Financial management in an IT company

Issues of financial accounting, planning and budgeting - an acute and relevant topic for all IT companies. As the company grows, cash flow is difficult to control and it becomes obvious that a systematic approach is needed.

Depending on the types of products and services that it produces - the accounting methodology in IT companies may differ significantly. Custom software development, the release of packaged solutions, the availability of technical support, the issuance of updates, the use of third-party licenses can significantly affect the recognition of income and expenses and the cash managment of an organization. An important basis for the organization of accounting and budgeting is the division of the company's activities into projects and the allocation of costs (not forming the cost price) into a pool of projects, according to a predetermined methodology.

Where to begin?

Earnings model

Initially, the management and owners of the company should determine and approve the model of earnings. That is, what the company will make money. This may be the production of a box solution, issue of licenses for use, custom development, etc.). Most often, the company will have two or more revenue generation options. Depending on the type of revenue, the income taxation system will also differ (licenses are not subject to VAT, technical support and sales of services include VAT). Given this, you can competently build a system of costs, as those who will form the cost, and those who will be recognized as costs of the period.

Project cost and pricing

The peculiarity of most IT companies in the absence of a large number of fixed assets. This is not a factory, not a production company and the main assets are people, specialists, developers, linguists, testers. It is their knowledge, skills and competencies expressed in customer services or products that generate revenue. On how the company manages this resource, and its cash flow and financial well-being depend.

In the Russian market, it is customary to use one of two pricing models (Fixed Price or Time & Materials).

The first model is the traditional model of project development, when the customer and the project manager determine the entire scope of work in the technical assignment, agree on a fixed budget and exact project implementation dates. In Fixed Price (or FP), customers pay for the final result, and the performer - the time of their developers. In this case, if programmers spend more time on development, and the budget does not change, then the company's profit decreases. Therefore, a lot depends on the ability of managers to estimate in advance the labor costs. Although the risks and force majeure may arise in any project.

The second model - Time & Materials (TM) - is the payment by the customer of actually spent resources - developer time.

Regardless of the model used, it is important to have an accounting system that shows what the total budget is, how much has already been done, how many hours it has spent - the Timesheet system.
Usually one developer takes part in the creation of some part of the project, and a large number of personnel participate in the production of the whole product. To accurately calculate how much a specific project costs for a company, it is necessary not only to take into account the cost of developer costs for the timesheet, but also to introduce a cost allocation system for fixed and variable costs. It is important for planning the project prices to take into account the costs not directly related to the development (such as space rental, office maintenance, etc.). They can be expressed in terms of OPEX per person per day or month. This approach will help to avoid “consuming” the project margins.

 The important point is to keep the plan \ the fact of the project budget in real-time mode. This will provide management with accurate data on the progress of the project, its current profitability and will provide an opportunity to warn or prevent the project from exceeding the budget or adjusting the cost of the project in time.

Where to begin…

  • determine the cost of each developer and other technical specialists
  • plan the timing of the work
  • break the project into stages: development, testing, commissioning, etc.
  • plan the budget for the purchase of equipment (if required) for the project

Technical equipment for costing, budget planning, management accounting

  • At the initial stage, for planning and accounting purposes, it is quite possible to manage with MS Excel or Google sheets.
  • As far as the company is simple, the management must take care to automate the process.
  • Today, the market has a fairly large number of specialized software. Starting from a fairly budget based on 1C to serious designers based on Olap cubes (Cognos, Anaplan). And other specialized solutions (Axapta, Navision, SAP)

Assessment of profitability of projects and business

Competent accounting and accurate distribution of time for projects will allow to evaluate the profitability of the project. The main problem of young companies is the attachment to accounting only in money, in fact in terms of cash flows. Such an approach significantly distorts information on the company and leads to disastrous results. It is more correct to do the calculation of the profitability of the project as well as the business as a whole, using the accrual method (that is, generating a report on the profits and losses of projects and companies), analyzing the company's solvency in terms of cash flow on projects and costs incurred, and on the basis of the balance sheet, income statement and loss and cash flow statements to produce a comprehensive analysis of the stability of the company.

Project accounting by accrual will allow to divide project revenues as part of total revenue. And the project cost and its factor analysis will show the share of project costs and the reasons for savings or overspending.

This approach will make it possible to single out unprofitable projects, for management to take measures to reduce losses or review development strategies. The result of the analysis should be not just bare numbers, but the conclusions of a competent specialist who will help make the right management decisions.

A good rule is to develop a KPI system for the project as well as for the company as a whole. Monitoring the implementation of KPI will provide a guarantee of business transparency for owners and managers.

The company-developer of games for mobile devices over the years has accumulated a number of unfinished projects. Financial analysis showed a decline in returns of 35% of projects. Based on the results of the analysis, the management decided to revise the conditions for projects that maintain growth potential and to complete projects whose life cycle is nearing completion.

Expenses that do not form a cost price

The cost is certainly a fundamental factor in obtaining an acceptable project margins, but in addition to it there are a number of costs, planning and accounting for which, when forming a commercial proposal, is also important.

Marketing, sales costs, payroll costs of administrative and support staff, taxes, administrative and management expenses, depreciation, interest on loans, etc. can be a significant part of the cost. The combination of such costs is better expressed in terms of OPEX. And the resulting value is used to determine the minimum comfortable profitability of the project.

Control points and financial indicators

Company management is vitally important to allocate time for a comprehensive analysis of current project results. Together with the leaders of the project teams to analyze the production and financial situation of the work and in the whole company.

Cost of projects: analysis of actual costs incurred for the project. Identification of problem projects or areas of work.

The amount of productive time and losses (Time is money). Analysis of financial indicators in conjunction with the production will give an understanding of the resource base. For example: writing off more developers' hours into the cost than planned should push the company's management to pay attention to the competence of the staff of developers, to take measures to improve the level of professionalism of workers, training, etc. Or revise the project planning methodology.

Profitability of projects. Controlling profitability of projects and business is a vital thing. Based on accurate accounting and planning. The magnitude of the fixed costs of business, as a rule, is static and should be included in the marginality of each project. Management determines the acceptable level of profitability of projects and business that should serve.
The structure of indirect costs: determine how much money spent on rent, development of employees, administrative staff and other indirect costs.

What if there is not enough money?

Initially, we must accept that the lack of money in the current account at the time does not mean that the business is unprofitable. Actually, as well as the opposite statement. Cash gap can be formed for various reasons. Like: losses due to low profitability, “bloated” costs, accumulated accounts receivable (in fact, this is lending to the buyer or customer), high levels of OPEX, etc. Regardless of the causes of the cash gap, it can be predicted and prevented.

Prevention measures

  • The introduction of financial planning, accounting and controlling.
  • Periodic level control OPEX. Revise it if necessary.
  • Control of minimum project profitability.
  • Active work with receivables and payables.
  • Attraction of borrowed funds.
  • Attracting investment. 

What to do with free money? Or money should bring money.

If there is an excess money supply at the moment of time, it will be logical to develop measures for their proper use (the withdrawal of the owner's dividends does not count).

Free cash can be invested in the development of the company: in staff training and raising the level of professionalism, in updating fixed assets. 
Or send cash surplus “earn”: to make investments in financial instruments of the banking or exchange sectors.

Recommendations to owners and managers of IT companies

  • Develop a system for recording the working time of production personnel.
  • Calculate the cost per hour of work of each group of production specialists for a clear understanding of the calculation of the cost of the project.
  • Calculate the cost of maintaining all employees per month (enter OPEX). This will help determine the optimal estimated level of project profitability.
  • Maximum automation of cash flow planning, compile a register of applications for payment and the payment calendar.
  • Pre-detect cash gaps and carry out measures to prevent gaps.
  • Invest in employee training and improvement of their professionalism.
  • Develop KPI indicators for projects and business. Monitor their implementation.
  • Do not focus on accounting and planning cash flow only. Develop a system of management accounting, planning and forecasting.
  • Implement rolling budgeting in the dimensions of "Plan", "Forecast", "Fact".
  • Use the opportunity to reduce the tax burden (accreditation to the Ministry of Communications and reduce deductions from the payroll fund from 30 to 14 percent, change of legal location to free economic zones or IT clusters such as Skolkovo, Innopolis FEZ, etc., reduce the income tax due to R & D, reduce the tax on profit due to instant depreciation, get regional benefits, get rid of VAT).

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