Due to the rapid expansion of the software industry around the globe, the need for SaaS solutions is becoming increasingly prevalent. The shift to a more digital-oriented society has led to a surge in demand for top-notch solutions, prompting SaaS companies to change accounting systems in order to keep up with the growth.
The core of SaaS accounting
As practice shows, traditional accounting methods are less effective in tracking the revenue and costs associated with SaaS businesses. This is because such companies often have recurring revenue models and offer services on a subscription basis, as opposed to one-time sales.
To properly track and control the accounting flow, follow a few core steps:
- Start with exploring the difference between revenue recognition and cash flow. Such companies typically recognize revenue on a subscription basis, meaning that the customer pays a recurring fee for services. SaaS revenue is recognized when the customer pays, not when the services are provided. Therefore, cash flow may be delayed, while revenue recognition is immediate.
- Track and manage costs associated with services. These costs may include software licenses, data storage, cloud computing services, and other related expenses. Additionally, it’s important to track customer acquisition costs such as marketing, advertising, and customer acquisition fees.
Finally, SaaS companies must also define the list of financial metrics and track them to understand the business wealth and make decisions about how to grow.
SaaS-specific metrics
When it comes to monitoring your business’s performance, various KPIs are available. Not taking the size of your business into account, the following SaaS KPIs include:
- gross margin
- CAC or customer acquisition cost
- customer churn rate
- CLV or simply Customer Lifetime Value
Gross margin is a measure of profitability and reflects the percentage of revenue that a company has left after deducting the cost of goods sold. CLV is the amount a customer brings in over their lifetime as a customer, while CAC is the cost associated with acquiring a new customer. Finally, the customer churn rate is the percentage of customers that have stopped using the company’s services over a given period of time.
Understanding the needs of SaaS accounting
SaaS organizations have unique accounting requirements that set them apart from traditional enterprises. Revenue recognition is one of the largest problems SaaS organizations have to deal with. Subscription-based services are often provided by SaaS firms, which implies that income is realized gradually. This necessitates a special accounting strategy that conventional organizations do not need.
Managing cash flow is another problem SaaS organizations have to deal with. SaaS firms often have significant up-front expenses for things like sales, marketing, and research & development. They do, however, get revenue gradually, which might be an issue in a cash flow. A SaaS company’s ability to handle its cash flow effectively is indispensable to its success.
Common financial companies’ reports remain essential to control the wealth of the business. Statement of Profit and Loss (P&L) provides a short overview of a company’s earnings, costs, and net loss for a certain period. It is a crucial report that must be completed to determine the strength of a company’s finances.
To stay up-to-date, the Accounts Receivable Aging Report is a must-have for Saas accounting. It lists all past-due client bills and their unpaid time and supports managing collection operations and keeping track of accounts receivable.
Typical bookkeeping methods among SaaS companies
SaaS firms have two choices when it comes to bookkeeping procedures. There are distinctive features of cash and accrual accounting. The primary distinction between the two is the timing of when SaaS revenue is stated on the income statement.
Cash accounting
With this method, a firm only records income and cogs SaaS companies as paid or disbursed. Businesses with conventional pricing strategies or lower inventory are more likely to utilize this style.
It does not result in the bookkeeping for receivable and payable accounts since income and costs are only recorded once payment is received. When a firm needs easy practice, this type is advantageous. However, due in part to the subscription payment model, there are more workable approaches for SaaS businesses.
Accrual calculation
In this system, revenue is acknowledged as it is received. Likewise, expenses are documented when a contract is completed rather than just when they are incurred. It is beneficial since it enables the company to estimate income and costs. Accrual bookkeeping may benefit quickly expanding SaaS enterprises, even if it is more complicated than cash accounting.
General revenue recognition remarks
The GAAP requirements include revenue recognition in considerable detail. It establishes the timing of when a payment is counted as revenue. To put it simply, it is of great importance to make your required payments to be income. It is vital to outline the idea of accrued revenue and deferred revenue, to comprehend income recognition procedures.
Accrued income
According to GAAP, revenue is acknowledged when it is gained or when a service is provided. Because you still need to bill clients for what they owe you, it’s also about unbilled income. Receivables are written down as actual assets on the balance sheet when using cash accounting. Because clients owe money to the firm, it is an asset. On your income statement, it is indispensable to incorporate it as earned income.
Accrued income is usual for SaaS organizations in circumstances where:
- The project is lengthy.
- They charge a one-time cost for installing and configuring the program.
- The item has multiple purchasing alternatives.
Because SaaS structures employ a subscription business model, income revision is the most apparent distinction in SaaS accounting. Customers of SaaS pay subscription and add-on service fees, which call for regular “maintenance” when users upgrade, downgrade or choose to opt in or out of various services.
Income of future periods
Unearned income is another name for deferred revenue. A client that purchases your goods before you deliver the service causes this situation. Prior period costs are classified as liabilities because you must still fulfill the performance responsibilities. Accrued revenue recognition prior to fulfilling contractual commitments may result in incorrect growth projections, which is undoubtedly wrong for the enterprise.
Income recognition typical steps
A five-step structure of income recognition is provided by ASC 606. These general remarks clarify the proper metrics and resolve the misunderstandings and inconsistencies in SaaS accounting procedures:
- Define a contract with a client: The procedure is used by businesses when they enroll new clients in a service.
- Define contract performance duties: The supplier must ensure the contract describes its services and the time frame.
- Identify the transactional cost: It is the payment the provider anticipates receiving in exchange of delivering the services specified in the contract. The sum includes both solo and combined services as well as any discounts.
- Highlight transactions: The calculations from the previous section are necessary.
- Revenue recognition upon fulfilling performance obligations: In the last phase, SaaS providers record income when they carry through their performance commitments. Before recognizing revenue from services, SaaS suppliers must have an established contract with the client, clearly outlined rights and obligations, and reasonable pricing and distribution.
When an investor seeks to determine the exact value of a SaaS firm, the lack of a defined COS can lead to uncertainty and controversy because the gross margin is one of the most crucial variables in assessing a SaaS company’s success and valuation.
Best practices of SaaS accounting to use
Implementing SaaS accounting in your business can be a complex process. Here are some best practices to help you get started.
Choose the right accounting software
Your SaaS accounting strategy’s success depends on the selection of accounting software. Try to choose software that has been created with SaaS businesses in mind and that has functions like revenue recognition, subscription billing, and financial reporting. Make sure the software is compatible with your other company systems, including your CRM and billing systems.
Define your chart of accounts
A list of all the accounts you apply to state financial transactions may be seen in your chart of accounts. Accounts for receipts, expenses, and assets fall under the category. Setting up your chart of accounts is crucial because it gives your financial data a structure. Ensure your chart of accounts is customized to meet the demands of your unique organization.
Implement a revenue recognition policy
An essential part of SaaS accounting is income recognition. It alludes to the practice of recognizing earnings gradually as opposed to all at once. Because SaaS businesses often employ recurring revenue models, it is significant. Implement a revenue recognition policy which adheres to industry norms and takes your business model into account.
Establish a billing and invoicing system
To all SaaS businesses, a billing and invoicing solution is crucial. Seek a system that may handle proration, one-time charges, and subscription charging. To guarantee that financial data is automatically captured, ensure your system connects with your accounting software.
Common mistakes to avoid in SaaS accounting
Implementing SaaS accounting standards can be a complex process, and there are many common mistakes that companies make. Here are some things to avoid:
- Lack of a defined revenue recognition policy. You can have issues with authorities or investors if your policy does not adhere to industry norms. Ensure that your policy is specific to your firm model and that it is written explicitly.
- Failing to keep an eye on key metrics. Monitoring essential KPIs is crucial. You may be overlooking insightful data if metrics like CAC, CLV, and MRR are not tracked. Make sure you have procedures in place for routinely tracking these indicators.
- Using ineffective systems for billing and invoicing. Your financial data may contain inaccuracies and delays as a result of using ineffective billing and invoicing methods. Ensure that the solution you’re utilizing interfaces with your accounting software and was created exclusively for SaaS businesses.
Moreover, it is vital to adhere to financial regulations. SaaS businesses must abide by a variety of accounting rules, such as tax legislation and revenue recognition. Penalties and fines may result from disregarding these rules. Make sure your accounting procedures are compliant with all applicable laws and regulations by keeping up to speed with them.
Conclusion
To ensure efficient operations for their expanding businesses, these organizations typically make use of the most up-to-date SaaS software for handling the entire process, including subscriptions and recurring charges. To meet this need, there are various SaaS accounting solutions available now which are secured, user-friendly, and cost-effective. They can help businesses save time and money by automating many of the laborious accounting tasks.
To stay on top of your finances and avoid many problems, think about professional help. Outsourcing bookkeeping tasks will free up your resources to develop the business.
