Accounting for SaaS: Complete Guide for SaaS startups

Image credit: Pexels

Key Takeaways

It's critical for SaaS startups to have a solid accounting system implemented from the launch. Since SaaS startups are often subscription-based, they require an accounting system that can handle the demands of a SaaS sales model.
Because of the subscription-based system employed by most SaaS startups, revenue tracking is by far the most noticeable distinction in SaaS accounting. Users pay subscription costs and fees for add-on services, which requires an accounting system that can accommodate upgrades, downgrades, or add/delete various services.
SaaS startups also have a distinct set of accounting solutions compared to your typical startups and small businesses, such as subscription management solutions and periodical billing systems. These require broader skills and understanding of best practices.
SaaS revenue recognition standards (like ASC-606 and IFRS 15) regulate the method by which revenue is recognized during the delivery of products or services. These guidelines require that income from a single customer payment be dispersed over time proportional to how the startup delivers the product or service in compliance with the customer's contracts.
Under the accrual accounting method, profit is not counted until it is earned, regardless of how much cash is on hand. Despite the fact that this way of accounting is more sophisticated, it is preferable for subscription-based SaaS startups. Investors and federal regulations may demand accrual accounting for your startup's accounts, so getting ahead of these regulations is a good idea.
Understanding SaaS revenue recognition might be difficult. Consider a one-year subscription as an example of how a SaaS accounting solution would approach this. The entire amount is not reported as revenue because the consumer paid upfront; this cash is classified as delayed or deferred revenue. The accountants will apply the percentage of cash that the startup generated during the one-month term from deferred revenue to revenue at the end of every month -- after the client has used the service.
Having a thorough understanding of just how much money comes in and out of the checking account is necessary for any startup to stay afloat. This is especially significant in the case of SaaS since despite recurring revenue being one of the key advantages of this financial model, it could also fluctuate a lot. Customers often leave on a regular basis, the customer acquisition process is complex and costly, and startups must keep detailed records of all of these transactions in order to make informed decisions.

Basic Accounting for SaaS

Software is among the world's fast-expanding sectors. Software-as-a-service, or SaaS, is becoming increasingly successful and profitable as humanity progresses towards a digitized world. As a result, it's critical for SaaS startups to have a solid accounting system set up from the outset.

Since SaaS startups are often subscription-based, they require an accounting system that can handle the demands of a SaaS sales model.

When it comes to getting a startup up and running, many founders don't address accounting head-on. They're more concerned with developing a fantastic product, serving their customers, and recruiting the best employees. However, the sooner entrepreneurs explore their accounting options, the less likely they are to face crippling accounting-related problems in their long journey ahead.

How is SaaS Accounting Different?

Because of the subscription-based system that is the basis of most SaaS startups, revenue tracking is by far the most noticeable distinction in SaaS accounting. Customers pay subscription costs and fees for add-on services, which expend a startup's resources when customers upgrade, downgrade, or subscribe/unsubscribe from various services.

SaaS startups also use a quite distinct set of accounting solutions compared to your typical startups and small businesses, such as subscription management solutions and periodical billing systems.

Why is Dependable Accounting Important for SaaS Startups?

Accounting offers a clear picture of a startup's revenue and procedures. Access to this data could greatly impact the prospects of a fast-expanding SaaS startup.

Putting your startup's finances in order can expedite the process of seeking venture capital money or prepping for an exit. If the startup lacks concise, dependable accounting statements and updated financial reports (such as profit and loss or income statements, balance sheets, and cash flow statements), then founders might have a difficult time raising funds, experience delays in financing due diligence, or might take a massive if they choose to exit. Last but not the least, financial disclosures are necessary for federal and state tax reports, and consistent, precise accounting helps avoid unintended tax infractions and unexpected tax liabilities. Keeping structured financial records allows many firms to take advantage of R&D tax credits as well.

When Does a SaaS Startup Need a Bookkeeping and Accounting System?

It is suggested that all startups establish an accounting system and a bank account from their inception. One will never know when a SaaS business may take off, so having a reliable accounting system in place will prove invaluable.

Accounting for SaaS Revenue

Key Requirements for Recognizing SaaS Revenue

If your startup enters into a commercial contract with a client to deliver products/services, you must follow ASC-606 (authorized by the Financial Accounting Standards Board) and IFRS 15 (published by the International Financial Reporting Standards) to comply with generally accepted accounting principles (GAAP).

Based on the following 5 processes, SaaS revenue recognition standards regulate the method by which revenue is recognized during the delivery of products or services:

Step 1: Determine the terms of the contract.
Step 2: Determine the contract's delivery obligations for the startup.
Step 3: Calculate the transaction cost.
Step 4: Assign the transaction cost to the contract's performance expectations.
Step 5: As and when the business fulfills a performance obligation, record income.

These guidelines require that income from a single customer payment be dispersed over time proportional to how the company delivers the product or service (the performance obligations) and in compliance with the customer's contracts.

Key Elements of SaaS Accounting

The major distinctions between traditional accounting and SaaS accounting are obvious. To effectively assist technology startups, SaaS accounting solutions must meet these specific criteria:

SaaS Accounting System Infrastructure

Cash vs. Accrual Accounting

Many startups begin by keeping track of their finances on a cash basis. Cash accounting is the process of calculating revenue as the cash comes in and costs as the cash goes out. This approach is straightforward to use and manage, and it's ideal for small firms with limited inventory or clientele -- but it's not suggested for SaaS startups.

Enter accrual accounting.

Under the accrual accounting method, profit is not counted until it is earned -- regardless of how much cash is on hand. While this method of accounting is more sophisticated, it is preferable for large corporations and subscription-based SaaS startups. In addition, investors and federal regulations may demand accrual accounting for your startup's accounts, so getting ahead of these regulations is a good idea.

GAAP-Compliant Accounting

GAAP, or the Generally Accepted Accounting Principles, is a set of accounting norms, standards, and laws that are used to coordinate commercial accounting processes across sectors. The purpose of GAAP is to ensure that financial reporting is transparent and consistent from one business to another.

While businesses are not obligated to adhere to GAAP accounting regulations, there are advantages to following them early on. Your planning, financial modeling, and profitability reporting will be more accurate and dependable since GAAP mandates all financial activities to be arranged in a uniform and similar manner. Managing precise and updated financials is essential for SaaS startups, which depend largely on financial predictions to drive significant company investments and operations.

In addition, GAAP will be used to assess the startup's finances by investors, lenders, and auditors. Putting this in order can save effort and resources if the startup seeks financing or a loan.

SaaS Financial Reporting and Metrics

Financial Statements

According to GAAP guidelines, every SaaS startup should generate 3 mandated financial reports every month,

The Profit & Loss (P&L) or income statement describes the sales, costs, and expenditures for a given period of time.
A balance sheet is a picture of a startup's assets, liabilities, and equity -- or what it owns and owes.
In contrast to a P&L statement, a cash flow statement illustrates incoming and outgoing cash transactions every month in considerably greater detail.

Bookings

“Booking” depicts the revenues that the startup expects to collect -- over a finite interval -- on client commitments. It assesses the worth of a contract before the payment is made. With SaaS startups, bookings are a critical statistic for determining the effectiveness of sales operations and prospective revenue growth.

Billings

The actual invoices billed to clients are referred to as "billings." This value is the real amount that your startup aims to recover from clients.

Revenue and Revenue Recognition

Revenue is the entire amount of money earned by a startup's main operations, which are usually the sales of products/services, and it indicates the startup's overall income or revenue.

The accrual accounting concept of recognizing revenue explains when and how the startup's sales and non-operating earnings can be recorded as revenue. It requires startups to designate pre-payments for operations as liabilities known as deferred/unearned revenue and to only earn and acknowledge the payment as revenue once the client has received the service that was pledged.

Understanding SaaS revenue recognition might be difficult. Consider a one-year subscription as an example of how a SaaS accounting solution would approach this. The whole amount as revenue is not reported because the customer paid upfront; this is cash classified as "delayed" or "deferred revenue." The accountants will apply the percentage of cash that the startup generated during the 1-month term from deferred revenue to revenue at the end of every month, after the client has used the service.

MRR & ARR

Recurring revenue is accumulated by subscription-based businesses, which is commonly quantified using two SaaS metrics:

Monthly Recurring Revenue (MRR)
Annual Recurring Revenue (ARR)

Both are time-based assessments of the anticipated revenue stream. Startups usually compute their MRR first, then multiply it by 12 to get their ARR. MRR should take into account:

Income from all customers on a recurring basis
All possible upgrades and downgrades
Discounts
Customer churn, often known as revenue loss

Metrics for SaaS

KPIs (key performance indicators) provide the most accurate picture of the startup's total performance. The essential financial metrics you ought to follow vary depending on your startup, but there are 5 KPIs that any SaaS company should monitor:

KPIs for the Top of the Funnel
Unit-Economics KPIs
Revenue KPIs
KPIs for product/market fit
Fiscal KPIs

Summary

Accounting refers to the process of monitoring a startup's income and financial transactions. In short, having a thorough understanding of just how much money comes in and out of the checking account is necessary for any startup to stay afloat. This is especially significant in the case of SaaS since, despite recurring revenue being one of the key advantages of this financial model, it could also fluctuate a lot. Customers often leave on a regular basis, the acquisition procedure is complex and costly, and startups must keep detailed records of all of these transactions in order to make informed decisions.

When paying federal taxes, you must also provide financial documents to avoid any tax infractions or unforeseen bills. That's why once you've established a bank account, you'll need to hire a trustworthy accountant. A good accounting solution will assist your startup and enable it to flourish.

Staying on top of your money may be simple when you initially start with your SaaS startup, but if you want to expand, you'll need an accounting solution that will keep your cash flow in control and ensure compliance with IRS requirements.

That’s where we come in.

Learn more with us

We can help!

At AbstractOps, we help early-stage founders streamline and automate regulatory and legal ops, HR, and finance so you can focus on what matters most —your business.

If you're looking for help with understanding accounting for SaaS startups, we have got your back. Get in touch with us.

Like our content?

Subscribe to our blog to stay updated on new posts. Our blog covers advice, inspiration, and practical guides for early-stage founders to navigate through their start-up journeys.

Note: Our content is for general information purposes only. AbstractOps does not provide legal, accounting, or certified expert advice. Consult a lawyer, CPA, or other professional for such services.