There has been huge growth in recent years in the market for software as a service (SaaS), driven by consumer demand, the rise of cloud computing and the entrepreneurial zeal of the providers themselves. This rise has led to a degree of confusion concerning SaaS accounting rules, and the point at which a small SaaS company has to start worrying about putting a strict accounting system in place.
This article will explain some of the more complex rules for SaaS accounting, but the answer to the question of when to start thinking about SaaS accounting for your business is simple – it’s “as soon as possible”.
Accounting for SaaS companies
Some SaaS start-up companies may feel it’s too soon to start worrying about the specifics of SaaS accounting rules, but this is a mistake. As with any other kind of business, the more you know about the cash that is coming in and flowing out, the better placed you’ll be to run that business efficiently. SaaS accounting rules may differ from the standard rules – thanks to the particular nature of the service and how it is provided – but this basic fact of business life still applies.
The specifics of SaaS accounting
A business that runs a standard licence model for the provision of services will create and send invoices that detail the following factors:
The initial licence
The implementation of the service
Any customisation provided
Support and maintenance offered
The business model of any SaaS business is different, however. All the fees are bundled together in the basic subscription fee, with the success of the business depending upon the number of customers willing to subscribe on a regular and recurring basis. This means that some aspects of accounting, such as calculating the gross margin, differ from normal accounting practices.
How to calculate the gross margin for a SaaS company
The gross margin of any company is a figure that shows how efficiently that company is creating revenue when compared to the cost of providing the product or service. The revenue generated is the income earned – in the case of SaaS through subscriptions – and the cost of goods sold is the cost of providing the service. The calculation used is as follows:
Revenue minus the cost of goods sold, with the resulting figure then being divided by the initial revenue figure.
The figure produced by this calculation, as a percentage, will give an indication of the amount of income a business is generating that can be reinvested in that business.
Guidance on SaaS accounting
There are two types of SaaS accounting and they differ in terms of when each sale is recorded in the accounts. Cash basis accounting records revenue when it is initially paid, and then subtracts expenses as they occur. It doesn’t include accounts receivable and payable, and is the method often used by smaller businesses with lower or non-existent inventory.
Accrual accounting, on the other hand, records revenues and expenses when they are first earned, rather than when the cash actually flows in or out of the business. This is a more complex method of accounting, but gives a more accurate picture of the state of the business at any given time.
The accrual method of accounting is particularly suited to the subscription model of SaaS, as it tracks monthly recurring revenues accurately, and provides a broader picture of the trends driving the business, since income and expenses over any period are recorded at the same time.
We Can Help
If you’re interested in finding out more about SaaS accounting, or any other aspect of your business finances, then get in touch with our financial experts at GoCardless. Find out how GoCardless can help you with ad hoc payments or recurring payments.