How do Businesses Report Cloud Computing Implementation Costs?

Today, many organizations rely on cloud-based tools to store and manage data. However, the costs to set up cloud computing services can be significant, and many business owners are unsure whether the implementation costs must be immediately expensed or capitalized. Changes made in recent years provide some much-needed clarity to the rules.

Advantages of cloud storage

Before diving into the accounting rules, it’s important to understand the potential benefits of cloud-computing arrangements, including:

Cost savings. Cloud storage reduces the need for physical servers and IT infrastructure, lowering capital expenses.

Remote access. Cloud systems let your team access data and tools from anywhere. This can be ideal for hybrid or remote work models — or small business owners who frequently travel.

Scalability. As your business grows, cloud services can easily scale to match your data and software needs.

However, it’s critical to vet cloud-service providers carefully. Always choose a provider that offers strong security protocols and automated data backup. This reduces the risk of data loss from hardware failure or human error. As companies grow, they may decide to switch to cloud providers that offer enhanced security or more robust features.

Implementation costs

Whether your business is adopting cloud services for the first time or transitioning from one provider to another, setup costs can be significant. These often range from several thousand to tens of thousands of dollars. First-time implementation costs typically include:

• Consulting and planning,

• System configuration,

• Data migration,

• Integration with existing tools,

• User training, and

• Post-launch support.

Among the most labor-intensive, expensive parts of the process are migrating data securely and ensuring that cloud applications are tailored to your workflow. Additionally, time spent coordinating between your team, vendors and consultants can add up quickly.

Switching cloud providers can also be costly. You’ll likely need to repeat many of the same implementation steps. Plus, you might face other challenges, such as reformatting or cleaning data, re-establishing integrations, retraining employees and minimizing downtime. Some providers may charge exit fees or make data retrieval cumbersome. The more customized your current system is, the harder (and costlier) it may be to transfer your setup to a new platform.

Accounting rules

Previously, U.S. Generally Accepted Accounting Principles (GAAP) required companies to immediately expense all setup costs for cloud contracts that didn’t include a software license. This treatment impaired a company’s profits in the year it implemented a cloud-computing arrangement.

Fortunately, the Financial Accounting Standards Board updated the accounting rules in 2018. Now, businesses can capitalize and amortize certain implementation costs for service contracts that don’t include a software license. Specifically, costs related to the application development phase — such as configuration, coding and testing — can be capitalized and gradually expensed over the life of the contract. However, costs from the preliminary research phase or post-launch support still must be immediately expensed. Spreading out certain implementation costs over the contract’s life can improve financial ratios and reduce year-over-year volatility in reported profits.

The updated guidance went into effect in 2020 for calendar-year public companies and in 2021 for all other entities. However, you may not be aware of these changes if your company is adopting cloud services for the first time — or if you previously implemented a cloud arrangement under the old rules and are now switching providers.

For more information 

The accounting rules for cloud computing arrangements can be complex, especially when determining which costs qualify and how to apply them across different contracts. Contact FMD for guidance on reporting these arrangements properly under current GAAP. We can help you review agreements, classify implementation costs, and choose a provider that offers both strong security and the functionality your business needs.

Budgeting Basics for Entrepreneurs

Starting a business can be rewarding, but the financial learning curve is often steep. The U.S. Bureau of Labor Statistics estimates that one in five new businesses will fail within one year of opening, roughly half will close within five years, and less than a third will survive for 10 years or longer. A common thread in early failures is weak financial planning and oversight.

A comprehensive, realistic budget can help your start-up minimize growing pains and thrive over the long run. However, accurate budgeting can be difficult when historical data is limited. Here are some tips to help jumpstart your start-up’s budgeting process:

Start at the top

First, forecast the top line of your company’s income statement — revenue. How much do you expect to sell over the next year? Monthly sales forecasts tend to become more reliable as the company builds momentum and management gains experience. But market research, industry benchmarks or small-scale test runs can help start-ups with limited history gauge future demand.

Next, evaluate whether you have the right mix of resources (such as people, equipment, tools, space and systems) to deliver forecasted revenue. If your current setup doesn’t support your goals, you may need to adjust your sales targets, pricing or operational capacity.

Get a handle on breakeven

Many costs — such as materials, labor, sales tax and shipping — vary based on revenue. Estimate how much you expect to earn on each $1 of revenue after subtracting direct costs. This is known as your contribution margin.

Some operating costs — such as rent, salaries and insurance — will be fixed, at least over the short run. Once you know your total monthly overhead costs, you can use your contribution margin to estimate how much you’ll need to sell each month to cover fixed costs. For instance, if your monthly fixed costs are $10,000 and your contribution margin is 40%, you’ll need to generate $25,000 in sales to break even.

However, don’t be discouraged if your small business isn’t profitable right away. Breaking even takes time and hard work. Once you do turn a profit, you’ll need to save room in your budget for income taxes.

Look beyond the income statement 

Next, forecast your balance sheet at the end of each month. Start-ups use assets to generate revenue. For instance, you might need equipment and marketing materials (including a website). Some operating assets (like accounts receivable and inventory) typically move in tandem with revenue. Assets are listed on the balance sheet, typically in order of liquidity (how quickly the item can be converted into cash).

How will you finance your company’s assets? Entrepreneurs may invest personal funds, receive money from other investors or take out loans. These items fall under liabilities and equity on the balance sheet.

Monitor cash flows

Even profitable businesses can run into trouble if they fail to manage cash wisely. That’s why cash flow forecasting is essential. Consider these questions:

• Will your business generate enough cash each month to cover fixed expenses, payroll, debt service and other short-term obligations?

• Can you speed up collection or postpone certain payments?

• Are you stockpiling excess inventory — or running too lean to meet demand?

Forecasting monthly cash flows helps identify when cash shortfalls, as well as seasonal peaks and troughs, are likely to occur. You should have a credit line or another backup plan in case you fall short.

Compare your results to the budget

Budgeting isn’t a static process. Each month, entrepreneurs should revisit their budgets and evaluate whether adjustments are needed based on actual results. For instance, you may have underbudgeted or overbudgeted on some items and, thus, spent more or less than you anticipated.

Some variances may be the result of macroeconomic forces. For example, increased government regulation, new competition or an economic downturn can adversely affect your budget. Although these items may be outside of your control, it’s critical to identify and address them early before variances spiral out of control.

Seek external guidance

Does your start-up struggle with budgeting? FMD can help you prepare a realistic budget based on past performance, industry benchmarks and evolving market trends. Contact us to help your small business build a better budget, evaluate variances and beat the odds in today’s competitive marketplace.