Revenue recognition is a crucial part of accounting for all businesses. It is the process of recording revenue and the policy whereby revenue is calculated in the financial statements. Recognizing revenue accurately is critical as it helps businesses track their revenue, understand their financial performance, and make informed decisions about future business activities.
Software as a Service (SaaS) startups are companies that generate revenue from software subscriptions. Typically, SaaS companies sell subscriptions to products that can be accessed remotely through the internet. This typically includes things like enterprise resource planning (ERP) tools, customer relationship management (CRM) systems, and productivity suites.
Recognizing revenue correctly is essential for SaaS companies to demonstrate accurate growth metrics and indicate business value.
How can I recognize revenue as a SaaS company?
Sales of subscription license-based products typically recognize revenue either as an upfront total amount or over the lifetime of the subscription. Both models are common in the SaaS sector.
To recognize SaaS subscription revenue, you first need to determine the subscription model that your SaaS company uses. This often requires them to estimate what portion of the subscription fee is attributable to usage over a certain period of time versus what should be recognized upfront or over a more limited timeframe. For the period of time variant there are several common models, such as usage-based, transaction-based, and term-based subscriptions.
Once you have identified the type of subscription that your SaaS company uses, you can start to apply the applicable SaaS revenue recognition criteria:
- the product has been delivered to and accepted by the customer
- payment has been received from the customer
- there is reasonable assurance that all conditions for liability recognition have been met
This means that SaaS companies must have effective billing systems in place and be able to clearly track sales transactions as they happen in order to accurately recognize revenue. They must also, in the case of usage or transaction-based models, have robust operational metrics tracking compliant with the revenue recognition policy.
There are generally several key considerations that SaaS companies should take into account when recognizing revenue. These include evaluating whether the product or service is being provided over a certain time period (such as monthly subscriptions), identifying whether any conditions need to be met in order for revenue to be earned (such as thresholds or quotas), and determining how contract terms impact the timing of recognition.
It’s also important to recognize that SaaS products often come with usage-based pricing models that rely on subscription fees or usage levels. At Rooled, we recommend that pricing models be clearly defined internal to the company and that there be a consistent presentation of the summarized models to customers. Much of the complexity around revenue recognition in accounting comes from the degree of variance between contracts with different customers and maintaining records on the different policies.
This process can be complex, but it’s important for SaaS companies to adhere to this revenue recognition model in order to ensure accuracy and transparency in their financial reporting.
The future of revenue recognition
There are several common mistakes that companies generally make when navigating revenue recognition requirements. For example, many will conflate their signed contract value with revenue while also treating invoiced amounts as revenue. Both actions typically result in overstated revenue. Other commonalities include:
- Not reconciling failed and unpaid contracts which have revenue reported
- Incorrectly managing the deferred revenue schedule
- Not reporting complex factors like refunds and discounts accurately
- Incorrectly handling gross and net revenue
Rooled advises clients throughout this process, ensuring the correct policies are being applied and that necessary documentation is retained. If you handle revenue recognition and related accounting services internally, you should ensure that your finance team has the requisite experience and skill set. However we still recommend that you obtain an external opinion from a CFO (Chief Financial Officer) or CPA (Certified Public Accounting) firm. We also recommend to all our clients that they share all contract details with the finance team and/or outsourced provider. If any questions arise over the revenue recognition policy, or if revenue is significant, it can be advisable to secure a letter of opinion from a CPA firm.
How can Rooled help?
Setting our clients up for success is at the heart of Rooled’s mission. We take it upon ourselves to ensure that:
- Experienced and skilled staff have reviewed and set the revenue recognition policy
- The policy is communicated to all stakeholders
- Financial reports listing contract KPIs (Key Performance Indicators) and resulting revenue include notes explaining the revenue recognition policy
Clients should also employ an outsourced providerCFO Consulting to handle accounting, particularly after seed or later stages of venture financing.
What does the regulatory landscape look like?
In addition to determining which products and services represent SaaS revenue, you must also consider the applicable accounting rules in your jurisdiction. Depending on the country where your SaaS company is located, there may be specific guidelines regarding how SaaS revenue should be reported and accounted for.
ASC 606 is the revenue recognition standard for accounting that was released in 2014 by the U.S. Financial Accounting Standards Board (FASB). The goal of the ASC 606 standard is to provide a more consistent and transparent revenue recognition process that will improve financial reporting.
The standard provides guidance on how revenue should be recognized, or recorded, in financial statements. In general, revenue should be recognized when it is earned, which is typically when goods or services are delivered to customers. The ASC 606 standard contains specific revenue recognition requirements for different types of transactions, such as sales of goods, services, and leases.
We expect to see incremental updates following ASC 606 that could impact the regulatory landscape, like Update No. 2020-05.
For companies to scale their businesses, they must adhere to the appropriate accounting principles and regulations – which can be made far easier with the support of an outsourced CFO. With proper revenue recognition, startups can ensure that they are making sound financial decisions and moving forward in a positive direction.