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SaaS Accounting:

The Ultimate Guide

Josh Leider

Josh Leider - Head of Growth

March 29, 2024

All companies need accounting and financial management, but you might be surprised to learn that the practice of accounting isn’t a one-size-fits-all method for every business. And one type of business that conventional accounting measures definitely don’t translate well to is that of a SaaS. We’ll explain more of why throughout this post.

Read on for the ultimate accounting guide for SaaS companies. We’ll explain why conventional accounting principles and practices don’t apply, some of the key challenges that the SaaS business model poses, KPIs and performance metrics that you’ll want to keep tabs on and more.

What is SaaS Accounting and Why Does it Matter?

SaaS companies have unique business models when you factor in how they generate revenue and subscribe customers. Hence, they also have unique financial needs, which SaaS accounting helps satisfy while maintaining regulatory compliance.

As you can tell, accounting for SaaS is very different from conventional accounting – largely due to the unique business model that a SaaS company operates by. Think about it this way. SaaS companies tend to charge based on the number of licenses they sell and any set-up fees associated with these licenses. There are also often subscription fees and support fees. Managing the cash flow tends to be a bit more complex than it is for most other types of companies.

Due to the subscription fees, conventional financial practices don’t tend to work well with SaaS companies. Hence, working with a good SaaS accounting firm can help manage cash flow, accounting rules and more so that your business can stay compliant with tax laws and regulations.

 

Why is SaaS Accounting Different?

 

SaaS accounting is different because SaaS companies are different. The way they earn money differs from how most conventional companies earn revenue, so conventional financial strategies and accounting methods don’t tend to apply very well to such businesses. SaaS accounting is largely different because of this, as it has to consider subscription and recurring revenue as its main financial indicators. For this reason, and the way the SaaS business model works, financial reports and statements have to be very SaaS business-specific. If conventional financial methods are applied to a SaaS business, chances are that forecasting and reporting are going to be inaccurate. You may also risk compliance and failure to adhere to the ASC 606 revenue recognition standard.

    Key Accounting Methods for SaaS Company

    We’ve already established how the accounting differs for SaaS companies compared to more traditional businesses. In this section, we’ll discuss some of the key accounting methods that they often use, the two most popular being cash-basis and accrual accounting. Here’s an overview of each of these:

    • Cash-basis accounting: Via this method, money is only recorded when it’s either owed, paid or received. Hence the name, revenue and expenses are documented as relevant to the money as it changes hands. It’s a simpler accounting method than accrual accounting, but it’s not relevant for all SaaS companies. For instance, if you’re a SaaS company or startup that uses a subscription-based model, it won’t apply.
    • Accrual accounting: Unlike cash-basis accounting, where money is recorded at the time it is paid, received or owed, accrual accounting documents revenue and expenses when they’re either earned or planned. While more complex than cash-basis accounting, it makes it easier to forecast and plan, something that can be very helpful for a startup company. You also may have to use this accounting method unless you hit certain income thresholds, per IRS requirements.

     

    Navigating SaaS Accounting Standards and Regulations

    As a company that requires unconventional accounting methods, it should be no surprise that there are various standards and regulations that SaaS businesses must abide by. Working with the right SaaS accounting partner, like Graphite Financial, can also help ensure that you are staying compliant with both SaaS specific and generally accepted accounting principles. Some of the relevant accounting standards include:

    • ASC 606: This is a newer revenue recognition standard that applies to any business that exchanges goods and services based on contractual agreements. SaaS companies would certainly qualify. To ensure compliance, companies must properly identify contracts with customers, set transaction pricing and recognize the revenue earned for the exchange of goods and services.
    • IFRS 15: IFRS 15 is another revenue recognition standard that impacts SaaS businesses. The main purpose of the IFRS 15 is to standardize how businesses report transactions. The steps are similar for IFRS 15 as they are for ASC 606 – the contract must be identified, the agreed upon service performed, prices must be agreed to and the transaction must be completed.

     

    Mastering Revenue Recognition in SaaS

      SaaS businesses are unique in that they don’t obtain any sort of control over the service they receive. Hence, it can be difficult for them to understand when to recognize revenue. However, recognition of revenue is crucial to ensure accurate financial statements, especially when it comes to compliance with the aforementioned ASC 606 and IFRS 15 standards.

      So how do you recognize revenue? It’s a five-step process, and while it’s outlined in both the ASC 606 and IFRS 15, here’s an overview of this process:

      1. Identify the contract: The process of recognizing revenue begins by agreeing to a contract with a customer. This contract will specifically spell out the product or service provided as well as user rights.
      2. Performance obligations: Products and services are described in the contract, including the time frame they’ll be carried out. The contract also details any deadlines.
      3. Agree on the price: Part of agreeing on the price is setting a specific price. This price may consist of the standalone service, the subscription price, and any discounts or promotions for new or existing users.
      4. Allocate the price: Price is then allocated based on the terms of the contract.
      5. Account for revenue: The final step is recognizing the revenue.

      Again, this is all something that a good SaaS accountant firm, like Graphite Financial can help your company navigate. For more information on the revenue recognition process, contact Graphite Financial or view this page for further details.

      Overcoming SaaS Accounting Challenges

      A good SaaS accountant can help companies overcome many of the challenges that they face. Some of the common challenges include:

      • Managing revenue recognition and deferred revenue.
      • Tax and expense management.
      • Accrued liabilities.
      • Complying with the ever-changing standards, such as ASC 606 and IRFS 15.
      • Intangible asset valuation.

      Other challenges include managing sales tax, especially across state lines when each individual state’s sales tax must be considered. And just because it’s worth mentioning again, revenue recognition is a key challenge.

      The Future of SaaS Accounting: Automation and Innovation

      Automation and innovation. Those two factors are the future of many industries – and practices like SaaS accounting can benefit from such as well. Automation can help streamline processes and reduce errors in financial reporting. And innovation keeps practices like SaaS financial reporting moving forward and continuously improving over time. Artificial intelligence and machine learning are also likely to play a role in the future of SaaS accounting, similar to how they’ve played a role in several other industries already.

      Contrary to what you may think, accounting isn’t some static industry. It’s evolving and growing as technology improves – and Graphite Financial is always adopting new technologies and practices to help make our services even better.

      Graphite Financial for SaaS Accounting

      As you can see, not just anyone can perform good SaaS accounting. It takes a true SaaS-focused accounting firm to comply with the latest regulations and ensure that a SaaS’s needs are fully met along the way. As a company that specializes in SaaS accounting, Graphite Financial can serve as the partner that you’re looking for. We’ll take the guesswork out of SaaS accounting to get you started and scale with your startup as it grows. Along the way, we’ll work with you to identify some key performance indicators and track these over time to truly get into the economics of your business.

      For more information on SaaS accounting and how Graphite Financial can serve as a true extension of your business, contact us today to learn more or to set up a free consultation.

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