SaaS and tech accounting demands a unique approach, mainly due to the nature of recurring revenue streams such as subscriptions. These impact how revenue is recognized and SaaS revenue recognition is different to more traditional businesses that sell tangible products.
From subscription-based revenue streams to collecting upfront payments for long-term contracts, plus hybrid revenue models, SaaS organizations often need the expert hand of a professional accountant to deliver industry-specific financial solutions.
Getting this wrong results in leaders not truly understanding the financial position of their business. That might cause them to misrepresent financial performance to investors and cause long-term severe accounting headaches. So, what is SaaS revenue recognition, and what does this process look like in practice? More importantly, how can you shore up your operations to ensure compliance and overall financial efficiency?
G-Squared Partners provides a wide range of outsourced CFO, accounting, and bookkeeping solutions to dozens of tech companies. Contact an advisor today to learn more about how we can support your business’s unique accounting needs.
Revenue Recognition for SaaS Businesses: A Definition
Revenue recognition is a fundamental accounting principle. Basically, it determines when a company can officially record income on its financial statements. Within SaaS accounting, before you can realize revenue collected from customers, you must first deliver the product or service.
How does this work? Let’s say a SaaS or other tech business sells a 12-month subscription to their product for $12,000, with payment collected in full when the contract is signed. Even though they have this cash in hand, they can’t recognize it all at once.
Instead, they need to follow the contractual breakdown of the service or product delivery over that predetermined period of time. In this example, they’d recognize $1,000 per month as they fulfill their obligations over the 12-month span.
Proper SaaS revenue recognition processes ensure your business remains in compliance with Generally Accepted Accounting Principles (GAAP) — an essential element of maintaining trust within the industry and remaining fiscally healthy in the eyes of investors.
It’s important to highlight that cash in hand doesn't equal revenue. While you might have a pile of cash from subscriptions, that won’t turn into revenue until the service is delivered.
The Five-Step SaaS Revenue Recognition Process
So, what does the SaaS revenue recognition process look like in practice? First, to ensure GAAP compliance, SaaS companies follow a specific set of guidelines known as ASC 606. This standard provides a framework for recognizing revenue as value is delivered to customers and clients. Here is a quick overview of the five-step process prescribed by ASC 606.
Identifying the Contract
A signed agreement between the SaaS business and the customer is the first step. In this agreement, you can find clearly outlined terms and conditions, including specific details about payment terms and schedules. It’s essential that both parties understand the contract terms and agree to said terms.
Identifying Performance Obligations
How do both parties know that the terms of the contract are being followed? While the delivery of a service or product is one area to consider, there are also other additional obligations, like implementation, uptime, user training, and more that must be met. The SaaS company must fulfill these obligations before it can recognize revenue. These performance obligations are typically measured monthly, allowing the SaaS business to recognize revenue on a monthly basis in its financial statements.
Determining Transaction Price
In exchange for fulfilling these performance obligations, the business will receive payment from its customers. This is the transaction price. Simply put, this is the total value of the contract. If your sales team has locked in a year-long contract for $100,000, the transaction price would be $100,000.
Allocating the Transaction Price
Once the total transaction price has been established, it must be allocated across various performance obligations or a period of time. If, as with many SaaS companies, these performance obligations are fulfilled on a monthly basis over a year-long contract, the business will allocate 8.33% of the transaction price to each monthly performance obligation.
Recognizing Revenue as Performance Obligations Are Met
As the SaaS business meets performance obligations, it can recognize the portion of the transaction price allocated to that particular obligation. Going back to our example of a contract that sits at $100,000 for the entire year, that means the business would recognize 8,33%, or $8,333.33, in revenue for each month in their financial statements.
Become GAAP Compliant with G-Squared Partners: An Experienced SaaSOutsourced Accounting Firm
If exact financial operations are at the core of successful businesses, SaaS revenue recognition is the heartbeat that helps tech companies stay safe, GAAP-compliant, and efficient. Inaccuracies in financial statements can have some significant consequences, scaring off potential investors and hindering your business’s ability to secure funding.
At G-Squared Partners, our team of experienced professionals understands the unique challenges faced by growing SaaS companies. We have a proven track record of helping businesses navigate the intricacies of ASC 606 and can help your team with a suite of services from outsourced accounting to more strategic and industry-specific financial guidance.
Contact G-Squared Partners today to schedule an initial consultation and learn how we can help your SaaS business achieve its full potential.
