Saas revenue recognition can be complicated and carry major implications for your cash flow and tax burden.
It seems as if there’s a new SaaS business that pops up each day. If you’re getting one started or have been operating one for a while, it can still be difficult to figure out how to account for your books, especially items such as COGS or even your sales.
SaaS companies, in particular, build their businesses around billing clients for something the customer hasn’t even utilized yet, which can get tricky in the accounting world. Let’s discuss the guidelines on revenue recognition as a SaaS business.
Revenue Recognition is one of those extensive terms in accounting that can become more complicated than it seems. To put it simply, it’s how your business records its revenue.
Once you get paid, you mark that as revenue, right? Not exactly.
It’s important to realize that there is a difference between receiving cash to your bank account versus revenue. Not all payments received can be deemed as revenue, at least not immediately.
There are two ways to recognize revenue; cash-basis accounting versus accrual accounting.
Accounting standards are in place to make it more streamlined for businesses to report their revenue and for stakeholders to understand their reporting. They make it more unified across different industries and companies.
The Financial Accounting Standards Board has set guidelines in place such as GAAP (Generally accepted accounting principles) to ensure that businesses understand how to report their revenue. One of these practices is ASC 606 which offers clarity in how businesses should report their revenue.
ASC 606 offers a 5-step model to understand how to record revenue.
There are 5 requirements to be able to recognize your billings as revenue in the SaaS world, but one of the main points is that it takes a month for the buyer to be considered in control of the product and assume the risk and reward. This really comes into play when it comes time to close the books each month.
Can a business report the revenue from a sale on the 25th of the month for an annual subscription?
Probably not. Because the customer hasn’t been using the product for more than a month by the 31st so the risk and reward hasn’t been transferred nor has the control of the product. There are also several situations in which the customer might require a refund or additional services.
Let’s look at some possible scenarios.
Consider a situation where you are selling an annual subscription for $6,000. We know we can’t just report $6,000 once we collect it, as that’s not in line with accrual accounting and ASC 606.
We also have to consider separate service lines for this company. What if they offer more than just an annual subscription as most companies do? How do we account for set up fees, customization support, or consultations? If these aren’t included in that same $6,000 fee, we’ll need to account for them over a different time period or possibly in a different way.
Now that you have a better understanding of revenue recognition and how to properly record your SaaS revenue, the question becomes how should you track your revenue to stay on target with your goals?
This an important distinction to make and track. Bookings are customer commitments to pay while billings are the actual invoiced amount. Bookings will help you forecast your incoming revenue in future periods. Billings can tell you what you’re more likely to make in the shorter term.
It’s important to see how your bookings align with your billings to make sure your cash flow is staying steady. You want to actually be billing your client for the amounts you are forecasting from bookings; otherwise, you’re not making as much as you are predicting and possibly budgeted for.
ARR is the amount of money you are forecasting from annual subscriptions, which is important to know if you’re trying to gauge your expected revenue in the longer term.
MRR is broken down by month and can be divided into these 3 divisions:
This is a confusing topic and there are many situations that can arise that make it even more complex. No need to worry about it too much because that’s how Founder’s CPA can help. We make SaaS revenue recognition as well as other accounting situations easy to understand!
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