The SaaS industry is currently on track to top $168 billion in annual revenue within the next two years.
That’s a huge market for entrepreneurs and startups to capitalize on. It also comes with a unique set of challenges, though—especially in the realm of accounting.
At FounderPath, we believe funding, accounting, and financial insights should be simple, transparent, and accessible for all bootstrapped SaaS founders. That’s why we created this ultimate guide to SaaS accounting.
Let’s dive in!
What Is SaaS Accounting?
SaaS accounting is the process of tracking, managing, and organizing financial transactions related to SaaS (software as a service) companies. It involves analyzing and recording all SaaS-related expenses, revenue, and other financial details to provide a comprehensive overview of a SaaS company’s finances.
Why is it important to specify that we’re talking about SaaS accounting? Good question!
What Makes SaaS Accounting Different From Traditional Accounting?
There are two different (but interconnected) ways to answer this question. The first is from a functional standpoint, the second is from a regulatory standpoint.
SaaS businesses function very differently to other types of businesses. They have unique pricing models, revenue recognition strategies, and customer onboarding processes that need to be taken into account when it comes to accounting and bookkeeping.
For example, SaaS companies have to account for usage-based pricing models, subscription-based pricing models, and trial periods—all of which require specialized accounting solutions and tools.
Traditional businesses don’t necessarily have to consider these complexities when it comes to their accounting practices.
Because of the functional differences between SaaS businesses and traditional businesses, there are also some pretty major regulatory differences. SaaS companies and traditional companies are now seen as distinct when it comes to accounting and financial reporting by both FASB and IFRS.
The criteria for determining which group your company falls into are:
- The company retains sole possession of the software.
- Customers may not run the software on their own or a third party’s hardware.
- The company’s employees administer the software services.
If your company meets all three criteria, it’s seen as a SaaS company and you need to comply with all SaaS-specific accounting regulations. To learn about these regulations in more depth than we’ll be going into here, check out FASB’s summary of ASC 606.
Why Is Careful SaaS Accounting Important?
Funding & Acquisitions
Careful SaaS accounting is important for a number of reasons, but one of the most crucial is in helping your company secure funding and/or be acquired by other companies.
Prospective investors will want to see detailed financial records before they commit their funds—and if those records are inaccurate or incomplete, it’s likely that the deal won’t go through.
At Founderpath, we look for very specific metrics that let us advance you cash based on your future earnings, including:
- Churn rate
If these metrics aren’t accurate or are poorly reported, you won’t be able to access this kind of capital.
Tax Compliance & Audits
Another key reason why careful SaaS accounting is so important is tax compliance and audits. If you’re filing taxes as a SaaS business or are subject to an audit, you’ll need to make sure that your financial records and reports are accurate and compliant with all local regulations.
Decision-Making & Cost-Saving
Finally, careful SaaS accounting is also important for decision-making and cost savings. By having a detailed overview of your company’s financials, you’ll be able to make more informed decisions about how best to manage your resources and expenses.
Key Elements of SaaS Accounting
Good SaaS accounting is the sum of its parts. There are quite a few key elements to cover here, so let’s dive right in:
SaaS companies—like all companies—are required to comply with Generally Accepted Accounting Principles (GAAP).
Part of being GAAP compliant in the SaaS industry means submitting monthly financial reports, including:
- Profit & Loss (P&L) or Income Statement: A comprehensive report of all income earned and expenses incurred within a given period of time.
- Balance Sheet: An overview of the financial health of your company at the end of a given period.
- Cash Flow Statement: A report of cash inflows and outflows during a given period.
When it comes to SaaS accounting methods, you have two main options:
- Cash-Basis: With this method, revenue and expenses are accounted for when they’re realized (i.e., when they’re actually received or paid out).
- Accrual-Basis: With this method, revenue and expenses are accounted for when they are incurred (i.e., when a service is rendered or a purchase is made).
The best method for your company will depend on the size and complexity of your business, so it’s worth consulting a professional accountant before deciding. That said, we highly recommend that you go with accrual-based accounting.
Cash-basis accounting may be simpler and more straightforward, but it’s also less accurate, less predictive, and can lead to tax compliance issues since companies that average more than $25 million in gross revenue are required by the IRS to use the accrual-basis method.
Accounting Metrics & KPIs
On top of your accounting method, you’ll also need to keep track of a few key accounting metrics and KPIs.
- Bookings: The total value of services or products sold in a given period.
- Billings: The total value of services or products billed to customers in a given period.
- MRR (Monthly Recurring Revenue): The amount of revenue that you can reliably count on each month.
- ARR (Annual Recurring Revenue): The amount of revenue that you can reliably count on each year.
- COGS (Cost of Goods Sold): The cost of providing services or products in a given period.
- Gross Margin: How much money is left after subtracting the cost of goods sold from revenue in a given period.
- Churn Rate: The percentage of customers who cancel their subscription in a given period.
Revenue recognition is an integral part of SaaS accounting. The basic principle here is simple—recognize revenue when you earn it by providing a service, not when it’s actually paid.
To better understand this concept, let’s talk about the three kinds of revenue SaaS companies are required to report on by GAAP:
- Accrued Revenue: This is revenue that’s been earned but not yet collected (e.g., when a customer signs up for an add-on but hasn’t yet paid).
- Unearned Revenue: This is revenue that’s been collected but not yet earned (e.g., when a customer pays for an annual subscription upfront).
- Earned Revenue: This is revenue that’s been both earned and collected (e.g., when a customer pays for a monthly subscription at the end of the month).
Again, understanding revenue recognition can be tricky, so it’s best to consult an accountant before you make any decisions.
How To Get Started With SaaS Accounting
Now that you know the basics, let’s talk about how to get started with SaaS accounting.
Step 1: Choose an Accounting Method
As we mentioned, the cash-basis versus accrual-basis debate can be tricky. That said, we strongly recommend that you go with the accrual-basis method for tax compliance and accuracy.
Step 2: Choose an Accounting Software
Once you know which accounting method you’re going to use, it’s time to choose an accounting software.
For SaaS companies with a lot of subscription revenue (i.e., almost all), platforms that were specifically designed for subscription accounting can be really helpful.
As an added bonus, you can use all of these tools (and more) to apply for flexible, interest-free funding through Founderpath. Just connect your accounting software, generate your Founderpath Score, and have funds wired to your account in as little as 24 hours.
Step 3: Set Up Your Accounts
Whether you go with cash-basis or accrual-basis accounting, the next step is to set up your accounts in your accounting software. Start by creating a separate account for each type of revenue and expense (e.g., sales, marketing, payroll, etc.). Then create subaccounts within those main accounts as needed (e.g., commissions, taxes).
Step 4: Track & Record Transactions
Now that you have your accounts set up, it’s time to start recording transactions. This involves tracking every sale, purchase and payment made within a given period and recording it in the appropriate accounts.
Once again, accounting software can make this process much easier. Not only can they automate recurring transactions like payroll and subscription payments, but they also make it easier to generate invoices, send out payments and receipts, and track expenses.
Step 5: Monitor & Analyze Metrics
Finally, don’t forget to monitor your key SaaS metrics over time. This includes things like MRR, ARR, COGS and churn rate—all of which are important for understanding how successful your business is (and where you need to improve).
For simple, comprehensive monitoring and analytics, we recommend taking advantage of a purpose-built report SaaS.
Unlock Your Full Potential With Founderpath
At the end of the day, SaaS accounting can be tricky. That’s why we recommend partnering with an experienced accountant and leveraging the right tools to make sure everything is done correctly (and efficiently).
And if you need funding to fuel your growth? Founderpath makes it easy to access flexible, non-dilutive capital using only your MRR—no fees, no interest payments, no debt. Plus, you’ll always have 12+ months to pay back your cash advance.
So why wait? Get started with Founderpath today and unlock your full potential.