Anyone who has ever worked in accounting for a software-as-a-service (SaaS) business will tell you the same thing: SaaS accounting is very different to standard accounting. Although the macro concerns and goals of SaaS accounting might resemble those of other industries – staying compliant, generating accurate reports, maximising efficiency – the challenges and barriers that face SaaS accounting teams are unique.
Because of this, an increasing number of SaaS companies are taking a more comprehensive approach to integrating their payments, billing and revenue management, an approach powered by Stripe. In order to improve customer experience, scale globally and increase recurring revenue, it makes sense for SaaS companies to consider accounting as one aspect of a cohesive sales and billing strategy.
With these goals in mind, here’s what SaaS businesses need to know about accounting in this industry, the standards that frame these concerns, and the methods and strategies that they can use to tackle accounting successfully.
What's in this article?
- What is SaaS accounting?
- Why is SaaS accounting important?
- Accounting methods for SaaS businesses
- Accounting standards for SaaS businesses
- Key performance indicators (KPIs) and statements for SaaS accounting
- SaaS accounting challenges
- Revenue recognition for SaaS businesses
What is SaaS accounting?
SaaS accounting refers to the recording, analysing and interpreting of financial data, information and reporting for SaaS businesses. These businesses typically use cloud-based SaaS accounting software to manage the entire process. This type of accounting considers the subscription and recurring revenue business model under which SaaS companies operate, meaning that financial statements are SaaS business-specific.
In SaaS businesses, subscription and setup fees include costs for the preliminary licence, implementation, customisation, and any maintenance or support. Generally, these are one-off fees, so the more people who use a SaaS product, the more successful that product is.
Accounting for SaaS companies is characterised by:
- Healthy gross margins of about 70%–85%
- Complex cash flow due to recurring payments
- Low COGS (cost of goods sold), mostly comprising product hosting, marketing and sales, and customer support
Why is SaaS accounting important?
There are specific requirements and challenges to operating a SaaS business, and the financial intricacies of these businesses are also specific. The subscriptions that power SaaS businesses make it complicated for financial professionals to apply traditional accounting rules, taxes, commissions and contracts in their work. Therefore, it’s important that your finance team ensures that your forecasting and reporting are fully accurate and compliant with the appropriate tax rules and laws in your jurisdiction.
Accounting methods for SaaS businesses
There are two main choices of accounting methods for SaaS companies: cash-basis and accrual accounting.
With cash-basis accounting, revenue and expenses are recorded only when money owed is paid or received, which means that there are no accounts payable or receivable accounts. This method is typically used by businesses operating with smaller inventory levels or traditional pricing models, and it’s a simpler method than accrual accounting – and easier to use. But it doesn’t lend itself to SaaS companies that use a subscription business model.
Businesses using accrual accounting record revenue and expenses at the time when they are earned or planned for, not when cash is received or an expense is incurred. Though accrual accounting is more complex than cash-basis accounting, this method makes forecasting and planning easier, especially for startup or fast-growing SaaS companies. And sometimes, it’s required: For US-based companies, if you’re consistently making at least $27 million in gross revenue, the IRS requires that you use the accrual method.
Accounting standards for SaaS businesses
In the US, the Finance Accounting Standards Board (FASB) sets and regulates accounting standards known as Generally Accepted Accounting Principles (GAAP). These standards allow you to analyse the finances of your SaaS business in the most transparent way possible. Failure to follow these principles can result in incorrect analyses and forecasts, leading to long-term, negative results for your business.
Though you aren’t required to follow GAAP standards in the US, it is highly recommended. Not only do they make reporting and benchmarking easier, but they are used by most investors when analysing a company’s financial health.
Key performance indicators (KPIs) and statements for SaaS accounting
GAAP standards specify that three financial statements must be completed in each financial period. These include the following documents:
- An income statement indicates your revenues and expenditures and whether your business is earning a profit or suffering a loss.
- A balance sheet shows what your business owes and what it still needs to collect, through assets, liabilities and shareholders’ equity.
- A cash flow statement notes how much money is entering and exiting your business. It reconciles the income statement and balance sheet to show your overall financial position.
Along with financial statements, there are a few key SaaS-specific accounting metrics, or KPIs, that will guide you in understanding the state and potential of your SaaS business’s growth.
This metric indicates how much money a customer has committed to spending with you, or your growth in future revenue. Since bookings represent a service yet to be provided and are not yet earned revenue, you’ll record them as deferred, or unearned, revenue, as a liability on your balance sheet. Be conservative with this number, as you don’t want to plan for growth or make investments based on unearned income.
These are payments for which you invoice customers and amounts owed to you. They should come to about the same amount as bookings, and a lower amount implies that you’re not collecting what you should. You can mitigate this by requiring or even incentivising customers to pay up front.
This is the income earned after you deliver your obligations or services to customers. SaaS businesses record accrued or unbilled revenue and treat it as an account receivable until the bill is paid, making it a current asset on your balance sheet. For example, if your service costs £100 per month and on 1 June a customer subscribes to your yearly plan for £1,200, your June revenue will only be £100 – even if you’ve billed the customer for the full £1,200. Bear in mind that if your accrued revenue is high, it could indicate that customers aren’t paying on time, and your cash flow may suffer.
The percentage of customers who stop using your product in a given time period is known as churn. Churn is key to understanding customer satisfaction and retention and how well your marketing and customer service is performing.
Monthly recurring revenue (MRR) and annual recurring revenue (ARR)
MRR is your total monthly revenue earned, regardless of the subscription plan, while ARR is your total revenue earned from subscriptions of at least 12 months. These metrics help you understand your growth momentum and provide insights into how you could be investing your earnings.
SaaS accounting challenges
SaaS businesses face specific hurdles and challenges in their accounting that can result in issues with reporting or risk of non-compliance with tax or other financial regulations. These challenges include:
SaaS businesses are often operating with remote teams and operations across multiple jurisdictions, each with its own sales tax laws. Wherever you operate, you’re responsible for determining how much sales tax you need to submit.
Expenses should be spread out across contract terms or anticipated customer relationship timelines, and you’ll need to know which expenses get amortised (paid off over time) and which need to be recognised straight away.
SaaS businesses must understand when to recognise revenue. This is a very common issue as SaaS customers don’t "obtain control" of the service that they receive, so businesses can’t use the typical revenue recognition rules. We’ll go deeper into the solution for this below.
Revenue recognition for SaaS businesses
As one of the GAAP principles key to SaaS accounting, revenue recognition is a way to recognise and account for revenue in financial statements. Businesses cannot recognise revenue until the goods or services associated with any given sale are realised or realisable, which can prove difficult for SaaS companies, which often sell recurring subscriptions. This type of contract needs flexibility around recognising revenue. Revenue recognition for SaaS businesses may need to include specific milestones and revenue amortisation.
Nevertheless, it’s important for SaaS businesses to recognise their recurring revenues consistently and in accordance with the standards of revenue recognition that govern all industries: ASC 606 and IFRS 15. Regulatory agencies and accounting standards boards have complicated guidelines to temper inflated and misleading revenue recognition, and the burden is on SaaS businesses to navigate how to reconcile their customer contracts with the requirements laid out by these standards.
ASC 606 and IFRS 15 lay out a flexible process that accounts for revenue recognition and has helped provide clarity around previously ambiguous and inconsistent SaaS accounting practices. Here’s a brief rundown of each of the five steps of revenue recognition:
1. Identify the contract
Specifies criteria to meet when establishing a mutually agreed-upon contract to provide products or services to a customer. The contract specifies each party’s obligations and rights.
2. State the performance obligations
Contract outlines all services offered and deliverables, and their time frame or deadlines, along with the rights and performance obligations of all parties. Individual products or services need to be described separately.
3. Specify the price
Includes every consideration related to determining price, including subscription service, standalone and discounted fees.
4. Allocate the price
Explains how price (including variable amounts) is assigned to all performance obligations in the contract. This is typically separated out into smaller amounts, often every 30 days.
5. Account for revenue as performance obligations are completed
Recognises revenue over time as a customer benefits from the product or service.
While there are many complex situations and contract variations that go beyond these guidelines – like those triggered by the typical subscription changes, upgrades, downgrades, credits and cancellations that SaaS businesses deal with on a regular basis – they’re an important starting point.
Even better, you can use SaaS accounting software to help tackle this challenge. A solution like Stripe unifies billing, payments, tax and revenue management within a single system that ensures compliance with ASC 606 and IFRS 15. Many SaaS businesses – over 80%, in fact – benefit from cloud accounting platforms that make these processes easier. For more information, have a look at Stripe’s guide to revenue recognition.