2024 is coming to a close, and it has been a terrific year for SaaS businesses as the industry has witnessed quite a favorable growth. For SaaS companies, accounting becomes one of the most crucial processes to understand their financial and overall business health, and then make informed decisions about future steps. SaaS accounting requires in-depth knowledge about the industry and your business, including the strenuous task of keeping a record of your company’s earnings and expenses. Most SaaS businesses prefer to manage their accounting processes through cloud-based software solutions, but even for that you need to know the nitty-gritties of SaaS accounting.
So if you are a new SaaS business owner or are planning to explore this market, here is a complete and comprehensive SaaS accounting guide to get started. So keep reading till the end!
What Is SaaS Accounting?
SaaS accounting is the process of recording, evaluating, and interpreting the financial data and information of your SaaS business to understand your overall financial health, growth momentum, and profitability, and make informed decisions about further steps. Keeping track of the accounting for SaaS businesses can be challenging because of the subscription model that they operate on, and that is why most companies opt for cloud-based software solutions to smoothen the processes.
However, SaaS accounting involves various factors and conditions that you must know if you are a business owner or planning to explore this market. In this blog, we will cover all of these and provide the best solutions to some common challenges as well.
Distinguishing Factors of SaaS Accounting
SaaS businesses operate differently from traditional businesses and involve different financial approaches, tactics, and challenges. So let us first understand the unique factors that affect SaaS accounting:
- ✅ Revenue Recognition: SaaS revenue depends on the subscription model, and the recurring nature of the income stream can create complexities in revenue recognition compared to traditional businesses. The revenue earned over the subscription period does not relate to the amount earned at a given point of sale like in traditional businesses. Hence SaaS companies have to maintain accurate records for timely revenue recognition and comply with guidelines like ASC 606 to ensure proper revenue recognition.
- ✅ Expense Management: SaaS companies have to spend often on various aspects like product development, marketing costs, customer support facilities, and much more. Therefore they must prioritize effective expense management and make informed decisions that will help in better resource allocation, smoothen the various business processes, and improve their profitability.
- ✅ Manage Subscription Billing: Managing subscription billing models can be a challenging aspect for SaaS businesses as it involves keeping track of different pricing structures over different subscription periods for each customer. This is an important process as you need to send invoices to customers on time and also collect revenue effectively. However, this process can be streamlined by automating the billing process to avoid any errors and save time and manual effort. Businesses can also get help from billing software and solutions to ease this process.
- ✅ Reviewing KPIs: KPIs or Key Performance Indicators are important for SaaS businesses. They provide valuable data to monitor business performance, pinpoint key areas to improve your efficiency and strategies, and make more informed decisions. These metrics include monthly recurring revenue (MRR), customer acquisition cost, churn rate, customer lifetime value, etc. If you are a SaaS business owner, you can invest in analytics tools to get better insights and data to analyze these metrics and make actionable decisions.
- ✅ Cash Flow Management: This means keeping track of the money coming into your business and monitoring the outgoing expenses like bills, operational costs, and salaries. Managing the cash flow becomes a crucial aspect for SaaS businesses with a subscription payment model. You can work on developing cash flow forecasts and try to automate your billing and payment processes to smoothen this process and improve efficiency.
SaaS businesses are dynamic and always changing, and there are many distinguishing factors that may affect them, but these are some of the more common ones that affect most businesses across industries and borders.
Types of SaaS Accounting
SaaS accounting can be of two types: Cash-basis accounting and Accrual accounting. Let us understand what they are and their difference.
1. Cash-Basis Accounting
Cash-basis accounting is a method of SaaS accounting where revenue is only recognized when the customers have made their payments, and the expenses are recorded when the company has paid those bills. Basically, it only recognizes the income and expenses when the cash is received or paid. This method of SaaS accounting is more suited for small to mid-size businesses that work with limited or no inventory. However, it would be so effective for large-sized enterprises with heavy inventory and complex billing cycles.
2. Accrual Accounting
This is the SaaS accounting method that recognizes all the income earned and the expenses incurred, even when the cash is not received or paid. Accrual accounting helps provide a more accurate picture of a company’s financial health, and it is more suited for larger SaaS enterprises with heavy inventory and complex subscription models.
Accrual accounting is more commonly used than the cash-basis accounting method for SaaS companies, and it is more advantageous for businesses to defer the revenue reporting on tax returns.
SaaS Accounting Standards: What is it?
SaaS accounting standards are some regulations and guidelines that you should follow to ensure transparency while recording and analyzing the financial health of your business. The FASB or Financial Accounting Standards Board sets accounting standards for SaaS businesses, and it is known as Generally Accepted Accounting Principles (GAAP). If you fail to follow these standards and regulations will lead to incorrect analysis and forecast of your financial information, and that can have adverse effects on your business.
Most SaaS businesses tend to use the GAAP standards because investors may use it to analyze the company’s financial health to invest in them, and the presence of these regulations across different industries and borders can help simplify the complex financial structures that SaaS businesses operate on.
The GAAP regulations specify three crucial financial statements that your business must complete before every financial period:
- The income statement which shows the earnings and expenditures of your business and determines whether your business is incurring profits or making losses.
- A balance sheet that displays what your company owes, and what customers and contractors owe you.
- A cash flow statement that determines and tracks the money coming into your business and monitoring the outgoing expenses like bills, operational costs, and salaries. This helps to show the overall financial health and position of your business.
Key Metrics of SaaS Accounting Standards
Several KPIs determine SaaS accounting standards. Here are some of the common key metrics that you should know:
1. Revenue
Revenue is the amount your company earns after delivering the products or services and fulfilling the obligations to your clients. So you can only consider this income as revenue when you are able to fulfill your obligation towards your clients successfully. As a SaaS business with a subscription payment model, you need to consider your revenue accordingly. For example, when your product costs $50 per month and a customer signs up for your yearly subscription of $600, your revenue for each month will be $50, even if you have billed them the total of $600.
2. MRR and ARR
MRR refers to your monthly revenue earned from recurring subscriptions, and ARR is the revenue earned by your company in a year. They help in understanding a predictable revenue stream for your company, determine its growth rate get important insights about how and when to invest your income.
3. Churn Rate
The customer churn rate is the percentage of customers you lose in a given month or year. It is an important metric for SaaS accounting because it helps you understand your customer retention and satisfaction so that you can develop better strategies and improve your services.
4. Bookings
Bookings show you the amount of money a customer has committed to spend for your products and services, but the service is yet to be provided, and you are yet to earn its revenue. This is why you need to record bookings as deferred or unearned revenue, and you must not make plans for growth or investments around this income because you have not earned it yet.
5. Billings
These are the payments you receive from your customers after delivering the promised products and services successfully. This can be done weekly, monthly, quarterly, or yearly, based on the subscription models your customer chooses, and the amount should be equal to the booking amount. If the billing amount is lower, it indicates that you are not being able to collect the money effectively. You can take a few steps to prevent this, like providing added benefits to customers for paying upfront or offering extra discounts for yearly subscriptions.
Revenue Recognition Standards
Revenue recognition becomes a crucial aspect of GAAP standards. Basically, it determines which payments are considered as revenue, and asserts that businesses cannot record any payment as revenue until it has successfully delivered the promised goods or services that are paid for. This regulation becomes challenging for SaaS businesses that are based on subscription models. That is why, SaaS businesses need more specific milestones and revenue amortization.
Monitoring recurring revenues consistently is crucial for SaaS businesses, and that is why they need to adhere to revenue recognition regulations that govern the industry: ASC 606 and IFRS 15.
Understanding ASC 606 and IFRS 15
They are revenue recognition standards that lay down flexible guidelines to help SaaS businesses report the financi