Commercial traction is a good sign for an SBIR/STTR company.

 

Customer pilots, paid demos, early product revenue, private contracts, investor interest, and commercialization activity can show that the technology has market potential.

But once commercial work begins, the accounting becomes more complicated.

 

The company now needs to separate federal award activity from customer-funded work, commercial product development, sales activity, fundraising, internal R&D, and general business costs.

 

That separation matters because federal funds should support the approved award scope, not general company growth or customer revenue activity.

 

At Peter Witts CPA PC, we help SBIR/STTR companies separate federal and commercial costs so award-funded R&D, customer-funded work, product development, sales activity, indirect costs, and internal business expenses are tracked clearly.

 

Why Federal and Commercial Cost Separation Matters

 

SBIR/STTR companies often operate in both worlds at the same time.

 

One team may be completing award-funded R&D while another team is preparing for customers, partners, investors, pilots, or market launch.

 

Sometimes the same founder, engineer, scientist, developer, or product lead supports both.

 

That creates accounting risk.

 

The company should be able to answer:

• Which costs support the federal award?
• Which costs support customer work?
• Which costs support commercial product development?
• Which costs support sales or marketing?
• Which costs are internal R&D?
• Which costs are general business expenses?
• Which costs are indirect?
• Which costs are unallowable for the award?
• Which records support each classification?

Without separation, the company may unintentionally charge commercial activity to a federal award.

 

Start With the Approved Award Scope

 

The first question is whether the cost supports the approved federal award.

 

Review the award documents:

• Notice of Award or contract
• Approved statement of work
• Approved budget
• Budget justification
• Project milestones
• Period of performance
• Agency terms and conditions
• Prior approval requirements
• Reporting obligations

A cost should not be charged to the federal award simply because it relates to the same technology.

 

The cost should support the approved award work.

 

For example, developing a prototype feature included in the approved statement of work may be award-funded R&D. Modifying the product for a specific paying customer may be customer-funded work. Preparing investor materials may be fundraising. Running sales demos may be commercial activity.

 

The distinction depends on the activity, not just the product.

 

Define Federal Award Work

 

Federal award work should be tied to the approved project.

 

This may include:

• Research tasks
• Prototype development
• Technical experiments
• Data analysis
• Testing and validation
• Award-specific engineering
• Approved software development
• Approved materials and supplies
• Approved consultant work
• Approved subaward activity
• Award-specific technical reporting
• Work tied to milestones or aims

Costs charged directly to the award should be necessary for that work, allocable to the award, and supported by records.

 

2 CFR 200.403 explains that costs must be necessary and reasonable for the federal award and allocable to that award.

 

Define Customer-Funded Work

 

Customer-funded work is work performed for a customer, pilot partner, commercial contract, beta user, or other non-federal revenue source.

 

This may include:

• Paid pilot implementation
• Customer-specific customization
• Commercial support
• Customer onboarding
• Product configuration for a client
• Customer data integration
• Service delivery
• Customer-funded testing
• Commercial deliverables
• Customer success activity

Even if the work relates to the same technology funded by the SBIR/STTR award, customer-funded work should generally be tracked separately.

 

The company should be able to show that customer costs were not charged to the federal award.

 

Define Commercial Product Work

 

Commercial product work may support the broader business rather than the federal award.

 

This may include:

• Product roadmap planning
• Market-driven feature development
• User interface improvements
• Packaging
• Pricing strategy
• Manufacturing scale-up
• Customer implementation tools
• Sales enablement materials
• Product launch planning
• Channel partner preparation
• Commercial release work

Some commercial product work may be related to federal R&D, but it may not be part of the approved award.

 

NIH states that SBIR/STTR funds cannot support commercialization activities except through Technical and Business Assistance or Commercialization Readiness Pilot funding opportunities.

 

That makes cost separation especially important for NIH-funded companies and a useful discipline for all SBIR/STTR awardees.

 

Define Sales, Marketing, and Fundraising Activity

 

Sales, marketing, and fundraising should be tracked separately from federal award work.

 

These activities may include:

• Sales calls
• Customer demos
• Trade shows
• Marketing campaigns
• Website updates
• Pitch deck preparation
• Investor meetings
• Due diligence support
• Fundraising strategy
• Partnership development
• General business development

These activities may be important to the company’s growth, but they should not be automatically charged to the award.

 

If a founder or technical employee spends time on sales, fundraising, or commercialization, that time should be coded separately in timekeeping and labor distribution.

 

Separate Internal R&D From Award-Funded R&D

 

Internal R&D is another common gray area.

 

A company may be improving the same technology platform while also performing SBIR/STTR award work.

 

Internal R&D may include:

• Future product features
• New use cases
• Technical exploration outside the award
• Work for a future proposal
• Commercial product improvements
• Platform development not included in the statement of work
• Testing not tied to the approved project
• Work funded by company cash or customer revenue

Internal R&D should not be charged to the federal award unless it falls within the approved award scope and budget.

 

The company should not treat the federal award as a general R&D funding pool.

 

Use Separate Project Codes

 

Project codes are one of the most important tools for separating federal and commercial work.

 

The accounting system should have separate codes for:

• Each federal award
• Each customer-funded project
• Internal R&D
• Commercialization activity
• Sales and marketing
• Fundraising
• General operations
• Unallowable or restricted costs
• Cost share, if applicable

2 CFR 200.302 requires financial systems to maintain records identifying the amount, source, and expenditure of federal funds and to compare expenditures with budget amounts for each federal award.

 

A single “R&D” code is usually not enough once the company has both federal and commercial activity.

 

Map Revenue and Costs Together

 

When customer revenue begins, the company should track both revenue and related costs.

 

For each customer-funded project, track:

• Customer contract or agreement
• Scope of work
• Revenue recognized or invoiced
• Labor costs
• Materials or supplies
• Consultant costs
• Travel
• Cloud or software costs
• Customer-specific equipment or tools
• Direct expenses
• Margin or project profitability

This helps prevent customer costs from being absorbed by the federal award.

 

It also gives leadership better visibility into whether commercial work is financially sustainable.

 

Timekeeping Should Separate Activities

 

Timekeeping is critical when the same people work across federal and commercial activities.

 

SBIR.gov identifies timekeeping as a key accounting system requirement and notes that timesheets help document employee time spent across business activities, proposal work, commercialization plans, and other non-client activities.

 

Timesheets should allow employees to code time to:

• Federal award direct labor
• Customer project labor
• Internal R&D
• Commercialization
• Sales and marketing
• Fundraising
• General administration
• Indirect labor
• Unallowable activity, when applicable

The goal is to show what people actually worked on, not simply where the budget has available funds.

 

Founder Time Needs Extra Review

 

Founder time is often the hardest cost to separate.

 

A founder may move between award-funded technical work, investor calls, customer demos, product planning, employee management, sales activity, and internal R&D in the same day.

 

Founder time should be tracked by actual activity.

 

Separate:

• Direct award technical work
• Award-specific project management
• Customer-funded work
• Commercial product work
• Sales and business development
• Fundraising and investor activity
• Internal R&D
• General management
• Indirect administration

Only the founder time that supports the approved award should be charged directly to the award.

 

A founder title does not make all founder time award labor.

 

Technical Staff May Split Between Federal and Customer Work

 

Technical employees may also work across multiple activities.

 

For example:

• An engineer may work on award-funded prototype development and customer-specific customization.
• A developer may build approved SBIR/STTR functionality and commercial release features.
• A scientist may perform award-funded testing and customer-funded validation.
• A product lead may support technical documentation and sales demos.

Timekeeping and project coding should show those splits clearly.

 

If technical staff time is charged entirely to the federal award while customer work is happening, the company may be mixing costs.

 

Labor Distribution Connects Payroll to the Right Work

 

Payroll records show what employees were paid.

 

Timekeeping shows where they worked.

 

Labor distribution shows where payroll costs belong.

 

A strong labor distribution process should separate:

• Federal award labor
• Customer-funded labor
• Internal R&D labor
• Commercialization labor
• Sales and marketing labor
• Fundraising labor
• Indirect labor
• General administration

SBIR.gov identifies labor distribution as an accounting system requirement that charges direct and indirect labor appropriately.

 

This report helps prevent payroll costs from being charged to the wrong activity.

 

Shared Costs Need Clear Treatment

 

Some costs may support both federal and commercial activity.

 

Shared costs may include:

• Software subscriptions
• Cloud computing
• Lab supplies
• Testing platforms
• Facility costs
• Administrative labor
• Insurance
• Accounting support
• Payroll processing
• Shared equipment
• Technical tools

The company should review whether a shared cost should be direct, indirect, allocated, or charged outside the award.

 

Ask:

• Does the cost benefit one project or multiple activities?
• Can the benefit be measured?
• Does the award allow direct charging?
• Is the treatment consistent with similar costs?
• Should the cost be in an indirect pool?
• Is an allocation method needed?
• Is documentation available?

Shared costs should not be charged to the federal award by default.

 

Use Reasonable Allocation Methods

 

When a shared cost benefits multiple activities, allocation may be needed.

 

The allocation method should be reasonable and documented.

 

Possible allocation bases include:

• Actual usage
• Time records
• Labor hours
• Machine hours
• Cloud usage reports
• Square footage
• Headcount
• Number of tests
• Project-specific usage logs
• Direct cost base

2 CFR 200.405 explains that when a cost benefits two or more projects or activities, it may be distributed in proportions that can be approximated using reasonable methods, and a cost allocable to one federal award may not be charged to another award to overcome funding deficiencies or restrictions.

 

The allocation should reflect benefit received, not budget convenience.

 

Indirect Rates Must Reflect Commercial Activity

 

Commercial revenue can affect indirect rates.

 

When a company has federal awards and commercial work, the indirect cost structure should reflect the full business.

 

Review:

• Direct labor by federal award
• Direct labor by customer project
• Internal R&D labor
• Commercialization labor
• Indirect labor
• Fringe costs
• Overhead costs
• G&A costs
• Allocation base
• Unallowable cost exclusions
• Commercial cost treatment
• Customer project cost treatment

If commercial work uses company resources but is not included properly in the cost structure, indirect rates may be distorted.

 

SBIR.gov explains that indirect rates should be based on the company’s own accounting system, annual budget, projected cost categories, or other company-specific cost information.

 

Watch for Unallowable Costs

 

Unallowable costs should be visible in the accounting system.

 

They should not be mixed with federal award direct costs or hidden in indirect pools.

 

Activities that may need separate review include:

• Fundraising
• Investor relations
• Certain lobbying
• Entertainment
• General sales activity
• Non-award commercialization
• Unsupported expenses
• Costs outside the period of performance
• Personal or non-business costs
• Costs restricted by the award terms

SBIR.gov says a good accounting system should isolate unallowable costs.

 

For companies with commercial activity, this separation becomes even more important.

 

Customer Contracts Should Have Their Own Cost Files

 

Each customer-funded project should have its own support file.

 

That file may include:

• Customer agreement
• Scope of work
• Invoices issued
• Revenue records
• Labor records
• Vendor costs
• Travel or materials
• Deliverables
• Payment records
• Project profitability report

This helps show that customer-funded activity has its own cost support and is not being subsidized by the federal award.

 

Federal Award Files Should Stay Award-Specific

 

Likewise, each federal award should have its own support file.

 

That file should include:

• Award documents
• Approved budget
• Statement of work
• Ledger reports
• Payroll and timekeeping
• Labor distribution
• Vendor invoices
• Consultant files
• Subaward records
• Travel and equipment documentation
• Indirect rate support
• Drawdown or invoice support
• Budget-to-actual reports
• Prior approvals
• Closeout records

A reviewer should be able to trace federal award costs without sorting through customer revenue activity.

 

Separate Customer-Funded Pilots

 

Customer-funded pilots can be especially tricky.

 

A pilot may look like research, validation, commercialization, customer support, product development, or service delivery.

 

Before charging any pilot-related cost to the federal award, ask:

• Is the pilot part of the approved federal scope?
• Is the customer paying for the work?
• Does the pilot create customer-specific deliverables?
• Does the pilot support sales or commercialization?
• Are federal funds being used to serve a paying customer?
• Are labor and materials coded to the customer project?
• Are any award-funded tasks clearly separated?

A customer-funded pilot should usually have its own project code and cost file.

 

Separate Commercial Product Development

 

Commercial product development should be carefully separated from award-funded R&D.

 

Examples may include:

• Feature hardening for market launch
• Customer onboarding tools
• UI and UX improvements
• Packaging or deployment workflows
• Commercial support systems
• Product documentation for sales
• Scalability improvements outside the award scope
• Manufacturing or operations planning

Some work may be technically related to the award, but if it is outside the approved statement of work, it should be coded separately.

 

Separate Sales and Marketing Costs

 

Sales and marketing costs should not be mixed with award-funded work.

 

Track separately:

• Sales calls
• CRM work
• Paid ads
• Trade shows
• Commercial website updates
• Demo preparation
• Customer proposals
• Sales travel
• Marketing collateral
• Public relations
• Channel partner outreach

These activities may help the business grow, but that does not mean they are award costs.

 

Separate Fundraising and Investor Activity

 

Fundraising activity should be clearly separated.

 

Track separately:

• Investor meetings
• Pitch deck preparation
• Financial model preparation for investors
• Due diligence responses
• Capital raise planning
• Term sheet discussions
• Board fundraising updates
• Investor reporting

This is especially important when founder time is involved.

 

A founder may discuss the federally funded technology with investors, but investor work is not the same as award performance.

 

Review Drawdowns and Invoices Before Submission

 

Before submitting federal drawdowns, invoices, or reimbursement requests, review whether any commercial costs have been included accidentally.

 

Check:

• Payroll allocations
• Founder time
• Vendor invoices
• Consultant costs
• Travel
• Cloud computing
• Materials
• Shared equipment
• Indirect cost calculations
• Cost transfers
• Budget-to-actual reports

The payment request should include only supported award costs.

 

Budget-to-Actual Reports Should Exclude Commercial Work

 

A federal award budget-to-actual report should reflect only award costs.

 

It should not include customer-funded work, general commercialization spending, sales activity, or internal business costs.

 

The report should show:

• Approved award budget
• Actual award costs
• Remaining award budget
• Variances
• Labor burn rate
• Consultant and subaward spending
• Travel and equipment
• Indirect costs
• Drawdowns or invoices
• Notes on changes or restrictions

This report helps leadership avoid using federal budget availability as a proxy for company-wide cash availability.

 

Cost Transfers Should Be Reviewed Carefully

 

Cost transfers may become more common when federal and commercial activity overlap.

 

A cost may be charged to the wrong project code and later moved.

 

Before transferring costs onto a federal award, document:

• Original charge
• Corrected charge
• Why the original coding was wrong
• Why the federal award benefited
• Period of performance
• Approved budget category
• Supporting documentation
• Approval
• Impact on drawdowns or invoices

A transfer from a commercial project to a federal award should be reviewed carefully.

 

The explanation should be specific and supportable.

 

Monthly Review Helps Prevent Cost Mixing

 

Federal and commercial cost separation should be reviewed monthly.

 

A monthly review should include:

• General ledger by project code
• Federal award costs
• Customer project costs
• Internal R&D
• Commercialization activity
• Payroll and timekeeping
• Labor distribution
• Shared cost allocations
• Vendor and consultant invoices
• Drawdowns and invoices
• Indirect rate impact
• Unallowable costs
• Cost transfers
• Budget-to-actual reports
• Documentation gaps

Monthly review helps catch errors before they affect reporting, billing, or closeout.

 

Common Mistakes When Commercial Revenue Begins

 

SBIR/STTR companies often run into cost separation problems when commercial traction starts.

 

Common mistakes include:

• Using one project code for all R&D
• Charging customer pilot labor to the federal award
• Treating commercial product development as award work
• Not separating founder sales or investor time
• Not tracking customer project costs
• Mixing federal and customer materials
• Charging shared tools entirely to the award
• Ignoring indirect rate impact
• Not isolating unallowable costs
• Moving costs between commercial and federal projects without support
• Preparing budget-to-actual reports that include non-award costs
• Treating federal funds as general working capital

These issues are easier to prevent when project codes, timekeeping, and review procedures are set up early.

 

Federal and Commercial Cost Separation Checklist

 

As commercial activity grows, review:

• Federal award scope
• Customer contracts
• Separate project codes
• Award-specific cost files
• Customer project cost files
• Timekeeping by activity
• Labor distribution
• Founder time classification
• Technical staff allocations
• Shared cost treatment
• Indirect rate impact
• Unallowable cost accounts
• Drawdown and invoice review
• Budget-to-actual reporting
• Cost transfer support
• Monthly reconciliation process

This checklist helps the company grow commercially without weakening federal award records.

 

Questions to Ask Before Charging Costs

 

Before charging costs to the federal award, ask:

• Does this cost support the approved federal scope?
• Is the cost within the period of performance?
• Is it included in the approved budget?
• Does a customer also benefit from this work?
• Is the company being paid by a customer for this activity?
• Is this internal R&D or commercial product work?
• Is this sales, marketing, or fundraising activity?
• Should the cost be direct, indirect, unallowable, or non-award?
• Is timekeeping available?
• Does labor distribution support the charge?
• Is there documentation in the federal award file?
• Would the cost still look appropriate during an agency or funder review?

These questions help prevent commercial activity from being mixed into federal award costs.

 

Final Thoughts: Commercial Growth Requires Stronger Cost Separation

 

Commercial revenue is a positive step for an SBIR/STTR company.

 

But as customer-funded work, commercial product development, sales activity, fundraising, and internal business activity grow, federal award accounting needs to become more disciplined.

 

The company should separate federal R&D, customer-funded pilots, commercial product work, internal R&D, sales activity, indirect costs, and unallowable costs through project codes, timekeeping, labor distribution, documentation, and monthly review.

 

At Peter Witts CPA PC, we help SBIR/STTR companies strengthen federal and commercial cost separation so commercialization growth does not create award accounting problems.

 

Need Help Separating Federal and Commercial Costs?

 

If your company is managing SBIR/STTR funding while also pursuing customer pilots, commercial revenue, product development, sales activity, or investor funding, Peter Witts CPA PC can help review your project codes, timekeeping, labor distribution, shared cost allocation, indirect rate impact, unallowable cost tracking, customer project records, drawdowns, invoices, and award support files.

 

Backed by 35+ years of government contract accounting experience and first-hand DCAA knowledge, our team helps innovators keep federal and commercial costs separated as the business grows.

 

Schedule a strategic consultation with Peter Witts CPA PC to separate federal and commercial costs.