Guide to SaaS Accounting

The Software as a Service (SaaS) industry has grown exponentially over the past few decades. In fact, Gartner reported that the value of the SaaS market in 2023 exceeds $195 billion. Moreover, statistics from CloudBees show that 60% of companies already use SaaS to enhance their business operations. 

Even so, many software developers are ill-equipped to handle the complexities of user subscription management and the potential a SaaS model presents. In this article, you will learn:

• What is SaaS accounting?
• How is SaaS accounting different?
• Types of SaaS accounting
• SaaS accounting challenges
• 5 Step revenue recognition for SaaS accounting
• SaaS financial reporting and metrics 
• Simplify SaaS accounting with QuickBooks

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What is SaaS accounting?

SaaS accounting involves tracking, evaluating, and gaining insight into financial information specific to your SaaS company. This method of accounting produces financial statements tailored to the needs of SaaS businesses and considers its unique characteristics, like the subscription model and annual recurring revenue.

Most SaaS companies use cloud accounting software to handle their financial statements and reporting because of the intricacy involved. 

How is SaaS accounting different? 

The subscription-based business model of SaaS companies vastly differs from the traditional license model. A company that operates under a license model would contain four main charges including: the initial license, customisation, implementation, and support and maintenance. 

In contrast, a SaaS company merges all of these costs into setup or subscription fees. The success of SaaS companies depends on the number of consumers willing to use the software regularly. 

SaaS accounting differs from traditional accounting methods in three key areas: cash flow dynamics, cost of goods sold and gross margins. 

• Cash flow dynamics: subscription-based business models require recurring payments , which drive complex cash flow dynamics. 
• Cost of goods sold: SaaS accounting relies on lower Cost of Goods Sold (COGS), which consists mainly of marketing and sales, to maintain the product and support. 

• Gross margins: It also uses more significant gross profit margins, ranging from 60-80%. 

Types of SaaS accounting 

There are two different SaaS accounting methods, depending on when the business records the sale. Here's a quick summary of the differences between cash and accrual accounting for SaaS businesses: 

Cash basis accounting

Cash basis accounting is often the first financial tracking method new companies use. This method records revenue as the business receives money and deducts expenses when the business pays incurred costs.

Accrual accounting

Accrual basis accounting records revenue and expenses in the order in which they occur rather than in the order in which they are paid or received. This approach works well for large corporations and SaaS companies that derive revenue from subscriptions. These businesses can also defer revenue reporting on their tax returns. 

SaaS accounting challenges

Due to the complex nature of SaaS subscription based business models, companies face a number of SaaS accounting challenges. While the Generally Accepted Accounting Principles (GAAP) in the United States and the International Financial Reporting Standards (IFRS) globally give a framework for recognising revenue and expenses, SaaS providers still encounter accounting challenges. 

• Recognising revenue at the right time: Revenue recognition determines when payment is recognised as revenue. The challenge for SaaS companies is knowing when to recognise revenue. 
• Managing expenses properly: SaaS providers spread many of their business expenses throughout the contract term or the expected duration of the customer relationship. Knowing which costs require amortisation and which you can write off immediately is crucial in a SaaS company. 
• Collecting sales taxes: local tax laws and regulations pose another challenge for SaaS accounting, particularly where companies operate internationally.

5 Step revenue recognition for SaaS accounting

GAAP regulated by the Financial Accounting Standards Board (FASB) and the IFRS, regulated by the International Accounting Standards Board (IASB) recognise revenue recognition as a core accounting principle. The FASB and the IASB issued a converged standard on revenue recognition ^[1] that specifies the circumstances under which you can recognise revenue and how you can record that revenue in financial statements. 

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. The principles of revenue recognition are the same across industries. ASC 606 and IFRS 15 revenue proposes a flexible, solid five-step structure for revenue recognition. 

1. Identify revenue from contracts with customers

This document specifies the conditions you must meet before making a sales agreement with a client. This contract is an agreement between two or more parties that spell out their responsibilities and rights. 

2. Identify performance obligations in your contract

When drafting a contract, you include all the specifics of deliverables and performance obligations here. If the services or products are distinct, you need to account for them separately. 

3. Establish a transaction price

In this step, consider standalone fees, subscription service costs, and any discounts when determining the final transaction price.

4. Allocate your transaction price

This part outlines the breakdown of the transaction price between the various obligations described in the contract. These amounts may be subject to change. 

5. Recognise revenue when meeting performance obligations

You will recognise revenue over time based on the customer experiencing the benefits of your product or service and the accompanying transfer of control from the seller to the buyer. 

SaaS financial reporting and metrics 

Accounting standards such as IFRS and GAAP establish financial accounting and reporting guidelines and demands for publicly listed SaaS companies in the global market while internal company goals and key performance indicators determine reporting standards and metrics for internal company stakeholders.

Reporting

Your company should produce three primary financial statements at the end of each financial period, as required by the standards mentioned above. 

• Income statement: This summarises the income, expenses, and other financial details for a given time frame. 
• Cash flow statement: This document details the monthly cash inflow and outflow with more detail than a Profit & Loss statement.
• Balance sheet: This gives you an overview of all things owed and owned by the business, such as the company's equity, assets, and liabilities. 

Metrics 

SaaS companies should monitor top-level SaaS metrics. A thorough familiarity with these metrics is essential for ensuring accurate and reliable reporting and compliance with relevant financial reporting standards. 

Bookings

Considering customer commitments, your number of bookings gives you an idea of how much money you can expect to make over time. Bookings can help you measure how well sales efforts are working and how much revenue growth you'll see. 

Billings

Billings are the actual payments that you charge clients, and the money customers owe to your business. 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. 

Monthly Recurring Revenue 

Revenue is the money your company makes from fulfilling performance obligations. In other words, you will only get paid once you successfully provide the software service to your customers. 

Simplify SaaS accounting with QuickBooks

SaaS accounting includes many rules and regulations that can feel daunting at first glance. That's why teaming up with an accounting solution is crucial to help accountants manage their clients’ SaaS accounting. 

Fortunately, QuickBooks Online Accountant provides a range of accounting tools to help accountants automate invoicing, reporting, and expense management for their SaaS clients. QuickBooks helps SaaS companies manage recurring invoices and produce financial reports including income statements, cash flow statements and balance sheets. Our cloud-based accounting solution is easily accessible from any device and gives accountants an overview of their clients; business performance in real-time from one login.

QuickBooks Online software can integrate with other corporate tools and apps like CRM systems and payment processors via the QuickBooks app library.

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