What is SaaS accounting? Different types and metrics to track

SaaS (software as a service) companies are about as far as you can get from traditional brick-and-mortar businesses.

So it's only natural that SaaS companies should move away from traditional accounting practices that don’t reflect the realities of selling software on a subscription basis.

In this article, we’ll explore the world of SaaS accounting. We’ll dive into how it works, why it's important for SaaS brands to adopt it, and the common challenges faced.

SaaS accounting definition

SaaS accounting is a tailored approach to managing the finances of businesses that deliver software via a subscription over the internet. Unlike traditional software sales, which recognize revenue at the point of sale, SaaS companies recognize revenue gradually over the subscription term as the service is provided.

Key differences between SaaS accounting and traditional accounting 

SaaS accounting differs from the traditional model of accounting in four distinct ways:

1. Revenue recognition

Traditional software companies typically recognize revenue upfront at the point of sale. SaaS businesses, on the other hand, recognize revenue over time as the service is delivered, even if the subscription is paid in advance (such as paying for an annual license).

2. Deferred revenue

In SaaS accounting, payments that are received in advance are recorded as deferred revenue until the service is delivered. Deferred revenue is a liability that is gradually transferred to revenue over time. Traditional accounting doesn’t always need this level of complexity for prepayments.

3. Metric tracking and integration

SaaS companies rely heavily on metrics such as churn rate and customer lifetime value (LTV) to inform financial forecasting. These metrics are much less relevant in the traditional transactional model. SaaS accounting often integrates with billing platforms to automate and track MRR, ARR, churn, and expansion.

4. Contract modification and upgrades

SaaS agreements are regularly amended during the contract term (such as when the customer upgrades their plan or adds more users), requiring more complex accounting adjustments that aren’t used in traditional accounting.

Common challenges faced by SaaS businesses in accounting 

SaaS accounting can be much more complex than traditional accounting, giving rise to these common challenges:

• Accurate revenue recognition: Determining how and when to recognize revenue for complex billing arrangements like multi-element or multi-year contracts can be difficult without automation or deep expertise.
• Managing deferred revenue: Since subscriptions are often billed in advance, SaaS businesses must closely track and manage deferred revenue in order to accurately reflect their financial position and to stay compliant with reporting requirements.
• Billing complexity: Proration, usage-based pricing, discounts, and plan changes all introduce complications in invoicing and accounting, especially without a robust billing system.
• Churns, upgrades, and expansions: SaaS contracts change frequently. Customers cancel, upgrade, downgrade, and add or reduce users all the time. This can make it challenging to keep revenue recognition, reporting, and forecasting accurate.
• GAAP and ASC 606 compliance: SaaS businesses must adhere to strict standards, such as ASC 606, which adds additional layers of complexity related to contract and performance obligations and the timing of revenue recognition.
• Forecasting and reporting: Traditional profit and loss forecasting methods aren’t super compatible with recurring revenue models, meaning SaaS finance teams need to forecast based on cohorts, churn trends, and other closely monitored recurring revenue metrics.

Key aspects of SaaS accounting 

Great SaaS accountants must have a strong understanding of these key aspects:

• Recurring revenue recognition: Revenue must be recognized evenly over the subscription period.
• Deferred revenue: Advance payments from customers are recorded as deferred revenue until the service is delivered.
• Subscription management: Subscription details like start and end dates and plan changes need to be accounted for in real time.
• Cost of Goods Sold (COGS): The types of expenses that go into COGS look different for SaaS companies. Examples include hosting costs, support staff, and API fees.
• KPIs: Financial reporting often includes SaaS-specific metrics such as MRR (Monthly Recurring Revenue), ARR (Annual Recurring Revenue), LTV (Customer Lifetime Value), CAC (Customer Acquisition Cost), and churn rate.
• Compliance: SaaS companies must follow revenue recognition standards like ASC 606 or IFRS 15. These set out rules around performance obligations and revenue recognition.

Why is SaaS accounting important? 

Quality, compliant, and accurate SaaS accounting is important for:

• Accurate financial statements that reflect the true health of the organization
• Providing reliable financial data that helps leaders make informed business decisions
• Attracting investors and building confidence by demonstrating predictable, recurring revenue
• Preparing for exits like IPOs or acquisitions, helping to streamline due diligence and improve business valuation
• Meeting regulatory and accounting standards like IFRS 15 or ASC 606

Types of SaaS accounting 

SaaS businesses have three main options when it comes to accounting models.

1. Cash basis accounting

With cash basis accounting, revenue and expenses are recorded when cash is received or paid.

This is a simple approach, but it's not often a good fit for SaaS since it doesn’t reflect long-term financial health and account for the nature of subscription billing.

2. Accrual accounting 

With accrual accounting, revenue is recorded when earned and expenses are recorded when they are incurred, regardless of when cash actually enters or leaves the business.

This is a better fit for SaaS brands, as it more accurately reflects the nature of a service-based business. It is also required for compliance with standards like ASC 606 and is preferred by investors and auditors.

3. Accrual accounting for SaaS

This is essentially a tailored version of standard accrual accounting, which is modified to include tracking deferred revenue, recurring billing, and performance obligations that determine when revenue can be recognized.

Compared to traditional accrual accounting, it enables better forecasting, valuation, and compliance for growing SaaS companies.

SaaS metrics to track 

SaaS accounting is uniquely tied to metrics that give leaders of subscription-based businesses informative insight into how the business is performing.

These are the critical metrics that every SaaS business should be tracking.

MRR (Monthly Recurring Revenue) and ARR (Annual Recurring Revenue)

MRR is the total predictable revenue a company expects to receive each month from its active subscriptions. ARR is the annualized version of that, used for longer-term forecasting.

Both metrics are crucial for measuring growth, predicting future income, and monitoring business performance as a whole.

CAC (Customer Acquisition Cost) and LTV (Customer Lifetime Value)

These are actually two separate metrics, but they are intricately tied together:

• CAC: Customer Acquisition Cost is the total cost of acquiring a new customer, including marketing and sales expenses.
• LTV: Customer Lifetime Value is the total revenue a company expects to earn from a customer over the duration of the relationship.

What’s most important is the relationship between the two. A high CAC is fine if your LTV is high enough to justify it, for example.

A healthy SaaS business typically aims for an LTV:CAC ratio of 3:1 or better.

Churn rate

Your customer churn rate is the percentage of customers who cancel their subscriptions during a given period of time.

It's calculated using this formula:

(Lost Customers ÷ Total Customers at Start of Period) × 100

This is a critical SaaS metric as high churn rates indicate retention issues, problems with product fit, and onboarding issues, or insufficient or ineffective customer support.

Calculating gross margin for SaaS 

Gross margin is an important metric in both traditional and SaaS accounting. It is calculated using this formula:

In the SaaS world, however, there are a few special considerations.

Revenue includes recurring subscription income from customers, so when finance teams are forecasting for gross margin, they’ll need to take into account expected churn, expansion, and contractual changes based on historical data.

COGS also looks a little different in the SaaS world.

Many expenses, like payment processing fees or third-party software licenses, that might otherwise be considered operating expenses, are often categorized as COGS in a SaaS business.

Revenue recognition in SaaS accounting 

In SaaS accounting, revenue recognition follows the accrual principle rather than the cash basis.

This means that SaaS companies must be recognized as the service is delivered, not when the payment for that service is actually received. Under ASC 606 / IFRS 15, revenue is recognized when the customer gains control of the promised service, usually ratably over the subscription period.

Multi-element contracts (such as those that wrap onboarding services into the same contract as software licenses) require that each component be accounted for separately, provided they represent distinct performance obligations.

In this case, the revenue earned for onboarding services would be recognized after onboarding has been completed, while the revenue for the software subscription would be recognized on a monthly basis.

The impact of subscription models on SaaS revenue recognition

SaaS customers often enter an open-ended, annual, or multi-year agreement, but that doesn’t mean that changes don’t occur along the way.

The nature of changing subscription contracts has an important impact on how revenue is recognized:

1. Upfront payments can’t be recognized immediately. They have to be spread evenly across the service period.
2. Plan changes (like upgrades and downgrades) require revenue scheduled to be adjusted to reflect the new terms and maintain accuracy.
3. Usage-based pricing or variable consideration may need recognition after the usage is measured, depending on the contract structure.

Best practices for accurate revenue reporting

Staying compliant and keeping on top of changing SaaS contracts can be challenging.

Here are a few important best practices to help you make sure your revenue reporting is accurate:

• Automate revenue recognition with accounting software that integrates with your billing system to avoid manual errors
• Reconcile deferred revenue on a monthly basis to make sure that liabilities and revenue are always aligned
• Track performance obligations clearly to ensure you’re recognizing revenue only when obligations are met
• Be sure to document all contracts and amendments, including any changes that are made to contract terms, duration, or pricing
• Work with an accountant who is familiar with SaaS models to stay compliant with ASC 606 / IFRS 15 

Streamlining your SaaS accounting processes 

There are a number of ways that teams can streamline their SaaS accounting processes.

Accounts payable and accounts receivable automation can:

• Automate recurring processes like invoice and deferred revenue tracking
• Reduce manual data entry and human error 
• Enable real-time updates to financials when customers change plans or churn

Modern cloud-based accounting solutions enable multi-user collaboration and provide access to accurate and up-to-date financial data on the go. Many offer seamless integrations with other components in your tech stack, like CRMs and billing platforms.

For instance, by integrating your accounting software with your CRM, you can automatically update revenue forecasts based on a signal in the CRM that a customer has upgraded their plan.

This can be synced with your billing platform automatically to ensure that payments received match the contract and the forecast.

Implement SaaS accounting effectively with BILL 

BILL’s integrated financial operations platform offers dozens of features for SaaS accountants, including:

• Powerful AR and AP automation 
• A dedicated accountant resource center 
• A built-in spend tracking solution 
• Integrations with all major accounting platforms 

Get started with BILL today.