to provide financial reports and show them a return on investment. They’ll want to know that their money is being put to good use and that you’re making progress. Financial reporting is a great way to keep everyone in the loop and show the credibility of your business to future investors.

When you’re carefully monitoring expenses and trying to stretch funds as far as possible, the last thing you want are penalties for missed payments or tax deadlines. Accounting software helps you stay alert to upcoming tax deadlines, invoice due dates and much more.

Choosing the best accounting software for your tech startup is essential for setting the right foundations and starting the journey towards unicorn status. It’s worth taking the time to find the best possible solution for your business needs.

Here are some of the features you’ll want to look for to find the best accounting software for your tech startup:

You’ll want accounting software that’s straightforward and easy to implement so you can get it up and running and go back to focusing on your business.

You don’t want to spend hours creating invoices and processing customer transactions. The best accounting software will make this process quick and easy.

You’ll need accounting software that helps you keep a close eye on your profit and loss. With real-time profit and loss, you’ll have up-to-date insights so you can make smart financial decisions about how your business grows.

If you’ve got big ambitions for your tech startup, you’ll want accounting software that can develop and scale as your business grows.

You might also want to choose accounting software with strong reviews from small business owners.

With Countingup, you can apply for a business current account online in minutes and for free. It automates the time-consuming aspects of financial admin, saving thousands of UK business owners time and money. Find out more here.