Learn the definition of SaaS deferred revenue, why it’s important to your accounting practices, and how to properly calculate it.
December 23, 2020
Software is one of the fastest-growing industries in the world. As we move into a digital-based world, software as a service, or SaaS, becomes more and more prevalent and profitable. For that reason, it’s important for SaaS startups to have the right accounting system in place from day one.
Because SaaS companies generally operate as subscription businesses, they need an accounting solution with experience and infrastructure in place to seamlessly support the needs of a SaaS business model.
In many cases, startup founders don’t prioritize accounting when they’re working to get their business up and running. They’re more focused with creating a great product and building an all-star team. But the sooner startup business leaders consider their accounting options, the less stress (and financial mess!) they will have to deal with in the future.
Revenue tracking is the most notable difference in SaaS accounting because of the subscription model used by SaaS businesses. Customers are charged subscription fees and add-on services fees, which require routine “maintenance” as customers upgrade, downgrade, or opt in/out of different services.
SaaS businesses also use a different set of accounting tools — like subscription management software and recurring billing platforms — which demand different skills and knowledge of best practices than traditional startup or small business accounting.
Good accounting provides insight into a company's revenue and operations. For a fast-growing SaaS startup, access to this information can make or break the company's future.
Along with the functional benefits of good accounting, having your startup financials in order streamlines the process of raising venture capital funds or preparing your business for an exit. If your startup does not have clear, reliable financial records and up-to-date financial statements (profit and loss, P&L, or income statement, balance sheet and cash flow statement), you may have a hard time raising capital, delay the fundraising due diligence process, or take a hit on your earnings in the event of an exit.
And last, financial records are required for state and federal tax filings, and ongoing, accurate accounting helps prevent unintentional tax violations and surprise tax bills. Plus, maintaining organized financial records helps maximize R&D tax credits available for startups.
It’s recommended that all companies set up an accounting solution on day one, along with a bank account. You never know when your SaaS startup’s growth will take off, and you won’t regret having a trusted accounting system in place to help guide and support your business through these exciting (and complex!) times.
The differences between regular accounting and SaaS accounting are clear. Solutions for SaaS accounting have to meet these certain elements to truly benefit these tech startups.
Many startups start by tracking their finances using cash basis accounting. Cash accounting is the practice of counting revenue as you receive cash and subtracting costs from that number. This method is easy to use and simple to maintain, and good for small businesses or those with little inventory or customer base — but not recommended for SaaS businesses.
Accrual basis accounting doesn’t count revenue until cash is earned, regardless of how much cash is on hand. Even though this method of accounting is more complicated, it’s better for large businesses and SaaS businesses with subscription-based income. Plus, investors and government regulators may require your business finances to follow accrual accounting so it’s not a bad idea to get ahead of these mandates.
Generally Accepted Accounting Principles, or GAAP, is a set of accounting rules, guidelines, and regulations to standardize business accounting methods across industries. GAAP exists to create transparency and consistency in financial reporting from one organization to the next.
While startups are not required to follow GAAP accounting principles, there are benefits of SaaS startups doing so from an early stage.
Because GAAP requires your financial activity to be organized in a consistent and comparable manner, your forecasting, financial modeling, and financial analysis is more accurate and reliable. For SaaS businesses, which rely heavily on financial projections to inform important business investments and decisions, working with accurate and up-to-date financials is crucial.
Furthermore, investors, bankers, and auditors will use GAAP to evaluate your company’s finances. In the event your business seeks investment or a loan, having this in place will save time and effort restating financial information during these cycles.
Following GAAP guidelines, there are three required financial statements every SaaS startup (or any business) should generate on a monthly basis:
Profit & Loss (P&L) or Income Statement summarizes the revenues, costs, and expenses from a specified time period.
Balance Sheet provides a snapshot of a company’s assets, liabilities, and equity, things owned and owed by the company.
Cash Flow Statement shows incoming and outgoing cash movements on (typically) a monthly basis, in much more detail than a P&L statement.
Booking paints a picture of the revenue you are expecting to earn over a period of time based on customer commitments; it looks at the value of a contract ahead of the payment completion.
Bookings are an important metric for SaaS businesses to understand the success of your sales efforts and potential revenue growth.
Billings are the actual amounts billed to customers. This figure is the actual amount you plan to collect from customers and represents the money owed to your company.
Revenue is the total amount of income generated by a business's primary operations, typically the sales of goods or services, and represents the business’s total earnings or profit.
Revenue recognition is the accrual accounting principle that specifies how and when you can record your business’s sales and non-operating income as revenue. It requires businesses to classify pre-payments for services as liabilities called deferred revenue or unearned revenue and only earn the payment and recognize it as revenue once you’ve provided the customer with the service promised.
SaaS revenue recognition can be tricky to understand. An example of how a SaaS accounting service would handle this is to imagine a 1-year subscription. The customer paid upfront but you don’t count the entire payment as revenue yet; this is cash categorized as deferred or unearned revenue. At the end of each month, after the customer consumed your service, your accountant will apply the portion of cash your business earned during the one-month period from deferred revenue to revenue.
Subscription-based services accumulate recurring revenue, which is typically measured with two SaaS metrics: monthly recurring revenue, or MRR, and annual recurring revenue, or ARR.
Both are measurements of your predictable revenue stream over a period of time. Businesses typically first calculate their MRR and then multiply that figure by 12 to find their ARR. MRR should reflect:
KPIs (key performance indicators) give you the best picture of how your company is doing overall. Which key financial metrics you track depends on your business, but there are five types of KPIs that all SaaS companies should track.
Zeni is a full-service finance firm that provides bookkeeping, accounting, tax and CFO services for startups. Our team of finance experts have deep experience working with SaaS businesses (Zeni itself is a SaaS business, too!) and bring 100+ years of experience to your startup’s bookkeeping and accounting system.
Whether you’re looking for a service that manages your every financial function (bill pay and invoicing included!), a senior finance expert to put together budgets and projections, or advice on filing your annual tax return, Zeni’s complete solution has you covered.
Advanced bookkeeping practices are the basis of what Zeni does, and are included in all our service plans. Our customers tell us they prefer Zeni to other startup bookkeeping solutions because they get the following benefits: