Financial accounting is a methodology for recording and classifying a firm's financial transactions, including reporting and analysis of these transactions. Accounting transactions are encompassed by the general ledger, which is a complete record of financial transactions over the life of a company. The general ledger (often referred to as “the books”) contains balance sheet and income statement accounts. Balance sheet accounts are assets and liabilities and stockholder's equity, and these accounts show a company's position at a specific moment in time. Income statement accounts include operating revenues and expenses, and show revenues, expenses, losses and net gain for a specified period of time such as a year or a quarter.
Accounting software automates transactional record keeping processes in each of these areas so that accounting transactions can be completed and tracked more efficiently and more accurately. As such, accounting software is quintessential back-office software concerned with record maintenance and regulatory compliance. This is quite distinct from corporate finance, which focuses on “front office” tasks like financial and strategic planning to maximize shareholder return.
But this broad definition of what accounting software does at the most basic level does not begin to describe the range of accounting software varieties on the market.
There are many different ways to segment the market, but the following broad distinctions can be made regarding the main different types of accounting software.
In the software realm, the term “accounting” is sometimes used interchangeably with Enterprise Resource Planning (ERP), but these software categories are not synonymous. ERP platforms certainly include general ledger accounting functionality, but they have evolved as fully-integrated platforms encompassing a broad range of capabilities usually including human resources, corporate performance management, customer service, supply chain management, manufacturing production and logistics, distribution and sometimes CRM. ERP products have evolved over time away from a unique focus on back-office processes and have swallowed entire software categories whole in pursuit of a single-platform approach.
The focus of this guide is accounting products, which necessarily includes ERP suites. But discussion of ERP products will be largely confined to the general ledger accounting aspects of these broad platforms.
Commercial firms use accounting systems to measure profit and loss performance by product, division, and company. Nonprofits have quite different accounting needs. Nonprofit fund accounting must track different funding sources and grants and allocate expenses across these funds. Additionally, funds must be carefully separated according to donors' restrictions. Nonprofits also need to understand the ratio of overhead to program expenses, which is a unique requirement.
Accounting software can be used by firms to manage their own accounting processes or by specialized firms (often public accountants) working on behalf of clients in what is sometimes referred to as a “platform-led BPO model”. Accounting firms using software products to serve multiple clients have an additional set of requirements, which are not a concern for standard users, such as a branded dashboard to share data with customers, or a billing bypass mechanism allowing the vendor to invoice to the CPA firm instead of the end-user client.
Traditionally, accounting software products were installed locally on servers located in the firm's location (on-premises software), and this kind of accounting software is still widely used today. Following the dominant trend in the broader software market though, many newer products are offered as cloud products, delivered over the Internet and accessed with a web browser. Older, on-premise-based installed products are sometimes offered in “hosted” deployments, but this is not the same thing. “Cloud” is usually used to mean Software-as-a-Service (SaaS) where the vendor manages the software application and the entire hosting infrastructure on behalf of all customers. The product is designed to be deployed in this one-to-many model and customers access the product through a simple web browser. An example of hosting is where a vendor offers a product that is usually installed on the customer's premises over the Internet, by hosting the software for a single client on a remote server, which is accessed via a client such as the Citrix client or a browser. This one-to-one model is not usually what is meant by when people talk about cloud software.
The primary general ledger features of most accounting tools include:
- Accounts Payable and Accounts Receivable, which includes automation and tracking of payment to vendors and suppliers and, on the receivable side, automation of invoices and collections.
- Cash management, which provides a complete picture of a company's cash flows, and streamlines payment processing.
- Bank reconciliation connecting the software to a company's financial institutions in order to reconcile accounting records with checking, savings and credit card accounts. Often month and year closing capabilities are included.
- Expense management for logging and tracking business expenses and reimbursements, including travel-related expenses, with the ability to tie them to particular projects.
- Time tracking enabling tracking of billable and non-billable employee time by project.
- Calculation and collection of sales tax for transactions.
- Fixed asset management, including location, checkout, maintenance scheduling, audit history, cost and depreciation.
- Support for transactions across multiple locations or branches and foreign currencies.
- Regulations compliance whereby the software helps users adhere to typical accounting standards and regulations such as IFRS, GASB, or GAAP.
- Security features like role-based user permissions and single-sign on capability.
- Reporting analytics including standardized reports like profit and loss, sales tax return, depreciation, foreign exchange gains and losses, etc., as well as customizable dashboards
In addition to these fundamental features, some accounting and especially ERP products also handle:
- Inventory management or the ability to track and manage the flow of goods or materials into and out of an inventory.
- Order management, which covers the ability to process orders, and track them from quote to cash.
- Payroll management, which handles employee salaries including payroll taxes like income tax withholding, social security, and federal unemployment tax.
Perhaps the biggest business technology story of the past ten years has been the rapid ascent of the cloud deployment model to a position of unquestioned dominance in the business software sector in general.
This is also one of the most significant areas of discussion in the accounting software realm today. Accounting and financial applications have been slower to switch to a cloud delivery model than some other sectors, partly because of client concerns around change management and potential client impact, in addition to security worries. Indeed, many companies are still using on-premise software like QuickBooks Desktop, AccountEdge, and Sage 50 (formerly Peachtree), all of which are fully featured and well established products. However, a wave of change is starting to build from the low end, as a number of cloud products designed for small businesses have emerged, such as Xero and Wave, as well as cloud products from QuickBooks, AccountEdge, and Sage. Similarly in the mid-market segment, some cloud vendors, most notably Intacct and NetSuite, have emerged to threaten the ground occupied by legacy installed ERP systems. The ERP world is still dominated by on-premise tools, but this too is changing. Cloud-based, or SaaS products (these terms are often used interchangeably even though they are not synonyms) have effectively won the day in other domains like CRM, which is now dominated by cloud pioneer Salesforce.com. The era of installed or on-premise software is coming to a close, and, in the accounting sphere as in others, the future is cloud deployment.
The advantages of the cloud deployment model include:
- No CapEx expense: No outlay for infrastructure and software. Instead, software is paid for monthly on a pay-as-you-go plan
- Access the software from anywhere: Users can access the software from anywhere they have an internet connection
- No upgrade or patch worries: Vendor updates the software and all customers are automatically on the latest version
Strongly related to the cloud deployment model is the growing importance of programmatic integration with other systems. Historically, accounting packages started life as simple general ledger tools for managing debits and credits. Over time though, CFOs began to see that having islands of general ledger functionality was of limited value, and that integration with other financial capabilities was essential. As a result, vendors began to build broader accounting suites, adding things like accounts payable and receivable, payroll, bill payment, inventory management, etc.
The cloud computing revolution transforming the accounting software sector has radically challenged this integrated suite approach paradigm. It is no longer necessary to purchase a fully integrated suite that does all the things you need it to do. The fact that products now reside in the cloud and do not need to be installed, means that it is much easier to pick and choose discrete products to handle different parts of the financial value chain. A financial accounting system can quite easily be hooked up to a best-of-breed payroll system or an expense management system. It's also relatively straightforward to integrate with an off-the-shelf business intelligence tool to produce automated visualizations of key financial metrics like accounts receivable days, debt to equity ratio, ROI and return on capital employed.
But integration is about more than just adding functional capabilities. There is significant value in automating processes so that human beings are freed from the drudgery of simple data entry. For example, a newer generation of cloud products like Wave and Xero are capable of importing bank data directly, eliminating the need for manual data entry. Automating clearing house transactions and data interchange further reduces manual coding. The automation of all data entry by tight integration with these external systems allows CPAs to concentrate on more strategic tasks while the technology handles the mechanical bookkeeping aspects.
Intuit has owned the small business accounting space for many years with QuickBooks, and still has about 90% market share. QuickBooks Online, which was released more than a decade ago, but has struggled in the face of emerging competition from pure-play online vendors. A sign of that competition is the fact that a completely modernized version of the QuickBooks Online product was released in 2013, with a more intuitive interface design and separate apps for iPad and iPhone.
New online products like FreshBooks, Kashoo, Wave and Xero have been designed for Internet deployment and each has an elegant, consumer-like design and an intuitive user interface. These products are generally easier to use for novice users than any QuickBooks product. Indeed, many of their customers are former QuickBooks users who have switched because they have found QuickBooks too difficult to use. These new tools are also inexpensive and one of the three—Wave—is actually free (it's supported by advertising revenue).
However, these products still command only a small portion of the market and are generally less fully-featured than the various flavors of QuickBooks Desktop. The on-premise versions of QuickBooks are still very popular with accountants and small businesses for exactly this reason. But the landscape is definitely shifting, and small businesses have more choice than ever before. As evidence of this change Brad Smith, CEO of Intuit, recently reported that “for Intuit's FYE2014 for the first time more new QuickBooks users chose the online version than the a traditional desktop version. Contrast that with our income tax preparation products where that shift happened 7 or 8 years ago.”
A similar dynamic is playing out at the mid and high-end where cloud pioneers like NetSuite, Intacct, and Workday are challenging the hegemony of traditional industry behemoths like SAP and Oracle. Many of the on-premise ERP heavyweights have made decades of investment in on-premise solutions only to see flat or declining sales while NetSuite and Intacct, for example, have been experiencing double-digit growth for the last several years. The response of the traditional on-premise vendors, of course, is to reposition their offerings and develop a coherent cloud strategy without abandoning their existing platforms. SAP has achieved some success with its cloud-based HANA technology, while Oracle is struggling to upgrade on-premise customers to its cloud platform, now called Oracle ERP Cloud. However, as with QuickBooks in the small-business market, these vendors do have a very dominant share of the market, and the challenge from new cloud vendors is still nascent.
The three main cloud challengers have relatively low market share with very high growth rates; they are, however, quite different one from another.
Intacct is a small to upper mid-market product serving a range of customer types from technology startups to divisions of multinational corporations. It is focused exclusively on finance applications, with strong integrations to other business applications like Salesforce.com. The Intacct Marketplace showcases a rich ecosystem of third-party integrations, some built by Intacct itself and others built by vendor partners.
NetSuite, on the other hand, is an integrated suite with a broad range of capabilities designed for larger customers. NetSuite's main product includes a fully featured ERP platform with financial management, ecommerce, order management and inventory control, and a CRM, in addition to a professional services automation (PSA) offering. Workday is a true large enterprise platform with an enviable growth rate of around 70% year over year.
BPO for small and medium firms is not a new phenomenon and is technology-driven, in a model that might be referred to as “platform-led BPO”. This, as the name implies, is all about using technology to facilitate collaboration between firms and public accounting firms and implement industry best practices. The use of technology to create lasting value through automation and best practices depends greatly on accounting software developments, and for that reason has gone through its own evolution. Initially, companies using on-premises products like QuickBooks used outsourcing as a way of securing write-up or financial statement compilation services. This cannot be considered true BPO, but is a kind of precursor. The next phase in the development of this model was accounting firms hosting desktop software on a server such that clients could log into the software using a Citrix client. But the real platform-led BPO tsunami was made possible by the development of cloud software, which enabled the accounting firm and clients to share the same software instance and to see precisely the same data in real time.
Accounting firms frequently offer outsourcing or BPO services to companies who do not have the staff, the skills, or the desire to manage F&A processes themselves, or desire to focus on only their core business, or who want to gain efficiencies and hence lower costs. Services offered span a spectrum from handling a few transactional services such as payroll, accounts payable and receivable, bookkeeping, etc. to offering more strategic services like tax management, yield management, or risk analysis. Specialization in vertical markets is also driving BPO adoption, and accounting firms frequently specialize in a particular market niche. Specialization allows accounting firms to acquire detailed knowledge of the challenges faced by companies in their niche and provide customized dashboards and benchmarking data.
The CPA firm sometimes (but not always) dictates the accounting platform to be used, and most CPA firms have expertise in a number of different cloud platforms to service clients of different types and sizes. Best practice for leading forms is standardize on a few platforms and then dictate the platform, but some firms default to the product that the client firm is already using. There are different models for CPAs in public practice, from referring clients to a particular vendor, to running the software on behalf of a client, to actually re-selling the software. Many accounting products now have CPA versions, which have been specifically designed to facilitate use of their products in this BPO model.
A typical scenario is the CPA firm setting up and running the software on behalf of clients and providing detailed views of the data via dashboards, which allow for mutual decision-making.
The goal of outsourcing from the CFO or financial executive standpoint has always been the same: removing some of the administrative cost overhead from a fairly rote set of operations. The traditional meaning of BPO usually adopted by large companies with over 1,000 employees is the model whereby large service providers like Accenture, Wipro, and Infosys essentially outsource accounting labor offshore to save money by wage differential arbitrage. Although still very widely implemented, this model, some analysts argue, has not achieved the desired aim for the simple reason that a model based on cheap labor is unlikely to be sustainable over the long term. In this model, less attention is paid to things like process standardization and automation through technology that are likely to make a significant difference. In short, a cheap labor model alone is unlikely to lead to sustainable value creation.
The following diagram shows the distribution of accounting products across size of client organization with the traditional sweet spot for CPA outsourcing services.
The following table summarizes the products featured in this guide, and gives an indication of the size of organizations typically served, whether they are on-premise or installed, and whether they are an ERP suite (vs. financials only). This is a useful guide to orient product selection according to the most basic criteria.
There are also additional factors worth considering.
Almost all accounting platforms have additional features beyond the core general ledger transactional accounting capabilities. Many, including small business-oriented solutions, have additional capabilities around things like payroll, time tracking, invoicing, electronic billing, and even business intelligence for analytics and reporting. It's important to understand which additional capabilities are built into the platform and whether they come at an additional cost.
The table above indicates products that are ERP platforms, rather than pure accounting products. However, ERP can mean a lot of different things. For example, although Intacct refers to itself as a “cloud ERP” platform and does include inventory management and project accounting, it is very focused on the accounting function and does not have the broad array of additional capabilities found in some other ERP products. NetSuite on the other hand has a very complete ERP product including supply chain, procurement, warehousing and fulfillment, human capital management and more. The core suite also includes customer relationship management (CRM), professional services automation (PSA), and ecommerce capabilities. Workday, in addition to financials, has its origin in a broad suite of HR tools.
Given the resurgence of a best-of-breed model, it is important to understand the ease of integration to specific 3rd-party systems. Instead of having to build connectors to target systems by using the API (which will be beyond the expertise of many companies), it is preferable if there are pre-built connectors to systems customers need to leverage. For example, Intacct has a connector to Salesforce.com, which can be set up with a few clicks and does not require IT support or help from expensive consultants. Xero has a connector to ADP Run, an HR platform specifically designed for small businesses. NetSuite too has connectors to other systems like Salesforce, Oracle E-Business Suite, SAP ERP and Google Apps. It is important to understand which connectors exist, whether they are third-party connectors or build in to the accounting application, how well they function, and which ones might be on the roadmap.
Elegant design is not a characteristic normally associated with accounting software, which historically has been functional but far from beautiful. However, some of the newer vendors in the small business sector have started to change that perception. The general trend known as the consumerization of business software has improved software usability dramatically across many different domains as vendors strive to match the completely intuitive experience they have come to expect from products like the iPhone. Accounting products too are starting to benefit from this phenomenon. For example, Xero was designed with usability in mind from the very beginning, and it looks much more like a consumer application than a business application. Intacct, in the mid-market, has also designed a clean, intuitive product with more of a consumer look-and-feel. Well-designed and even beautiful products are products that people love to use. Additionally, intuitive workflows produce far fewer calls to support with the consequent loss in productivity that implies. Product design and usability can no longer be considered simply “nice to have” but are an inherently critical factor in successful product adoption and ROI.