Updated: Nov 1, 2022
SaaS Revenue Recognition is increasingly important for scaling SaaS companies. We’ve covered this topic before so we decided to outline SaaS revenue recognition for you again below, but if you’re just interested in the key challenges of revenue recognition skip to the last section.
Are you a SaaS business looking to analyze revenue recognition in Salesforce? Then book a demo today to find out how our Salesforce integration, Precursive PSA, can help you do just that.
WHAT IS SAAS REVENUE RECOGNITION?
Revenue Recognition is an accounting principle that highlights standard conditions for when income can be reported and how accounting should manage it (check out our full guide to revenue recognition for more info). It can appear complex so many organizations now resort to revenue recognition software that can aid this process.
Software as a Service (SaaS) Revenue Recognition means using a specially designed software or tool to assist your business’s revenue recognition. These tools will automatically process the transactions which are required for revenue recognition, meaning the data can be tracked in real time and summarised instantly depending on your business’s individual needs.
WHY IS SAAS REVENUE RECOGNITION IMPORTANT?
Software as a Service (SaaS) Revenue Recognition is a uniform online framework in which to work towards, as revenue recognition impacts the performance of all aspects of your business
Many companies choose to operate their revenue recognition through their Customer Relationship Management (CRM) systems, so that all parts of the business can provide accurate data to feed the metric
An example is how Revenue Recognition in Salesforce has used SaaS Revenue Recognition to make up significant functionality in their CPQ product
It’s important because it automatically marks the point where sales become revenue, preventing any delays which could affect your bottom line
This is why Revenue Recognition is a Generally Accepted Accounting Principle (GAAP)
WHAT ARE THE TYPES OF SAAS REVENUE RECOGNITION?
When it comes to SaaS revenue recognition companies, there are two main types to be aware of:
Cash basis - A simple accounting method of recognizing revenue when you receive it, as in when you’ve been paid. Expenses can simply be minused off this. This is good for smaller businesses as they can declare money as it enters and leaves the company, meaning they then don’t have to pay tax on money they didn’t actually have in the account.
Whilst the simplicity is good, this method does make forecasting difficult and if your inventory scales with your business then it’s harder to keep track.
Accrual - Both revenue and expenses are accounted for when they are booked, not when they are paid, in turn making accurate tracking of monthly recognized revenue (MRR) possible. This is better for larger organizations, not least as it is an IRS stipulation if you earn more than $25 million gross per year.
SO WHAT IS ASC606 & IFRS15?
This is the accounting standard for revenue recognition as compiled by the Financial Account Standards Board (FASB) and International Financial Reporting Standards (IFRS) meaning there is a standardized framework to work with. ASC606 is good revenue recognition for SaaS organizations as financial statements can be simplified, using five stages.
THE FIVE STAGES OF REVENUE RECOGNITION FOR SAAS
The process of SaaS Revenue Recognition can be broken down into five stages:
Identify the contract with the customer by outlining the criteria for creating the contract and the mutually agreed upon obligations of both parties.
Identify the obligations that form the contract, describing all performance requirements and deliverables. If services or products are separate, the accounting of them also needs to be distinct.
Agree on the transaction price and the considerations of the individual charges. List all revenue streams that should be accounted for in the SaaS revenue recognition process, including initial ones and those that are to be received incrementally.
Allocate the transaction price at the inception of the contract. All items must have a stand-alone value i.e. the cost it would be should it be sold separately.
Recognize revenue as the customer benefits from your product or service. When the customer has control of it, you can recognize the revenue.
KEY CHALLENGES OF SAAS REVENUE RECOGNITION
Whilst this five-stage process may make recognizing revenue for a SaaS business seem surprisingly simple, in reality there are a number of problems you might face:
Subscription model | If your customer subscribes annually to your SaaS product then revenue recognition is easy. But it gets complicated due to the degree of flexibility provided, especially as such flexibility is becoming commonplace. If the customer cancels the annual subscription before the year is out, you may have to provide a refund, credit note or recognize revenue as deferred. Alternatively, if no refund is due you can bring forward the revenue instead of recognizing it incrementally. Either way it complicates the way revenue is recognized.
Switching from monthly to annual | If people are paying monthly for your software, you can recognize that revenue monthly and forecast future revenues on that basis. But if they then decide to switch to an annual plan at a non-convenient time, for example in the middle of a tax year, the accounting process will have to take into account services received in days, when the switch is, calculate deferred revenue and then they will have to hold a prorated amount. Similar actions have to be taken into consideration if a customer chooses to downgrade their account, although this time revenue recognized will have to be reduced.
Time-consuming and prone to error | Tracking revenue from invoices to spreadsheets is not only dull but the volume of data is high. In transferring line items, mistakes can be made, leading to incorrect data that maps into your figures for revenue recognition (which can lead to problems with the tax man). Plus, as you grow your customer base, the process becomes more time-consuming and errors are more likely to occur. Even small errors can significantly impact your records. As a result, ensure you get out of spreadsheets and into a system that records the information both accurately and with a degree of automation.
Some software misses key SaaS metrics | Subscription models are the norm for SaaS companies these days, so you’ll need software that tracks those key metrics important to your business like recognizable revenue, deferred revenue and unbilled accrued revenue.
Customer fails to pay | This happens and if a customer defaults you’ll have to write off revenue as bad debt, either partially or in-full. This complicates reporting on that revenue if such revenue is deemed uncollectible.
Bundled features and services | SaaS implementations will often come with support and services fees, plus fees for initial implementation and set-up. Additionally, your customer might want some customization which increases costs and then requires further consultation, again with additional fees. You might bundle these costs together for a more attractive and marketable pricing model, but for revenue recognition to conform, you’ll need to separate all individual costs as if separate, just like in stage four of revenue recognition.
With these problems in mind, SaaS Revenue Recognition may now sound like more of a daunting task however it can be simplified as you bring together recurring billing in-line with how you recognize revenue. To demystify and decomplicate the process, look to a system, such as Precursive PSA, that can make the management of SaaS Revenue Recognition simple and in keeping with your customer data.
Precursive helps SaaS companies recognize revenue earlier by reducing the time to launch. To find out how, book a meeting with our team. Alternatively, download our free playbook which explores the opportunities of recurring revenue in your professional services delivery and highlights the cost of failed and delayed implementations that can impact your revenue recognition practices.