3 Common SaaS Accounting Issues: In English Please?
Managing accounting records can be complicated and confusing to begin with. We accountants talk in terms like "cash vs. accrual," "recognized revenue vs. received revenue," and "capitalizing vs. expensing," to name a few. Then we go and add the complexities of specific accounting for SaaS business. The truth is these accounting complexities, if followed, will aide you in not only managing your business, but also in obtaining funding to grow your business. Let's take a look at 3 common accounting issues:
1) When does Revenue show up on your Profit & Loss Statement?
It's important to record revenue properly, in order to reflect an accurate snapshot of how the business is preforming. If revenue is recorded in one month but all the expenses are recorded in a later month, it will be difficult to determine if the company is operating profitably until it’s too late to make any needed adjustments. So how should it work?
Revenue should appear on a SaaS company's profit & loss (P&L) statement when the services have been provided and not necessarily when payment is received. For example, if your sales team closes a two-year deal for $12,000 in annual services, revenue recorded would be $500 each month for two years, starting the month in which the services began. Recording revenue this way also helps management in determining the operating efficiency of the business. By recording the revenue evenly through the course of the contract, revenues and expenses are more aligned (this is known as the “matching principal”) and represents a better comparison of its profitability.
2) No Need for Cost-of-Goods-Sold, Right?
A SaaS company should not have cost-of-goods (COGS) sold on its P&L because there is no tangible goods sold, right? Not exactly. Like product-based companies, SaaS companies have both fixed and variable costs. Variable costs fluctuate with a company's revenues and should be separated from the fixed costs, which do not fluctuate with revenue.
For a SaaS company, the heading should be Cost-of-Service (COS) rather than Cost-of-Goods sold. Any expense that would not be incurred without gaining each dollar of revenue would be categorized as a COS. This would include items such as hosting fees and sales commissions. These costs can sometimes make or break a company. The difference between revenues and COS represents the amount available to cover the company's remaining expenses (known as the profit-margin). If the profit-margin is not sufficient enough or is diminishing over time, a business may find itself in financial hardship and maybe even have to shut down completely.
3) Capitalizing Cost of Acquisition (CAC)
One of the new requirements for both private and public companies in 2019 is to expense any cost associated with the new sale over the customer’s lifetime. This is similar to how revenue appears on the P&L statement.
An example of this is commissions/bonuses paid to a sales member for closing the deal (to see a more detailed explanation on calculating your CAC click here). This is done by totaling the costs and treating it similar to booking a fixed asset that is then depreciated over time.
Things to Consider
Like everything, the devil is in the details and the details dictate how accounting records should look. SaaS companies have a unique business model, so they require a unique approach to accounting. Doing it wrong will lead to challenges when management needs to make important decisions and pitch to investors for capital funding. Consider finding an accounting person/team that is familiar with SaaS business models and how the accounting records should be maintained. It will save time and energy when the time comes to grow rapidly.
Chris Royer is the Founder and CEO of SaaS Accounting & Consulting. He uses his 15 years of public and private accounting experience to help both early and mid-stage SaaS companies see the financial story in their own business and achieve financial success with strategic growth strategies.