SaaS accounting refers to recording, calculating, analyzing, and interpreting the financial data of your SaaS business.
Unlike traditional accounting, the process has unique attributes when dealing with subscription models. The delay between subscription payment and service delivery (i.e., performance obligation(s)) requires SaaS businesses to account for deferred revenues, recurring revenues, and irregular cash inflows.
It also involves complying with tax laws (e.g., filing annual tax returns), ASC 606, the broader Generally Accepted Accounting Principles (GAAP) in the US, and the International Accounting Standards Board (IASB) regulations when operating globally. While these compliance requirements broadly align with each other, their individual variances create additional accounting headaches.
Regarding the books, SaaS businesses can use cash-basis or accrual accounting in financial reporting. However, most prefer the accrual method, as it provides a more accurate view of a company’s performance via the double-entry involved.
Key SaaS Accounting Principles and Concepts
SaaS accounting’s primary principles and concepts include:
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Revenue recognition: This is converting cash from bookings or subscriptions into revenue. In SaaS businesses, revenue is generally recognized after it’s earned rather than when cash is received.
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Accrual accounting: SaaS companies prefer the accrual accounting method, which records revenue when it’s earned (i.e. after the service agreement has been fulfilled).
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Cash flow management: It is important to monitor your cash flow to control expenses and track where your money is going. Regularly review your cash flow statement to gain insights into your inflows and outflows.
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Deferred revenue: This is the money you have received from customers, but you can’t recognize it as revenue as the service hasn’t been fulfilled yet. It’s listed as a liability on the balance sheet.
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Paying attention to these principles and concepts ensures accurate reporting and accounting. It is also essential to stay compliant with industry regulations and standards and provide an audit trail.
The Importance of Revenue Recognition Compliance (ASC 606)
SaaS and software companies must adhere to the Financial Accounting Standards Board’s (FASB’s) ASC 606 standard, which mandates recognizing revenue after transferring the promised services or goods.
The ASC 606 standard provides a five-step process for recognizing revenue:
- Identify a contract: The business and customer must have a contract to deliver goods or services. It must have commercial substance and must provide the payment terms.
- Identify performance obligations: The contract must clearly show the business’s obligations or promises to the customer. If there are several, be sure to itemize them for easy reporting. Also, be sure to distinguish between recurring and one-time performance obligations.
- Determine the price: Calculate the price your business will receive after transferring the goods or services. This can be cash or non-cash compensation, and it should factor in any upgrades, discounts, or prorations.
- Allocate the price: Distribute the total price to all performance obligations to ensure accurate financial reporting. In subscription models, the performance obligation is continuous, making the process complex but more crucial. The price allocations depend on the standalone selling price (SSP) for individual goods and services (e.g., distinct modules). You can determine SSPs by:
- Adjusted market assessments to estimate based on existing competitors’ pricing
- Expected cost plus margin formula to ensure forecasted costs are accounted for
- Residual approach to use remaining prices and performance obligations after accounting for known SSPs
- Recognize revenue: You should recognize revenue only after meeting each performance obligation. If a customer pays an annual subscription at $15, you must attribute each month’s payment to its respective period.
When done manually, this SaaS revenue recognition process can get messy. However, you can implement a software solution to automate the process and stay compliant with ASC 606, IFRS 15, and Generally Accepted Accounting Principles (GAAP).
Accounting for SaaS Subscriptions and Recurring Revenue
SaaS companies support different billing models, such as monthly, annual, freemium, and enterprise-level. Each model has varying accounting implications and impacts recurring revenue.
For instance, the annual model requires careful tracking and streamlined financial management. The year’s upfront payments must be recorded as deferred revenue, but this subscription interval offers high cash flow at the start of each contract. Conversely, freemium models must manage initially low cash flow, increasing it through higher conversion rates.
SaaS vendors that offer tiered services and usage-based pricing will need to account for variations in pricing and pricing allocation (i.e., Steps 3 and 4 above) and monitor customers’ consumption.
It’s also important to manage upgrades, downgrades, one-time charges (e.g., implementation, training), and cancellations as they impact revenue, income statements, and churn rates. The best practice is to manage and recognize (deferred) revenue adjustments based on subscription changes.
Much like the solutions SaaS businesses provide, a robust SaaS accounting system—with properly configured integrations and automation—helps streamline and simplify the process immensely. Moreover, centralizing your accounting and financial systems augments analysis and refines reporting to illuminate new insights.
SaaS Expenses and Cost Accounting
SaaS businesses must track and categorize expenses to accurately report their finances, including:
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- Cost of goods sold (COGS): These are the direct costs of offering your SaaS service, including hosting, personnel, transaction fees, and software licenses.
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- Operating expenses: These are your everyday expenses, such as marketing, R&D, rent, salaries, and utilities. You can classify them as either fixed or variable.
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- Development costs: The costs associated with developing or enhancing your software, including license costs and developer salaries. You can capitalize on these costs after establishing technological feasibility.
Reducing these costs can improve your SaaS company’s profit margins. Use your accounting software to review and identify unnecessary or high operating costs in areas like rent, salaries, utilities, and administrative functions.
Metrics and KPIs for SaaS Accounting
The most important financial metrics and key performance indicators (KPIs) for SaaS companies to monitor—especially when handling accounting for startups—include:
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- Monthly recurring revenue (MRR) and annual recurring revenue (ARR): These are key metrics for tracking monthly or annual business revenue. MRR helps to analyze trends and measure the impact of your campaigns, while ARR helps with long-term planning, forecasting, and budgeting.
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- Churn rate: This is the percentage of customers who stop using your offerings. You can calculate it monthly, quarterly, or yearly. It impacts your recurring revenues, financial forecasting, and financial health.
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- Customer lifetime value (CLTV) and customer acquisition cost (CAC): These metrics help you gauge profitability. CLTV measures the total revenue a customer will generate for your business, while CAC measures the cost of occurring a customer.
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- Net revenue retention (NRR): Also known as net dollar retention (NDR), NRR measures how well your SaaS company retains customers and increases revenue from the existing customer base.
Setting up a SaaS metrics dashboard simplifies financial tracking and analysis. Pick the KPIs and metrics to track, select your data sources, and build a dashboard with insightful graphs. You can build dashboards with tools like Power BI, Domo, and Tableau, but most accounting software solutions already offer this functionality.
The Role of Automation in SaaS Accounting
SaaS accounting processes may be complex, but they don’t need to be hard or as time-consuming as they often become—automation allows you to streamline processes, save time, and reduce errors. This is possible with accounting tools like QuickBooks, FreshBooks, Sage Intacct, and NetSuite.
Software solutions support integrations with your ERP, CRM, payment gateways, and other platforms to automate tasks and consolidate financial data in one place. They can automate tasks like financial reporting, reconciliation, and data entry.
Automation frees up your accounting teams to focus on core competencies and strategic activities like investment planning, budgeting, and pricing strategy. It also allows your team to handle an increased workload and supports consistent customer experiences.
How Nimbl Can Help With SaaS Accounting
SaaS businesses have unique characteristics that demand a different approach to accounting. Dealing with deferred revenue, recurring revenue, and different billing models adds a layer of complexity to typical processes. Best practices involve recording revenue correctly, using accrual accounting, automating processes, and keeping detailed records.
But you can seamlessly manage it with the right accounting systems, integrations, automation, and guidance.
At Nimbl, we deliver astute and tailored accounting solutions to help you navigate the complexities of SaaS accounting. Our team of accounting and integration specialists will set up the foundation for managing accounts payables, revenue tracking, reporting, 1099 filing, cash flow projections, sales tax compliance, and more.
But what are foundations, if not to build upon? Once your SaaS business’ backend accounting systems are fully integrated and automated, what’s the best way to leverage all the reporting and analytics you’re now collecting? Where should you reinvest realized savings for the best return?
Nimbl also provides strategic finance guidance, combining day-to-day accounting operations with C-level forecasting to set goals and take a step-by-step approach to achieve them.
SaaS accounting’s complexities require businesses to stay Nimbl—so let’s talk.
