SAAS ACCOUNTING: A CPAs Guide

Our SaaS clients have raised billions in seed and venture capital funding - so we’ve helped hundreds of SaaS clients complete important financial diligence. We know the accounting metrics a Software as a Service company needs to have ready for diligence. It’s not just ARR, MRR and CAC - the best investors have questions around cohort churn rates, revenue run rates and more. In fact, our team has been interviewed by TechCrunch about the metrics needed to raise rounds and trends in the VC market.

MRR needs to match your recognized revenue

During diligence, your potential investors will compare your historical books to the ARR metrics you share with them. Many companies produce their MRR/ARR metrics out of a billing system, like Chargbee, Shopify, through QuickBooks invoicing, an internal product database, etc. However, these systems don’t always sync perfectly into the accounting books. In fact, a major reason SaaS VCs recommend us to their portfolio companies is that they realize that the current accounting provider is not able to produce accrual based revenue - critical for a recurring revenue business. Make sure your accounting provider can produce GAAP compliant revenue metrics to ensure a smoother fundraising process!

With hundreds of clients who have raised billions of dollars in VC funding, we know what revenue a SaaS company needs to raise a seed, A or B round. Keep in mind that financing for these types of startups is usually based on a number of factors, not just revenue size - in particular, revenue growth matters as well. 

This analysis was done for the height of the recent boom in startup financing. We’ve noticed that in 2022, SaaS companies need higher revenue to raise funding - we’ll update the metrics soon!

We analyzed over 200 fundraises and noticed a distinct trend where the revenue needed to successfully raise a round decreased around the second quarter of 2021. This was certainly a “hot” time to fundraise, and the numbers show it. Here is the data:

ARR at Close of Financing

How much Revenue does a SaaS company need to raise a Seed round?

We are seeing plenty of slam-dunk seed rounds happening with SaaS startups that have $100k+ in ARR and good growth. However, this is significantly harder that the hot fundraising market of 2021. Prior to the second quarter of 2021, the average SaaS startup needed about $340k of ARR, with a 12 month trailing growth rate of about 600% to raise a seed round of financing. During the hot financing market, starting around Q2 2021, the average company needed just under $60k of ARR and was only growing at about 140% year over year - a tremendous drop on both size and growth metrics. 

How much Revenue does a SaaS company need to raise a Series A round?

In early 2023, SaaS startups with ARR of over $3M are the average at the Series A. However, we do see some companies with ARR as low as $1M (and some pre-revenue) companies raising an A successfully - just not as much as we saw in the boom times of 2021. Prior to the second quarter of 2021, the average SaaS startup needed about $1.8 million of ARR, with a 12 month trailing growth rate of about 330% to raise a Series A. When the venture market heated up, starting around Q2 2021, the average company needed about $1.2 million of ARR and was only growing at about 170% year over year. Once again, this was a tremendous drop on both size and growth metrics. 

How much Revenue does a SaaS company need to raise a Series B round?

In early 2023, SaaS startups need significant revenue to raise a Series B - on average, over $8M in ARR with solid growth. In our analysis of over 200 SaaS companies that raised funding, before Q2 2021, the average SaaS company needed about $11million in ARR, with a 12 month trailing growth rate of about 180% to raise a Series B. In Q2 2021, the average company needed only $3.4 million in ARR and was only growing at 220% year over year. That’s a massive drop in ARR, likely driven by hedge funds moving into the market and bidding aggressively to lead Series B’s. It makes sense that the revenue growth would go up on a smaller ARR base, so at least there is some rationality at the Series B vs. the Series A and Seed numbers we referenced above. Once again, we’d expect that the ARR hurdle would increase in early 2022 as the funding market may be cooling. 

Every business needs a chart of accounts - we’ve got a sample chart of accounts for a SaaS company here for you to use if you’d like. Keep in mind that every business is unique - so you may want to modify it to fit your specific business.

If you don’t know what a chart of accounts is you should probably hire a good bookkeeper, but what it does is translates your general ledger entries into your income statement, balance sheet, etc. It’s like the map of where the specific expenses and other accounting items flow to in your financial statements.

• Revenue recognition
• Sales tax
• Understanding gross profit - parsing server and R&D costs between serving customers and R&D, correctly positioning customer service, etc.
• Customer refunds or upsells
• Deferred revenue
• LTV to CAC and other SaaS-specific metrics

Revenue is the lifeblood of SaaS businesses, but the accounting is anything but simple. Later on in this article on SaaS accounting we’ll discuss what goes into calculating ARR, but here we’ll discuss how revenue is recognized, and the different flavors of revenue that founders and VCs like to track.

Revenue recognition in SaaS businesses

While many of the best subscription businesses collect payment upfront, they recognize revenue over the life of the contract. According to GAAP, a SaaS business can recognize revenue when 1) evidence of an arrangement exists; 2) services have been rendered/the product is live; 3) the price is set; 4) collectibility is probable.
Once these criteria are met, the SaaS business can recognize revenue over the term of the contract, usually on a subscription basis.

Revenue recognition in a subscription service over the lifetime of the contract is done using the subscription revenue model. The following steps are involved in recognizing revenue:

1. Determining the contract value: The total amount of revenue to be recognized over the contract period is calculated. 
2. Allocating the contract value: The total contract value is then allocated to each period over the contract term. For most SaaS companies, this is relatively simple accounting, with the total contract value being divided by the number of months that the contract is live.
3. Recognizing revenue: Revenue is recognized each period based, based on the allocated contract value in that period.

This method of revenue recognition is used as it accurately reflects the value of the services being provided to the customer over the contract term and provides a consistent and predictable revenue recognition pattern. 

Here are a few examples of subscription contracts with the total contract value and how the revenue is recognized over time:

24-Month Subscription Contract:
Total Contract Value: $24,000
Revenue Recognition: $1,000 per month for 24 months

12-Month Subscription Contract:
Total Contract Value: $12,000
Revenue Recognition: $1,000 per month for 12 months

18-Month Subscription Contract:
Total Contract Value: $18,000
Revenue Recognition: $1,000 per month for 18 months

In each of these examples, SaaS accounting requires the revenue to be recognized on a recurring basis ratably over the lifetime of the contract. This helps the SaaS business to accurately reflect the value of the services being provided to the customer over the contract term and provides a consistent and predictable revenue recognition. The sweet, sweet predicitbility loved by VCs!

Revenue metrics in SaaS Accounting

Founders of SaaS companies have several top-line metrics that they may be tracking - bookings, billings and MRR (which gets annualized into the all too famous ARR number). These revenue items can get a little confusing for founders who aren’t experienced finance professionals. This is a great place that an experienced accountant can help a founder stay focused.

Bookings

Bookings is the dollar amount of a signed contract with a customer - it shows written commitment from a customer to purchase your service.

Bookings is not actually defined by GAAP, so SaaS accountants don’t usually produce this metric out of the accounting system - instead, it is produced out of a sales CRM like Salesforce or Hubspot. 

Founders should clearly define what bookings means at their SaaS company, since this is NOT a GAAP defined metric. What exactly constitutes a signed contract? Does this metric include multi-year deals, or just the annualized contract value? 

Bookings really only matters for companies that are signing contracts with clients and then where there is a gap between when the contract is signed and the service period delivery begins. This can happen with enterprise focused companies, in particular. 

Billings

A billing is produced when a company actually sends a bill (really, and invoice) to a client. While invoicing usually lives in a SaaS company’s accounting system, it’s not the same as the revenue item that is officially recognized under the GAAP revenue recognition definition. For a business that bills and collects immediately, this is a much less important accounting metric. Examples would include a consumer-SaaS company that bills and collects through an app store - billing and collection happen at the same time, so there is no need to monitory this metric separately. 

For enterprise companies that track bookings, billings become very important. Bookings indicated the dollar amount of a signed contract with a customer - it shows written commitment from a customer to purchase your service. The book to bill ratio shows how healthy and committed the signed contracts are (that are tracked by the bookings metric). A low book to bill number is an indication that a company is having problems getting signed contracts to convert into live customers. 

MRR - Monthly Recurring Revenue

This is where a founder, their sales team, their accounting system and their SaaS accountant need to be in tight sync! Companies recognize revenue when the service is actually delivered to the client. SaaS accounting rules state that a contract is recognized ratably over the life of the contract live/as the service is used by the customer.

MRR is a difficult metric to fully automate. Companies that try to fully automate their MMR recognition often find that their payments processor has a different metric than their accounting system - something that experienced VCs will notice during due diligence. Read on to learn more about how we think about recognizing revenue. 

Gross margins and gross profit are important accounting metrics closely watched by venture capitalists - and the best founders. Low gross profit companies are described as having poor unit economics. And experienced investors like David Sacks often talk about the importance of software margins - leading us to remind founders that accounting matters!

The accounting formula that calculates gross profit is:

Recognized revenue - cost of goods sold = gross profit

And the gross margin is usually expressed as a percentage that is calculated as:

Gross profit (in dollars) / recognized revenue = gross profit margin

The COGS in a SaaS business typically includes costs related to hosting, server and network infrastructure, as well as personnel costs for customer service and billing expenses. To accurately calculate the gross margin, it is important to track and account for these costs appropriately.

The gross margin/gross profit in a subscription business matters because this is the amount of customer dollars that will be available to service and cover the other operations of the business, like sales and marketing or R&D. Proper accounting matters. 

It is also important to note that the gross margin calculation provides a snapshot of the efficiency of the SaaS business in generating revenue from its operations, and does not take into account other expenses such as marketing, research and development, and general and administrative expenses. These expenses should also be considered when evaluating the overall profitability of the SaaS business. And many of the most popular SaaS metrics should be calculated using gross profit, not revenue. 

Through our work with hundreds of funded startups, we realized that VC backed businesses like to purchase all their services like a SaaS business. That’s why we price our bookkeeping services on a set, recurring monthly level - our clients can know what their basic accounting will cost each and every month. This helps them manage their cashflow, plus it gives our founders less mental overhead when they think about their upcoming expenses.

Getting the books right for a SaaS business is surprisingly challenging. The biggest issue we see with clients that come to Kruze from another bookkeeper is serious mistakes with revenue recognition and deferred revenue - especially from “bot” bookkeepers and from non-SaaS accountants. Because of the way revenue transactions recur in a subscription business, small errors can become big problems if not caught early - including having to restate the balance sheet and income statement.

At Kruze, we combine automated software with experienced controllers and CFOs. We can work with both enterprise and SMB/consumer focused companies with recurring revenue streams. Our custom-built automated software works directly with QuickBooks Online, saving you money through the labor-savings, while putting your financials into an industry standard, 3rd party software so you can take it to any provider or use it with any potential acquirer or auditor.The best SaaS accountants understand the complications of revenue recognition, GAAP expense recognition, enterprise vs consumer software as a service billing systems and more. Plus, accountants specialized in the recurring business model have the ability to help founders think through the cash implications of different billing and pricing plans. Our accounting team has over 11 years, on average, experience, and collectively our team has experience with everything from hardware as a service to recurring app-revenue models to enterprise SaaS contract revenue recognition.

We believe that it’s our team’s job to help save our CEOs time and take care of the basic bookkeeping tasks that other services dump onto their clients. Our SaaS clients have raised billions in venture capital, and former clients have been acquired by massive public companies like Cisco, Apple and others - so we know how to prepare you for due diligence. If you’re ready to work with the top SaaS accountants in Silicon Valley (and beyond), reach out to us. 

SaaS accounting refers to the financial management, tax and bookkeeping practices specific to businesses that operate on a software as a service model. Subscription businesses that follow accrual/GAAP based accounting need to correctly account for recurring revenue recognition, subscription billing, deferred revenue, and expense accrual. Additionally, subscription companies have unique revenue forecasting, cash management and specialized KPIs.

One of the reasons investors love subscription businesses is that they are easier to forecast - which is also why it’s really important to create a great financial model for your SaaS business. Thankfully, this has all been done before, and we have some free model templates that will help you get started. Here is how to begin.

Startup Model Template

To begin with, every startup should have a financial model that includes revenue and expense projections, along with a net cash position. Although some comprehensive templates comprise the three main financial statements (income statement, cash flow statement, and balance sheet), these might be too complex for early-stage startups without professional assistance.

To maintain investor confidence and avoid errors, we recommend a simpler model, one that prioritizes the income statement and a projected cash position. These models are easier to manage and sufficient for most early-stage SaaS startups. We have free templates available here.

Forecasting Best Practices

It is a great idea to start with a three-year model that is dynamic, allowing changes to assumptions for each year. Sales (and revenue recognition) will be primary things to focus on once you are generating revenue. Also, consider the delays in your sales cycle and customer collections as these have a direct impact on your cash flows.

Stress testing the model against variables like conversion rates and growth rates will help you prepare for eventualities. Remember, honesty and realism are key in building your model.

Creating a Financial Model

The process of creating a financial model for your startup begins with understanding the model’s purpose. Identify the level of complexity necessary for your goals. Whether you’re sizing the market, raising capital, or creating a detailed cash flow model, the level of detail will vary.

Next, determine the key performance indicators (KPIs) for your company. Organizing your KPIs numerically helps track your performance against projections. Using industry standard KPIs as a starting point is a good practice.

We recommend using an existing financial model template as a base instead of starting from scratch. Once you have a template, incorporate your actual financial results into it to ground your projections in reality.

Revenue forecasting is the next step. Understand the drivers of your revenue, be it the number of customers, salespeople, or marketing spend. Our article on B2B SaaS financial models goes into this in depth. 

For SaaS startups, headcount is usually the largest expense, so project your personnel needs accurately. Additionally, estimate other expenses, using benchmarks from successful companies if needed.

Reviewing Projections

Finally, it is essential to review and perform a sanity check on your financial projections. This ensures the projections align with your business narrative and makes sense in terms of the SaaS industry’s financial norms. And we recommend a recurring budget vs actuals exercise, where you compare recent results with projections to understand how you are performing vs expectations. 

A well-structured financial model is crucial for SaaS startups. It not only aids in understanding your business’s financial health but also helps in fundraising, strategic planning, and tracking your progress against milestones.