SBIR and STTR funding can help innovative companies move from research to commercialization, but federal funding also brings financial expectations that many early-stage teams are not prepared for.

 

One of the most important questions is whether the company has an adequate accounting system.

 

For SBIR/STTR applicants and awardees, an adequate accounting system is not just accounting software. It is the structure, process, documentation, and control needed to track federal funds properly, support costs, manage indirect rates, prepare invoices or drawdowns, and respond to agency or audit review.

 

At Peter Witts CPA PC, we help SBIR/STTR applicants and awardees build accounting systems that support federal funding from proposal planning through award management, reporting, and growth.

 

Why Accounting System Adequacy Matters

Many SBIR/STTR companies begin with simple bookkeeping. That may be enough for basic business operations, but federal funding often requires a higher level of financial structure.

 

Your accounting system may need to show that your company can:

• Track costs by project, contract, grant, or award
• Separate direct costs from indirect costs
• Identify and exclude unallowable costs
• Support labor charges with proper timekeeping
• Maintain documentation for expenses charged to the award
• Calculate and monitor indirect rates
• Support invoices, vouchers, drawdowns, or reimbursement requests
• Produce budget-to-actual reports
• Maintain records that can be reviewed by an agency or auditor

For many companies, this becomes especially important when moving toward Phase II, cost-reimbursable contracts, or larger federal awards.

 

Adequate Does Not Mean Complicated

An adequate accounting system does not have to be overly complex. Early-stage companies do not always need the same system as a mature government contractor with multiple agencies, contracts, and cost pools.

 

But the system does need to be designed around federal requirements.

 

A simple system can still be adequate if it properly tracks costs, separates cost categories, supports labor, maintains documentation, and produces reliable reports. On the other hand, a more expensive or sophisticated software platform may still be inadequate if the chart of accounts, timekeeping, cost classifications, policies, and internal controls are not set up correctly.

 

The question is not only what software you use. The question is whether the financial system can support the award.

 

What Federal Reviewers Are Looking For

When agencies or auditors evaluate accounting system adequacy, they are often looking for evidence that the company can manage federal funds responsibly.

 

For DoD-related SBIR/STTR work, DCAA may be asked to evaluate whether the accounting system is suitable for the type of contract being awarded. DCAA’s pre-award accounting system adequacy checklist is used to document how a contractor’s system is designed to meet SF 1408 criteria.

 

In practical terms, reviewers may want to understand whether the system can:

• Accumulate direct costs by contract or project
• Separate direct, indirect, and unallowable costs
• Apply indirect rates consistently
• Support labor distribution and timekeeping
• Track costs under general ledger control
• Produce interim cost reports
• Support billing or reimbursement requests
• Maintain adequate documentation and internal controls

The goal is to show that the company has a financial process that can support federal funding before problems appear.

 

1. Project-Level Cost Tracking

An adequate accounting system should be able to track costs by project, contract, grant, or award.

 

This matters because SBIR/STTR funding is usually tied to specific work. Costs should not be buried in general business activity without a way to connect them back to the funded project.

 

Project-level tracking helps support:

• Budget-to-actual reporting
• Drawdowns or invoices
• Labor distribution
• Consultant and subcontractor costs
• Materials and supplies
• Agency questions
• Award closeout
• Future audits or reviews

If your company cannot easily tell which costs belong to which award, the accounting system may need to be strengthened.

 

2. Separation of Direct, Indirect, and Unallowable Costs

Federal funding requires clear cost classification.

 

Direct costs are tied specifically to the funded project. Indirect costs support the business more broadly. Unallowable costs are costs that generally cannot be charged to federal funds.

 

An adequate accounting system should keep these categories separate so that the company can support cost allowability, indirect rate calculations, billing, reporting, and audit readiness.

 

For SBIR/STTR companies, this can become more important as the business grows. A company with one small award may be able to manage with a simple structure, but a company pursuing Phase II, multiple awards, or cost-reimbursable work will usually need more disciplined cost segregation.

 

3. Timekeeping and Labor Distribution

Labor is often one of the largest costs in an SBIR/STTR budget. That makes timekeeping one of the most important parts of accounting system adequacy.

 

A strong timekeeping process should show:

• Who performed the work
• When the work was performed
• Which project, contract, or award the time supported
• Whether the time was direct, indirect, or unallowable
• Whether the employee certified the time
• Whether a supervisor reviewed and approved it
• Whether corrections or adjustments were documented

Timekeeping should not be recreated after the fact. It should be part of normal operations from the beginning of the award.

 

Good labor distribution connects time records to payroll, project costs, indirect rates, invoices, and reports.

 

4. Indirect Rate Support

An adequate accounting system should support the indirect rate used in the proposal and during award performance.

 

This means the company should understand:

• What costs are included in the indirect pool
• What costs are excluded
• What allocation base is used
• How direct and indirect costs are separated
• Whether unallowable costs are excluded
• How actual rates compare to proposed or provisional rates
• How rates are monitored over time

For SBIR/STTR companies, indirect rates can affect proposal competitiveness, cost recovery, cash flow, and future funding strategy. A rate that looks acceptable in a budget spreadsheet can create problems if the accounting system cannot support it after award.

 

5. Written Policies and Procedures

A system is stronger when the process is documented.

 

Written policies help explain how the company handles cost classification, timekeeping, approvals, purchasing, indirect rates, expense reimbursement, unallowable costs, invoicing, and month-end close.

 

For early-stage companies, policies do not need to be overly long or complicated. They should be clear enough for the team to follow and strong enough to show that financial responsibilities are being managed consistently.

 

Helpful policies may include:

• Accounting policies and procedures
• Timekeeping policy
• Labor distribution procedures
• Expense reimbursement policy
• Direct and indirect cost classification guidance
• Unallowable cost policy
• Purchasing and approval procedures
• Month-end close checklist
• Billing, drawdown, or invoicing procedures

Policies help turn accounting readiness into daily practice.

 

6. Internal Controls and Approvals

An adequate accounting system should include internal controls that reduce errors and support accountability.

 

Internal controls may include:

• Separation of duties where possible
• Supervisor approval of time
• Review of expense reports
• Approval of vendor payments
• Reconciliation of bank and credit card accounts
• Review of payroll and labor distribution
• Monthly financial close procedures
• Management review of budget-to-actual reports
• Documentation of corrections or adjustments

For small companies, separation of duties can be difficult because the team is lean. But the company should still have review procedures, approvals, and documentation that show financial activity is being monitored.

 

7. Billing, Drawdown, and Reporting Support

The accounting system should support the way the company receives federal funds.

 

Depending on the agency and award type, this may involve invoices, vouchers, drawdowns, reimbursement requests, or financial reports. The company should be able to connect each request for funds back to the general ledger, payroll records, vendor invoices, timekeeping records, and approved budget.

 

Before award performance begins, companies should ask:

• How will we request payment?
• What documentation will support each request?
• Can we reconcile requests to the accounting system?
• Can we produce budget-to-actual reports?
• Can we show remaining funding and burn rate?
• Can we support closeout when the award ends?

Funding requests should not require manual reconstruction every time. The system should make the financial trail clear.

 

8. Documentation and Recordkeeping

An adequate accounting system depends on organized documentation.

 

The company should maintain records that support costs charged to the award, including:

• Payroll records
• Timesheets
• Employee approvals
• Consultant agreements
• Subcontractor invoices
• Vendor invoices
• Purchase approvals
• Travel receipts
• Indirect rate calculations
• Budget assumptions
• General ledger detail
• Bank and credit card reconciliations
• Award agreements and modifications
• Agency correspondence

The best time to organize documentation is before questions arise. Waiting until a review, report, or audit request creates pressure can make the process harder.

 

9. Financial Reporting for Leadership

Accounting system adequacy is not only about agency review. It should also help leadership understand the financial health of the project and company.

 

A useful system should help answer:

• How much of the award has been spent?
• How much funding remains?
• Are costs aligned with the approved budget?
• Are indirect rates tracking as expected?
• Are we underbilling or overbilling?
• Is cash flow sufficient to perform the work?
• Are subcontractor or consultant costs on track?
• Are we prepared for the next phase of funding?

Strong reporting helps leadership make better decisions and reduces the risk of being surprised later.

 

Common Signs Your Accounting System Is Not Ready

SBIR/STTR companies may need to strengthen their accounting system if:

• Costs are only tracked by broad expense category
• Project costs are mixed with general business costs
• Time is not recorded daily or by project
• Direct and indirect costs are not separated consistently
• Unallowable costs are not identified
• Indirect rates are estimated but not supported
• Invoices or drawdowns require manual reconstruction
• Budget-to-actual reports are difficult to produce
• Documentation is scattered across email, spreadsheets, and folders
• Leadership cannot easily see project spending or remaining funding
• The system does not match the proposal budget

These issues are easier to correct before award activity grows.

 

When Should SBIR/STTR Companies Review Accounting System Adequacy?

The best time to review accounting system adequacy is before a funding deadline, agency request, or award review creates pressure.

 

Companies should consider a readiness review when:

• Preparing an SBIR/STTR proposal budget
• Moving from Phase I to Phase II
• Pursuing DoD or cost-reimbursable funding
• Adding employees, consultants, or subcontractors
• Developing an indirect rate strategy
• Preparing for drawdowns, invoicing, or reimbursement requests
• Receiving questions from an agency or contracting officer
• Planning for multiple federal awards
• Preparing for audit or closeout

Accounting readiness is easier to build before the company is already managing complex award activity.

 

Final Thoughts: Adequacy Is About Readiness, Not Just Compliance

An adequate accounting system helps SBIR/STTR companies do more than satisfy a requirement. It helps them manage federal funds responsibly, support proposal budgets, recover costs properly, track award activity, prepare for review, and make better financial decisions as they grow.

 

For early-stage innovators, the right system should bring structure without unnecessary complexity. It should support the company’s current award while preparing it for Phase II, follow-on funding, and larger federal opportunities.

 

At Peter Witts CPA PC, we help SBIR/STTR applicants and awardees build accounting systems that support the full federal funding lifecycle, from proposal planning and award setup to reporting, audit readiness, and growth.

 

Need Help Assessing Your SBIR/STTR Accounting System?

If your company is preparing for SBIR/STTR funding, Phase II growth, or a federal accounting system review, Peter Witts CPA PC can help evaluate your current structure and identify what needs attention.

 

Backed by 35+ years of government contract accounting experience and first-hand DCAA knowledge, our team helps innovators build accounting systems that support funding, compliance, and long-term growth.

 

Schedule a strategic consultation with Peter Witts CPA PC to assess your SBIR/STTR accounting system readiness.