SaaS Accounting: Challenges and Solutions for Subscription-Based Tech Companies

Whether you’re a seasoned SaaS veteran or a founder just starting, you must have a robust accounting system. Most startups start with cash accounting (revenue recognized only when a cash inflow is received) and then move to an accrual basis as they attract investors and scale. Learn the best info about SaaS Accounting.

But accrual-based accounting presents challenges different from the traditional, transaction-based cash model. For one, many SaaS businesses offer multiple-element arrangements, including various services and discounts. For each of these elements, you need to know their standalone selling prices and recognize them separately over the contract’s lifetime. This complicated process requires reliable accounting software and an accountant who understands the rules of revenue recognition for SaaS businesses.

For example, SaaS companies typically offer installation support, training, and consulting with each subscription purchase. Each of these elements has a unique standalone selling price, and you need to separate them from the total subscription purchase for each quarter to recognize them separately. This is challenging to do in a spreadsheet, and even with add-on software, it cannot be easy to accomplish in a full-featured accounting system.

Another challenge of SaaS accounting is measuring and predicting customer churn. The churn rate metric is a key performance indicator for many startups, and venture capitalists often use it to determine if a startup can make it to its next round of funding. Fortunately, some helpful SaaS accounting metrics can help you measure and manage churn rates in the early stages of your business.

Finally, a number that all SaaS companies should be familiar with is gross profit. This metric is a crucial measure of the company’s overall profitability and can be calculated by subtracting its cost of goods sold (COGS) from its revenue. Usually, the gross profit margin is expressed as a percentage and indicates how much of the payment is being turned into profit.

A sound SaaS accounting system will also make it easy for a company to track its expenses and closely monitor the balance sheet. A standard metric that VCs look for is the LTV to CAC ratio, which combines a prediction of a customer’s lifetime value with the upfront cost to acquire them. This metric gives a VC a sense of how much potential profit a new SaaS customer will generate and whether developing them is worth the investment.

Read Also: Introducing SEBA: The UK’s Largest Business Students’ Association