SaaS Accounting - All you need to know
SaaS has been one of the hottest business models for the past decade, if not more. But accounting for SaaS is anything but simple.
From revenue recognition to understanding R&D vs customer service costs, SaaS business founders rely on tons of metrics to run their business. And VCs look for specialized SaaS ratios and calculations, like LTV to CAC, magic numbers and more.
Here are some of the reasons an high-growth SaaS business needs great accounting:
If you haven’t been keeping track of your SaaS bookkeeping by the time you raise your first outside money, you need to get your books in order.
We generally recommend that businesses move away from spreadsheets and into an accounting software as soon as possible. Because well-run SaaS businesses are so metrics driven, it is especially important for SaaS accounting to be done well from the start!
The good news is that pre-revenue SaaS accounting isn’t that hard, and a good founder can handle the basic bookkeeping on their own.
Steps to get DIY SaaS accounting running
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.
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
|2019 - Q1 2021||Q2 2021 - Q4 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. We’d expect that this trend will reverse in the middle of Q1 2022, and that stronger metrics will be needed for the average company to successfully finish a round.
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. We’d expect that this trend will reverse in the middle of Q1 2022, and that stronger metrics will be required.
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.
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SaaS companies can serve enterprises, consumers or anything in between. The size and type of contractual relationship with a client makes enterprise focused Software as a Service companies completely different from consumer apps sold on a recurring revenue stream through an app store. While the LTV to CAC relationship and other metrics matter for both, enterprise-focused companies have to deal with other metrics like book to bill. And consumer focused businesses should be monitoring churn cohorts and other user data very closely.
The good news is that Kruze’s team is familiar with all flavors of Software as Service business models, and we can support your financials and metrics whether you sell to Fortune 500’s or to consumers.
Software as Service companies need to regularly produce three major financial statements. These are the Income Statement, Cash Flow Statement and Balance Sheet. Additionally, SaaS companies have other metrics that may or may not be on the actual financial statements - like bookings, ARR and more. It makes sense to work with an expert bookkeeper or controller who understands how these numbers relate to your business’ GAAP financials.
The income statement shows the company’s:
The cash flow statement shows the company’s:
The balance sheet shows:
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.
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 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.
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.
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.
Our Software as a Service companies tend to carefully track their MRR and ARR. However, along with deferred revenue, MRR and ARR calculation and revenue recognition is the most difficult part of providing SaaS accounting services.
ARR, MRR and recognized revenue are difficult for many SaaS companies. While accounting systems can produce automated revenue numbers, someone needs to review them. And if there isn’t a real accounting doing that, the work falls to the SaaS company’s CEO.
In SaaS, the customer never “obtains control” of the software/service, so the general rules of revenue recognition don’t cleanly apply. Instead, accounting rules generally require SaaS businesses to recognize revenue over the contract term. This recognition is the case regardless of when the client pays the SaaS company, so even if the client pays upfront or quarterly, the revenue is recognized the same. We can’t tell you how often we see this mistake when a SaaS company uses an “automated” accounting provider.
Deferred revenue is even more complicated since it’s not as easy of a financial figure to understand. At its most basic level, if your clients are paying ahead of time for services, your company will put a deferred revenue liability onto the balance sheet. And as you deliver this service and recognized revenue, the deferred revenue liability decreases.
The price of incorrectly accounting for revenue and deferred revenue can be high. During due diligence, experienced SaaS VCs will request your financial statements, and they expect the numbers to match (although, reporting a bookings ARR number is 100% legitimate and won’t be reflected in your GAAP financial statements). Public technology companies spend even more time doing due diligence of SaaS revenue recognition, so if you are going to be acquired these numbers matter.
Invest in a good partner to help your business get these right!
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.
The answer to this question involves accrual accounting, which is the best way for startups to handle their accounting. Venture capital firms, venture lenders, investors, and others want to see your financials on an accrual basis. You need to recognize that revenue on a monthly basis as you provide the service over the year. Essentially, you’ll recognize 1/12 of that upfront payment each month. If you recognize the full amount when you received it, that’s called cash accounting. And you’ll have a really good month, followed by 11 months of no revenue. That doesn’t accurately represent your financial position. So you need to book this revenue on an accrual basis.
Since a recent court ruling, SaaS companies have become subject to charging (or at least collecting!) sales tax in many states. This is one of the most difficult recent changes that SaaS companies have to think about vis a vis their accounting. Of course, we recommend you work with a CPA like Kruze, since we have in-house tax experts who can interface with your monthly financial reporting/accounting team to help deal with compliance issues, like sales tax, proactively.
We're huge fans of Vanessa and the folks at Kruze Consulting. They set up our books, finances, and other operations, and are constantly organized and on top of things. As a startup, you have to focus on your product and customers, and Kruze takes care of everything else (which is a massive sigh of relief). I highly highly highly recommend working with Vanessa and her team.
Co-Founder @ Superhuman
As a startup, moving quickly is a top priority for us and we just needed to get our tax return done. After we uploaded our docs, we got our tax return in 3 days! E-filing was confirmed by Day 4. Super responsive and helpful!
VP, Operations of Calm.com
Avochato has been growing rapidly in the past year – in fact, too quickly for us to keep up with books, taxes, and budgeting for growth. Partnering with Kruze Consulting has been fantastic to manage, track, and analyze our finances while we continue focusing on building our customer base. Kruze’s team knows what startups need.
Alex De Simone
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Everybody, go to Kruze Consulting. They do a great job. I personally can tell you, they've done a great job for our companies, including Calm.com. I'm sure they’ll do a great job for you.
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