SaaS Accounting 101: Financial Fundamentals

The key to quality SaaS accounting is automated systems that manage customer subscriptions, handles recurring billing, and streamline the bookkeeping, accounting, and tax services. Your bread and butter is likely generated by selling services on a recurring schedule. If you are accepting prepayments, you’ll need to spread out revenue for the duration of your contract. Recognize revenue and expenses in installments throughout the year based on customer usage. Reviewing the contracts you hold each month is imperative so that you don’t prematurely recognize revenue.

We believe services provided by the SaaS provider that could be performed internally or by a third party other than the SaaS provider are generally distinct from the SaaS. Contractual restrictions requiring the customer to obtain the services from the SaaS provider do not alter this assessment. Recognizing deferred revenue before fulfilling your contractual obligations can lead to inaccurate growth forecasts, which, as we know, is terrible for business. Deferred revenue is the money you’ve already billed, but you can’t recognize as revenue because the service is yet to be provided. These articles and related content is the property of The Sage Group plc or its contractors or its licensors (“Sage”). Please do not copy, reproduce, modify, distribute or disburse without express consent from Sage.

Our toolbox of SaaS technologies automates many tedious, manual processes — bill pay, payroll, accounting solutions, and more — ultimately improving efficiency and accuracy across the board. Viewpoint is our online digital resource for the latest news, PwC guidance, webcasts, research materials and full text of the authoritative accounting… Given its origins as an invoicing tool, it should come as no surprise that invoicing is among FreshBook’s most frequently praised features. FreshBooks excels particularly if your SaaS model entails dealing with high volumes of recurring invoices.

QuickBooks Online

This is not a comprehensive or specialized tool in the way that some of the others are, nor does it offer the popularity of QuickBooks Online. For those running sales information through an online marketplace, nearly every major eCommerce tool has some integration. The ability to change the broad functionality of your software in Real-time is incredible, though does present some potential issues. Xero is frequently recommended for SaaS companies due to its 3rd party integration marketplace, which is head-and-shoulders above its competitors. That, and its cloud-based structure, makes it ideal for small and growing SaaS businesses.

We know the accounting metrics a Software as a Service company needs to have ready for diligence. It’s not just ARR, MRR and CAC – the best investors have questions around cohort churn rates, revenue run rates and more. In fact, our team has been interviewed by TechCrunch about the metrics needed to raise rounds and trends in the VC market. In cash based accounting, you’d recognize $120,000 in revenue in January. Then in February, you’d have zero revenue from this contract – even though you are delivering service to the customer.

Billings are the payments you invoice customers after successful service and product delivery. Billing can happen weekly, monthly, quarterly, or annually, depending on the subscription model your business uses. This model is advantageous in the sense that your business can better forecast revenue and expenses. Although complicated compared to cash-basis accounting, accrual accounting can better serve quickly growing SaaS businesses. In Accrual accounting, on the other hand, revenues and expenses are recorded when they are earned, regardless of when the cash actually comes in or when expenses are incurred.

You can use job boards and search engines to find freelance or full-time SAAS accountants or bookkeepers, or you can work with a company that specializes in providing accounting services to SAAS businesses. Another challenge is determining the fair value of the services being provided. SAAS companies must be able to estimate the fair value of their services at the time of the contract, as this will impact revenue recognition. This can be particularly challenging for new or innovative services that have no comparable market value. Server costs are a major expense for SAAS businesses as they need to maintain servers to host their software. These costs can include server hardware, software licenses, and maintenance fees.

Instead, accounting rules generally require SaaS businesses to recognize revenue over the contract term. This recognition is the case regardless of when the client pays the SaaS company, so even if the client pays upfront or quarterly, the revenue is recognized the same. We can’t tell you how often we see this mistake when a SaaS company uses an “automated” accounting provider.

Marshall Anne is Director of Product Marketing for VMware End-User Computing (EUC), with more than 5 years of experience specializing in mobility and end user productivity. You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions. As the world becomes more digital, Software as a Service (SAAS) businesses are becoming increasingly popular. In this article, we’ll break down everything you need to know about SAAS accounting. If you don’t understand where you have been (your historical financials), you will never know where you are going. To state it another way, if you don’t understand your current performance, how can you be expected to predict your future financial performance.

To keep their finances afloat, SaaS companies must devise strategies to raise billings and advance client payments. Offering discounts for SaaS annual plans is one way to accomplish this goal. When drafting a contract, you include all the specifics of deliverables and performance obligations here. If the services Saas accounting or products are distinct, you need to account for them separately. In some SaaS arrangements, the SaaS provider may perform implementation services in addition to providing the SaaS. In that case, a customer should assess the implementation services and determine whether they are distinct from the SaaS.

Bookings

During the hot financing market, starting around Q2 2021, the average company needed just under $60k of ARR and was only growing at about 140% year over year – a tremendous drop on both size and growth metrics. For new SaaS companies, QuickBooks is the best accounting solution that allows you to collaborate with your accountant. QuickBooks is perfect for startups because it is user-friendly and easy to get the hang of, no matter your level of experience. GAAP’s Accounting Standards Codification 606 (ASC 606) [2] and IFRS 15 [3] is a converged SaaS revenue recognition standard developed by FASB and IASB to drive consistency in financial reporting. ASC 606 and IFRS 15 revenue proposes a flexible, solid five-step structure for revenue recognition.

SAAS businesses often have unique expenses that need to be tracked, such as server costs, software development costs, and customer support costs. These expenses can vary greatly depending on the size of your SAAS business and can make accounting more complex than traditional businesses. Compliance with these standards is critical for SAAS businesses as it ensures the accuracy and transparency of financial reporting. For instance, if your SAAS business charges $100 per month for a subscription, and a customer signs up for a year, then you would recognize $1,200 in revenue over the year, rather than all at once. This is known as recurring revenue and is a fundamental aspect of SAAS accounting. Getting on board with GAAP compliance, in addition to accrual accounting, is beneficial from the start of a company.

One aspect that makes SaaS accounting different is the dynamics of cash flows in SaaS businesses. For instance, recurring payments and the ability to downgrade, upgrade or purchase add-ons make SaaS accounting different from traditional models. Furthermore, the success of the SaaS business is dependent on whether customers are willing to make recurring payments to access a product.

Learn how Chargebee empowers your SaaS Accounting

If you don’t know what a chart of accounts is you should probably hire a good bookkeeper, but what it does is translates your general ledger entries into your income statement, balance sheet, etc. It’s like the map of where the specific expenses and other accounting items flow to in your financial statements. If a company determines that a hosting arrangement does not give rise to a software intangible asset, it recognizes the related expenditure as it receives the SaaS – i.e. over the SaaS period. If a company pays for the SaaS in advance, it recognizes a prepaid asset. Conversely, a company recognizes a financial liability if it receives access to the software in advance of paying for it. A SaaS arrangement, like those for platform-as-a-service (PaaS) and infrastructure-as-a-service (IaaS), is a cloud computing arrangement.

• Auditors, bankers and investors will use GAAP to evaluate the financial picture of the business.
• Likewise, the SaaS company agrees to provide a service for a contracted amount of time.
• If you want to future-proof your accounting software, ask vendors what specific features are on their roadmaps, and whether their focus is on integrating third-party tools or developing those functions natively.

The biggest issue we see with clients that come to Kruze from another bookkeeper is serious mistakes with revenue recognition and deferred revenue – especially from “bot” bookkeepers and from non-SaaS accountants. Because of the way revenue transactions recur in a subscription business, small errors can become big problems if not caught early – including having to restate the balance sheet and income statement. Deferred revenue is even more complicated since it’s not as easy of a financial figure to understand. At its most basic level, if your clients are paying ahead of time for services, your company will put a deferred revenue liability onto the balance sheet. And as you deliver this service and recognized revenue, the deferred revenue liability decreases.

Add-ons to Accounting Software

Tracking accounting, budgets and key performance indicators all year long are critical components of improving your business’s performance. When a typical non-Saas business makes a sale, it’s a single transaction in which a service or goods are exchanged for money. Next, determine the key performance indicators (KPIs) for your company. Organizing your KPIs numerically helps track your performance against projections. Bookings is not actually defined by GAAP, so SaaS accountants don’t usually produce this metric out of the accounting system – instead, it is produced out of a sales CRM like Salesforce or Hubspot.

SAAS companies are unique in that they provide their services over a period of time, rather than delivering a tangible product. This makes revenue recognition more complex, as it requires the company to recognize revenue over the life of the contract. The second method, modified accrual accounting, is a bit more complex than cash-basis accounting. This method involves recognizing income when it is earned but recognizing expenses when they are paid. This means that you record revenue when it is earned, regardless of when payment is received, but you only record expenses when they are actually paid.

SaaS revenue recognition is a principle that determines the period when payment (cash) by clients is recognized as revenue in financial statements. The pre-payments made by clients before service delivery are treated as deferred revenue, and hence, a liability. In cash-basis accounting, you debit accrued revenue as a current asset on the balance sheet.

Venture capital firms, venture lenders, investors, and others want to see your financials on an accrual basis. You need to recognize that revenue on a monthly basis as you provide the service over the year. If you recognize the full amount when you received it, that’s called cash accounting. And you’ll have a really good month, followed by 11 months of no revenue. In SaaS, the customer never “obtains control” of the software/service, so the general rules of revenue recognition don’t cleanly apply.

Accountants also use accounting software as a service in their accounting firms to provide accounting services to their clients. Customers in software-as-a-service (SaaS) arrangements face complexity in determining the appropriate accounting under IFRS Standards for fees paid to the cloud service provider and related implementation costs. A recent agenda decision of the IFRS Interpretations Committee (IC) provides some clarity, and confirms differences with US GAAP. In this article we summarize financial reporting considerations and provide a framework for accounting for the related implementation costs. Monthly Recurring Revenue (MRR) is an important metric for SaaS businesses and Accrual accounting suits subscription businesses because accrual revenue, if recognized correctly, actually tracks the MRR. Since it allows tracking revenues and expenses together in the same period, it provides comparable trends for SaaS businesses.