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SaaS Revenue Recognition

Business Academy

What is Revenue Recognition? 

Revenue tracking may seem straightforward until you actually get into the details. 

You sign a contract with a new client, for example, and you send them an invoice that’s due within 30 days— and it’s already December.

So when do you record the revenue? Do you base it on the date of invoice, which would mean that you record it for the current year? Or do you wait until payment comes in, meaning you’ll record the revenue for the coming year instead? 

Knowing how and when to record (or “recognize”) your business’s revenue is essential, and that’s where revenue recognition matters. 

First: Cash vs. Accrual Accounting 

Before we go any further, we need to discuss the two common types of accounting: Cash accounting and accrual accounting. Both track your income and total expenses differently. 

Cash-based accounting processes recognize income and expenses when the money changes hands. It’s most commonly used by businesses without an inventory or sole proprietors. 

If you log into your billing software to send an invoice today but it isn’t paid until next month, the revenue is recorded under next month’s revenue. It’s a straightforward process, because revenue and expenses are recorded right when the bills are settled. 

Accrual accounting, on the other hand, is the opposite. It recognizes income based on other standards, which may be when you send the invoice or when the product or service is delivered to the customer. The same is true for expenses; the cost is logged when you receive the bill, even if you won’t pay it for another month. 

Accrual accounting can be more difficult to track, because there are rules in place regarding when you can record income and expenses. 

What is Revenue Recognition? 

The revenue recognition principle stipulates when and how businesses recognize their revenue when using accrual-based accounting. It’s a generally acceptable accounting principle (GAAP) that includes a five-step process needed to record the revenue. 

In other words, this is a shared accounting practice that provides predictability and transparency into a business’s accounting practices. It’s easier for the business (and its financial team) to assess revenue. They can make smarter financial decisions, and pass along accurate data to any investors, shareholders, and stakeholders. 

The 5-Step GAAP Revenue Recognition Process 

The ASC 606 and IFRS 15 outline joint standards that require companies to follow a specific revenue recognition process.  

These are the five steps you need to follow. 

1. Create the Customer Contract 

The first part of establishing recognized revenue is to create or identify the customer contract. 

Contracts don’t necessarily need to be signed formal documents with a long list of clauses; verbal agreements can be considered a contract. 

The only requirements of a contract include:

  • It must be a commercial agreement where payment terms and obligations are clearly stated and agreed upon. 
  • Contracts can either involve formal written agreements or receipts from a point-of-sale purchase.

SaaS businesses almost always have a formal contract, especially when dealing with large and enterprise clients. That said, users signing up for subscriptions without negotiations through a self-service portal often means they agree to a terms of service while making the purchase online. 

2. Identify the contract’s specific performance obligations

The revenue recognition standards require that not only do you have a contract, but that all parties are in agreement about that contract’s performance obligations.

This is, essentially, the goods or services that you, the seller, as agreed to deliver to the customer. 

For SaaS businesses, this may mean delivering the following distinct products each month:

  • The price for the plan and scale that both parties agreed upon.
  • The costs of specific add-on features. 

3. Determine the Transaction Price & Terms 

A transaction price isn’t just the price of the plan of the SaaS software that both parties agreed upon. It can also include:

  • Discounts offered during the negotiation period.
  • The right to cancel a plan and request a return.
  • Whether or not it’s an annual or monthly plan.

Returns, after all, can be tricky in SaaS businesses. If a client pays for an annual subscription to get a discount, are they allowed to request a refund if they cancel six months into the year? And if so, how much of a refund? 

Make sure these details are ironed out in a formal contract or terms of service to protect your business. 

4. Allocate Price to Distinct Transaction Prices

You’ve already defined distinct performance obligations, and now it’s time to tie pricing to those obligations. 

For SaaS businesses and subscription startups, this is typically an easy process. The client either uses a self-service portal to take advantage of an offer and make their product and plan selections, and they purchase. Or, there may be a negotiation period for enterprise accounts, after which detailed pricing is agreed upon and a contract is signed. 

Just make sure you specify what price is tied to which deliverables in your invoices. 

5. Recognize revenue when you’ve fulfilled each performance obligation

Here’s where it gets tricky: You only get to actually recognize the revenue when your performance obligation is complete. 

It doesn’t matter if your customer has paid you upfront for the cost and services of good— you should consider that deferred revenue or unearned revenue

Once you’ve actually delivered the good or service to your customer, that’s when you get to recognize the revenue.

So for SaaS subscription businesses, the performance obligation (aka the software that customers are accessing over a month- or year-long period) can be delivered over a period of time, so you’d recognize the revenue evenly throughout that service period. 

Some business models allow you to recognize revenue based on factors like external mile stones, percentage of production completed, costs, or labour hours even if a service is completed over time.

Final Thoughts 

There’s a reason accountants make good money: Trying to follow revenue recognition standards can be tricky.

The good news is that the right financial analytics software for subscription businesses will make your job infinitely easier.

Baremetrics’ revenue analytics platform has 26 metrics that every subscription business needs to track, including your monthly recurring revenue (MRR). 

And this data is accurate— if an account is delinquent, paused, inactive, or hasn’t received payment for any reason, we don’t record revenue that isn’t there (which actually sets us apart from many other tools). 

Your accounting team can use our intuitive dashboard to get all the information needed to recognize revenue according to the GAAP reporting standards, keeping your business compliant.

Ready to learn more about your business’s finances? Get started with Baremetrics here



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