Guide to SaaS Accounting for SaaS Startups
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Contributed by the team at Zeni, a full-service finance firm that provides bookkeeping, accounting, tax, and CFO services for startups.
Software-as-a-service (SaaS) is one of the fastest-growing and most profitable industries in the world.
But because SaaS companies generally operate as subscription businesses, they need a special kind of accounting solution with the infrastructure catered to the business model.
Let’s take a deeper look at what makes accounting for SaaS companies different and how to put the proper accounting tools in place for your business.
What makes SaaS accounting different?
Revenue tracking is the most notable difference in SaaS accounting because of the subscription model of SaaS businesses. Subscription and add-on service fees require routine “maintenance” as customers upgrade, downgrade, or opt in and out of different services.
SaaS businesses also use different accounting tools like subscription management software and recurring billing platforms. These tools also demand different skills and knowledge of best practices from traditional business accounting.
Why is reliable accounting important for SaaS companies?
Good accounting provides insight into a company’s revenue and operations. For a fast-growing SaaS startup, access to this information can make or break the company’s future.
Along with the functional benefits of good accounting, reliable accounting streamlines the process of raising venture capital funds or preparing your business for an exit. Suppose your startup does not have clear, reliable financial records and up-to-date financial statements (like profit and loss statements, balance sheets, or cash flow statements). You may have a hard time raising capital, delay the fundraising due diligence process, or take a hit on your earnings in the event of an exit.
State and federal tax filings also require financial records. And ongoing, accurate accounting helps prevent unintentional tax violations and surprise tax bills. Plus, maintaining organized financial records helps maximize R&D tax credits available for startups.
When does a SaaS startup need a bookkeeping and accounting system?
All companies should set up an accounting solution and a bank account on day one. You never know when your SaaS startup will grow, and you won’t regret having a trusted accounting system to help guide and support your business through the exciting (and complex) growth.
How to set up a SaaS accounting system
Accounting solutions for SaaS companies must meet certain elements to be beneficial for the SaaS model. This all starts with how you choose to set up your accounting and being aware of important financial regulations. When laying down your infrastructure, be sure to consider:
Opt for accrual accounting over cash accounting
Many startups start tracking their finances using cash basis accounting. Cash accounting counts revenue as you receive cash and subtracts costs from that number once cash leaves your bank account. This method is easy to use and maintain. It is also good for small businesses or those with little inventory or customer base—but not recommended for SaaS businesses.
Accrual basis accounting doesn’t count revenue until cash is earned, regardless of how much cash is on hand. Even though this method of accounting is more complicated, it’s better for large businesses and SaaS businesses with subscription-based income. Plus, investors and government regulators may require your business finances to follow accrual accounting, so it’s not a bad idea to get ahead of these mandates.
Strive for GAAP-compliant financial management
Generally Accepted Accounting Principles, or GAAP, are accounting rules, guidelines, and regulations to standardize business accounting methods across industries. GAAP exists to create transparency and consistency in financial reporting from one organization to the next.
While startups are not required to follow GAAP accounting principles, there are benefits of SaaS startups doing so from an early stage. Investors, banks, and auditors may also require GAAP compliance.
7 SaaS financial reporting and metrics you’ll want to track
Once you set up your accounting system, you’ll want to understand and track these business metrics:
1. Monthly financial reports
When following GAAP guidelines, SaaS startups (or any business) should generate three required financial statements every month:
- Profit & Loss (P&L) or income statement: Summarizes the revenues, costs, and expenses from a specified period
- Balance sheet: Provides a snapshot of a company’s assets, liabilities, and equity owned and owed
- Cash flow statement: Shows incoming and outgoing cash movements on (typically) a monthly basis, in much more detail than a P&L statement
Booking paints a picture of the revenue you expect to earn over time based on customer commitments. It looks at the value of a contract and anticipated income ahead of payment completion. Bookings are an essential metric for SaaS businesses to understand sales efforts and potential revenue growth.
Billings are the actual amounts billed to customers. This figure is the actual amount you plan to collect from customers and represents the money owed to your company.
As a SaaS business, payroll may look a little less traditional. Aside from your salaried employees, most SaaS businesses have a robust sales team, meaning your payroll fluctuates month to month because of bonuses and commissions. Payroll for your sales and marketing teams can fall into your Operating Expenses category because they are costs incurred in selling and promoting your product.
5. Revenue and revenue recognition
Revenue is the total amount of income generated by a business’s primary operations—typically the sales of goods or services—and represents the business’s total earnings or profit.
Revenue recognition is the accrual accounting principle that specifies how and when you can record your business’s sales and non-operating income as revenue. It requires businesses to classify pre-payments for services as liabilities (called deferred revenue or unearned revenue). Your business only earns and recognizes the payment as revenue once you’ve provided the customer with the service promised.
6. MRR & ARR
Subscription-based services accumulate recurring revenue, which is typically measured with two SaaS metrics: monthly recurring revenue, or MRR, and annual recurring revenue, or ARR.
Both are measurements of your predictable revenue stream. Businesses typically first calculate their MRR and then multiply that figure by 12 to find their ARR. MRR should reflect:
- Recurring revenue from all customers
- Upgrades and downgrades
- Customer churn, or lost revenue
7. Other SaaS KPIs
KPIs (key performance indicators) give you a picture of how your company is doing overall. Which key financial metrics you track depends on your business, but there are five types of KPIs that all SaaS companies should monitor:
- Top-of-funnel KPIs
- Revenue KPIs
- Unit economics KPIs
- Product/market fit KPIs
- Financial KPIs
Set up robust SaaS accounting before you think you need it
As you can see, SaaS accounting has a lot of moving parts. But getting started from day-one will set you on the right path for success in this quickly growing industry. William Shakespeare once said, “Defer no time. Delays have dangerous ends.” Put your SaaS accounting plan into place sooner rather than later, and you’ll set yourself up for confident financial growth rather than a complicated, low-visibility journey.
Zeni’s finance experts have deep experience working with SaaS businesses (Zeni itself is a SaaS business, too!) and bring 100+ years of experience to your startup’s bookkeeping and accounting system. Whether you need a service that manages your every financial function, a senior finance expert to put together budgets and projections, or advice on filing your annual tax return, Zeni’s complete solution has you covered. Book a demo with Zeni.