Accounting for SaaS Companies: A Complete Guide

Profitjets offers superior-grade accounting services to startups and SaaS companies to help you build a solid financial foundation for your business.

In recent years, there has been a surge in startup companies; among them, SaaS companies have proudly taken precedence. Along with that, accounting practices have also seen a major shift. Software as a Service (SaaS) is becoming a more common and successful business venture as we transition to a digital-based future. Accounting for SaaS companies can be overwhelming sometimes, and because of this, SaaS companies must set up the right kind of accounting system.

Many entrepreneurs often wonder about when to start having a robust accounting system. Whether they should have an efficient accounting system at the early stage of the business or when the company turns into an SMB or even takes an enterprise form, the bottom line is you must set up the right accounting system from the early stage of your business and maintain it as a priority along with building an efficient team, making your products/services better, and growing your business.

What is SaaS Accounting?

SaaS Accounting consists of recording, interpreting, and analyzing a SaaS company’s financial data. SaaS accounting is a specifically designed accounting service for companies that offer software-as-a-service. SaaS companies consider the subscription-based billing model for recurring revenue generation while preparing the financial statements of such businesses. Accounting for SaaS companies can be daunting, so most companies deploy cloud SaaS accounting software to manage their financial statements and reporting.

What Makes SaaS Accounting Different?

Accounting for SaaS companies differs from the accounting of companies in other industries as the cash flow dynamics are more complex. As opposed to traditional startup or small business accounting, SaaS businesses use different accounting technologies, such as subscription management software and recurring billing platforms, which require different skills and understanding of best practices. SaaS companies tend to have a higher gross margin compared to other companies.

Because SaaS businesses use a subscription business model, revenue monitoring is the most obvious distinction in SaaS accounting. Customers of SaaS pay subscription and add-on service fees, which call for regular “maintenance” as users upgrade, downgrade or choose to opt in or out of various services.

Why Do SaaS Companies Require A Reliable Accounting System?

All SaaS companies need SaaS accounting because it produces accurate financial statements and offers insight into its operations to aid corporate decision-making. Making educated judgments about the company’s direction would be challenging without precise financial statements. The future of a rapidly expanding SaaS firm can be made or broken by having access to this data.

Along with the practical advantages of efficient accounting, having organized startup finances makes it easier to raise venture capital or become ready to sell your company. Your startup may find it difficult to raise money, the fundraising due diligence process may be delayed, or you may experience a decline in profits in the event of an exit if you don’t have clear, trustworthy financial records and current financial statements (profit and loss, or income statement, balance sheet, and cash flow statement).

Accurate financial records are also necessary for compliance with state and federal tax rules. Keeping track of these accounts helps avoid accidental tax infractions and unexpected tax costs. Also, meticulous financial records let you take full advantage of startup and R&D tax incentives.

Accounting for SaaS Companies - Methods

There are two accounting options available to SaaS companies. There is accrual accounting as well as cash-basis accounting. The main distinction between the two is the timing of when sales revenue is reported in the income statement.

Cash-basis accounting

With this accounting technique, a company only records revenue and expenses after receiving or making a debt payment. Most businesses with traditional pricing patterns or a smaller inventory employ cash-basis accounting.

Cash-basis accounting does not handle receivables and payables because revenue and expenses are only recorded when paid. Cash-basis accounting is advantageous when a business desires an accounting system that is simple to manage. However, due in part to the subscription pricing model, it is not a workable accounting method for SaaS enterprises.

Accrual accounting

In an accrual accounting system, a company records revenue as earned rather than necessarily as paid. Expenses are also reported when a contract is established rather than as they are incurred. With the help of this model, your company may more accurately predict revenue and expenses. Although more difficult than cash-basis accounting, accrual accounting can better support SaaS enterprises that are expanding swiftly.

Remember that the Internal Revenue Service (IRS) mandates using an accrual accounting methodology for any company with average annual gross revenues of $25 million or more.

Accounting for SaaS Companies - Best Practices

These best practices can create a robust and efficient accounting system for your SaaS business, ensuring accurate financial reporting, compliance, and informed decision-making.

Craft Solid Accounting Processes

Establish a foundation for accurate and efficient financial management by defining standardized processes. Develop a chart of accounts, a structured listing of income, expense, asset, and liability categories tailored to your business needs. Implement consistent rules for transaction recording, including date, amount, description, and account category, to ensure all financial activities are documented clearly.

Design a transparent and regular invoicing schedule and format encompassing subscription charges, one-time fees, and applicable taxes. Establish clear procedures for accepting payments (online, check, etc.) and recording received funds promptly. Lastly, schedule regular reconciliations of bank statements with internal records to identify and rectify discrepancies, maintaining data integrity.

Master the Art of Revenue Recognition

Understanding and adhering to established accounting standards, particularly ASC 606, is crucial for accurate revenue recognition in SaaS businesses. Gain a thorough understanding of ASC 606 guidelines that govern how SaaS companies recognize revenue over time based on performance obligations fulfilled.

Clearly define the specific services or features delivered in each billing cycle, forming the basis for identifying performance obligations. Meticulously track the portion of subscription fees considered earned revenue for each period, reflecting income generated from delivered services. For pre-paid subscriptions, accurately record deferred revenue until it’s gradually recognized as earned throughout the service period.

Maintain Impeccable Financial Records

Even without dedicated software, meticulous record-keeping is vital. Utilize spreadsheets effectively, organizing financial data in well-structured formats with formulas for calculations and automated functions when feasible. Ensure strict separation of personal and business funds by dedicating accounts solely for your SaaS business transactions. Safeguard your data by regularly backing up spreadsheets and financial documents, protecting against potential data loss.

Leverage Existing Technology Strategically

While robust accounting software offers advantages, explore alternative technology solutions to enhance your manual systems. Utilize online banking for transactions, account monitoring, and electronic statements, streamlining data access and reconciliation. Consider exploring e-invoicing solutions for streamlined invoice sending and receiving, potentially boosting efficiency and reducing manual work.

Integrate payment gateways for online payment processing and automated reconciliation, simplifying collection and reducing potential errors. Basic tax software can be valuable for preparing and filing business tax returns and ensuring compliance with regulations.

Seek Professional Guidance When Needed

While managing your accounting initially, consider consulting with a qualified accountant experienced in SaaS companies. Their expertise can be invaluable for navigating complex accounting principles, ensuring compliance with regulations, and receiving tailored advice on best practices for your business context.

Additionally, explore educational resources offered by accounting institutes or online platforms, enriching your understanding of best practices and industry trends.

Accrual Accounting for SaaS Companies

Because of its subscription-based business model, accounting for SaaS companies is a little more complex. The revenue is a mixture of upfront payments, one-time fees, and routine modifications (such as plan upgrades and downgrades).

Monthly Recurring Revenue (MRR) is a crucial measure for SaaS companies, and subscription firms benefit from accrual accounting since, when done correctly, accrual revenue matches MRR. It offers comparable trends for SaaS companies because it enables tracking sales and expenses concurrently. Depending on when revenue is recognized, different accounting techniques are used.

Benefits of Accrual Accounting for SaaS Companies

The more transparent representation of profit actually at a given period
Easier forecasting of future expenses
A higher degree of accuracy in the prediction of revenue generation
Compliant with GAAP
More simplified strategic planning

Who Regulates the Accounting Standards

The Generally Accepted Accounting Principles (GAAP) are usually brought forth and, at the same time, regulated by the Finance Accounting Standards Board. Not all businesses will indeed need to comply with the GAAP. However, at the same time, having a precise idea to use them in the inception can be crucial. For many investors, the GAAP is the standard to analyze whether they want to put money into a company based on the financial condition.

The principles are usually uniform, making it easy to draw financial conclusions. Three pillars are important in the financial statements and include the income statement, cash flow statement, and balance sheet.

What is a SaaS company income statement? It brings forth the expenditure of the business and makes it easier to understand the cost and the revenue. The income statement will make it clear for the owner to understand the profit or loss margin.

By introducing standardization and transparency to financial reporting across businesses and industries, you may eliminate differences in how organizations in different industries manage to account for comparable transactions. Make it simple for stakeholders and investors to understand and compare financial statements across different businesses and industries.

On the other hand, the balance sheet helps one understand the expenses a company owes and the amount it will receive. Usually, one needs to report the assets, liabilities, and equity for a detailed report. And finally, the cash flow statement helps you understand the cash flow you receive and spend as a business. It is the standing ground that helps you to mediate between the income statement and the balance sheet.

For more help, contact us at Profitjets, and we will help you with the best solutions.

What is SaaS GAAP Accounting?

The Finance Accounting Standards Board (FASB) regulates the Generally Accepted Accounting Principles(GAAP). All other accounting standards used by organizations are derived from GAAP. Even if GAAP is optional for all businesses, it is crucial to use it as the basis for your accounting standards.

Generally Accepted Accounting Principles (GAAP) are accounting rules and standards that help maintain uniform business accounting practices across different industries. The purpose of having GAAP in place for accounting is to ensure consistency in financial reporting across all businesses. Although GAAP accounting standards are not mandatory for companies, adopting so from the beginning has advantages.

Your forecasts, financial modeling, and analysis are more accurate and dependable because GAAP mandates organized, consistent, and comparable financials. SaaS businesses must work with accurate and current financials, relying on financial projections to guide important business investments and choices.

In addition, accountants, lenders, and investors use GAAP to assess your company’s financial position. Having this in place will save time and work when it comes to restating financial data during these cycles if your company is looking for investment.

SaaS-Specific Financial Reporting and Metrics

Financial Statements

If you go by GAAP, there are usually three types of financial statements that every Saas-based startup company needs to focus on.

A. Profit Loss Statement:
The profit loss statement is often referred to as the income statement. It helps you know the income and the cost for a particular period.

B. Balance Sheet:
The balance sheet gives you a good idea about the liabilities, assets as well as equity that the company owns.

C. Cash Flow Statement:
Finally, the cash flow statement helps one know the cash monthly and helps you generate the profit and loss statement more intricately.

Bookings

Your number of bookings helps you understand how much you can generate as a company. It is a contract usually made before a client makes the actual payment.

A booking is a very important measure that will help a SaaS business. It helps one to analyze the success of the sales and the revenue growth that one can expect.

Billings

As you can understand from the title, billing is the formal anticipation of the money you will collect from the clients. It is the complete figure representation and the amount of money you owe as a company.

Revenue and Revenue Recognition

As you can see from the name, the revenue is the amount you collect as a business. The revenue generated from the sales of the products of your business is the real profit or loss of your business.

What is revenue recognition? Accrual accounting allows you to address the non-operating income as the pertinent revenue. For this, you usually need to list the prepaid options as liabilities. The unearned revenue is usually the amount of money you still need to generate, and you will earn the revenue only after you have successfully rendered the service.

The SaaS revenue recognition is difficult to analyze. For example, the money you get from the client for a yearly service before you provide the service or the products is referred to as deferred or unearned revenue. Once every month, the client starts using your services; your company accountant needs to put it as the revenue you earn.

MRR & ARR

The term MRR refers to monthly recurring revenue, and the term ARP refers to Annual Recurring Revenue. These are the two SaaS metrics one uses on a wide-scale basis. In the simplest terms, these are the probable revenue, and that too over some time. For the calculation of the ARR, you need to find out what your MRR is and multiply the same with the help of 12. Ideally, some of the most important factors that your MRR should project include the following:

The revenue is recurrent from the clients.
All the upgrades and downgrades are associated.
Discounts that you provide.
The revenue that you have lost due to customer loss.

SaaS KPIs

Finally, the term KPI refers to key performance indicators. It gives you a better and more detailed understanding of the company’s revenue. Usually, the key financial metrics that you use tend to depend on the business that you are venturing into. However, at the same time, there are five important components that every SaaS-based startup tends to make good use of. These include;

The Top of Funnel KPI
Financial based KPI
Unit Economics KPI
Revenue Based KPI
Market or Product-Based KPI.

Revenue Recognition for SaaS Companies

Revenue recognition is often considered one of the most crucial principles for Generally Accepted Accounting Principles. The major tenet is that it gives you a good idea about where you need to recognize the revenue and how you can choose to account for the same as well.

According to the accrual accounting method, revenues must be recorded on the income statement when realized and generated, not necessarily when cash is received. Earned revenue represents the money that a company spends on goods or services. Most SaaS providers employ accrual accounting, which records revenue at the time of sale, rather than on a cash basis, which records revenue at receipt of payment.

When organizations should recognize revenue for contracted services is governed by ASC 606 and IFRS 15. This typically occurs when a business hands over the service to the client. The “transfer” occurs during the contract, although SaaS clients never actually take ownership of the service. As a result, SaaS providers are required under ASC 606 and IFRS 15 to recognize revenue from services sold in installments throughout the client contract.

However, it is crucial that before you analyze the SaaS-based implications, you have a good idea about some other components that are equally crucial.

Deferred Revenue

Simply put, it can be referred to as the revenue a company has already billed. But simultaneously, one cannot recognize it because you still need to provide the services. In the balance sheet, this is usually referred to as a liability, and in many cases, it is also very popularly referred to as unearned revenue because of its theoretical rendition. The deferred revenue is the amount you are yet to recognize; hence, it is time-dependent.

Accrued Revenue

The next important component, in this case, is the accrued revenue, which is the revenue that one has realized but has yet to recognize. The invoice is yet to be billed to the client, but at the same time, the business has already earned the revenue, and hence it is recognized. Not only that but the accrued revenue, in a lot of cases, is also referred to as the unbilled revenue as well.

The accrued revenue is often called accounts receivable unless the customer pays the bill. The balance sheet is usually referred to as the current asset. If you notice that the accrued revenue is very high, then there is a high probability that, as a business, you are not getting paid for the services that you are rendering. It can be difficult and ruin your business's cash flow.

In most of Accounting for SaaS companies cases, you will notice that the accrued revenue can be attributed to:

Upgrades are usually made based on the plans and the quantity.
The one-time charges like subscription fees.
The purchases are often referred to as add.

ASC 606 and SaaS Revenue Recognition

It is a five-step model, and this model aims to help you analyze the principles for the collection of revenue. The addition of this model has proven to be extremely beneficial for a better understanding of the accounts, which is crucial. The five steps under this model include the following:

Step 1: Understand Your Contract With The Clients

You must establish these criteria with the client before providing any service. It is usually a contract that is mutually decided by both the company as well as the client. Not only that, this is self-explanatory and refers to the obligations and rights of each party.

Step 2: Analyze the Obligations Of Performance in the Contract

The contract helps you to understand all the obligations that are mentioned for the domain of performance. However, if one notices that the services are somewhat unique, you must ensure that you distinctly account for the same.

Step 3: Set The Transaction Price

This refers to all the steps before selecting any particular transaction price.

Step 4: Allocation of the Price

It refers to the way the allocation of the transaction price takes place. This is done across the performance obligation, usually mentioned in the contract. The allocation of the price might include prices that are variable as well.

Step 5: Recognize Revenue After Having A Satisfying Performance Obligation

The step is self-explanatory. As a company, you are supposed to recognize the revenue, which should happen stepwise whenever you deliver the performance obligations.

However, it can still be confusing to understand, and hence, if you need more help with any of the steps, feel free to contact us at Profitjets.

How to Manage SaaS Startup Accounting Easily

Profitjets is a full-service accounting firm, and we offer you various services to make your accounting easy. Be it accounting, bookkeeping, tax consultation, or CFO services for startup SaaS companies, along with managing the recurring billing for your company.

We believe that spreadsheets are an age-old concept for a growing SaaS company. It takes too much time to manage a spreadsheet and also has chances of making errors. If you measure these, you may find the workflow to have some things that could be improved. And the key to mitigating such errors is automating the repetitive task process.

All SaaS companies need a specialized tool to manage subscriptions and recurring billing and ultimately streamline the whole process of finance operations. Profitjets manage your recurring billing easily while making identifying, reporting, and remaining compliant a breeze. Contact Profitjets right now if you’re seeking a service that handles your financial tasks like bill payment and invoicing! We provide a senior finance professional to create estimates and budgets and offer you guidance on filling your annual tax return.

Efficiently Powered Technology

Our major focus is to use technology-oriented approaches, including artificial intelligence and machine learning. It aids us in better formulating your GAAP and, simultaneously, can perform more detailed bookkeeping responsibilities.

Best Experts

For us at Profitjets, our experts are our most coveted possessions. You get to contact a specific expert for all the queries, which does not raise doubts. We will ensure that once you have raised the query, we can assign someone who will take care of the same as soon as possible. We also have an extremely comprehensive finance dashboard and a finance concierge; as clients, you can access the same round the clock. Sounds convenient.

Advice

We pridefully say that our team is one of the best and most experienced, and we have worked for years with the best SaaS-based companies. The experience aids us in giving you the most detailed explanation, no matter your doubts! Not only that, we like to take up an effective part in the entire decision-making process for your company. Hence, we will ensure you know the benefits and problems you can go through under all circumstances.

Monthly Fee

We ensure that our monthly fees for your SaaS-based startup services are extremely pocket-friendly and do not burn a hole in your pocket!

Finance Insights

We don't believe in delaying the time at all. Hence there is no need to wait at all, and we will give you a detailed insight into all the financial statements and that too by maintaining precision. For this, all you need to do is access our Profitjets finance dashboard, and thankfully, you will get all the information you need related to your company accounts.

Comprehensive Services

Finally, we have experience, so we aid you in a complete round of the best services you can expect from us. We understand that as your company grows, you will need more services like the complex accounting inclusion of a CFO, and we are ready to aid you with the same!

Types of SaaS Expenses

SaaS businesses incur many of the same costs as others, including some exclusive to software vendors and cloud-based businesses. These often fit into four kinds of expenditures:

General and Administrative

The daily operating expenditures of running a business unrelated to creating a good or service are called G&A expenses. SG&A expenses are required to operate a SaaS provider’s business, even if they are unrelated to creating their goods or services. Office space, utilities, supplies, and salaries are typical SG&A costs.

Sales and Marketing

The “S” in the commonly used SG&A KPI stands for sales and marketing costs, which concern how well a SaaS provider advertises and markets its products. Print, TV, digital, sales and marketing collateral, customer-facing website charges, marketing automation technologies, and public relations costs are all included in sales and marketing expenses. These costs should cover wages for sales and marketing workers, including commissions, similar to R&D staffing.

Research and development (R&D)

A SaaS provider’s budget may include significant R&D costs, especially early on. These expenditures cover the price of hardware, the cost of a software license, and any other costs related to creating the software and services. The staffing costs for creating the software and services a SaaS provider sells, such as the salary of the engineering team, are included in R&D even though most payroll is regarded as an SG&A expense.

Cost of goods sold (COGS)

The term “cost of goods sold” (COGS) refers solely to the direct costs of providing SaaS applications. Hosting and server costs and transaction fees are some of the most typical costs for calculating COGS for a SaaS company. The cost of revenue, which includes all COGS components and direct costs for the sales function, including commissions, sales discounts, distribution, and marketing, is another similar measure that SaaS providers may employ. Cost of revenue, like COGS, does not include indirect G&A expenses like manager wages unrelated to sales. SaaS enterprises can recognize some of the costs above, but others must be postponed.

Accounting for SaaS Companies - Rules

While the specific technicalities of SaaS Accounting regulations depend on your unique circumstances, mastering some core principles can set you on the right path. Here’s a breakdown of key areas to focus on without venturing into potentially misleading specifics

Revenue Recognition

ASC 606/IFRS 15: Become familiar with these overarching frameworks, but remember nuances based on your location and industry may apply. Consult an accountant for tailored guidance.
Earning Your Stripes: Identify the specific services or features included in each subscription tier to measure earned revenue for each period accurately. Consider multi-year contracts and usage-based billing complexities.
Deferred Revenue: Track unearned revenue meticulously, considering factors like cancellation rights and refund policies. Remember, it gradually transforms into earned revenue as service obligations are fulfilled.

Matching Expenses and Revenue

Connecting the Dots: Allocate costs to specific product or service lines whenever possible. For example, differentiate the expenses incurred for developing core features versus add-on modules.
Timing is Key: Utilize accrual accounting to recognize revenue and expenses when they are earned or incurred, regardless of cash flow timing. This provides a more accurate picture of your financial performance.
Prepaid Expenses: Carefully distinguish between prepaid expenses (future benefits) and accrued expenses (past obligations). Allocate them to the appropriate accounting period to ensure accurate matching.

Building Strong Internal Defenses

Safeguarding Your Treasures: Implement access controls to restrict unauthorized access to financial data. Additionally, regularly back up your accounting records to prevent data loss.
Segregation of Duties: Establish a clear division of responsibilities for handling financial transactions, approvals, and reconciliations. This minimizes the risk of fraud or errors.
Regular Reviews: Conduct internal audits and reconciliations of bank statements and financial records to identify and address discrepancies promptly.

Understanding the Taxation Terrain

Taxes, Taxes, Everywhere: Stay informed about relevant sales tax regulations based on your physical and digital presence across different jurisdictions. Consider seeking tax advice for complex situations.
Income Tax Maze: Understand the tax implications of subscription revenue, deferred revenue, and expenses according to your location and business structure.
International Expansion: If you operate internationally, dive into international tax treaties and regulations to ensure compliance and avoid double taxation.

Speaking the Language of Finance

Financial Statements: Understand the basic components and functions of the income statement, balance sheet, and cash flow statement. These are essential tools for communicating your financial health to stakeholders.
Key Performance Indicators (KPIs): Track relevant SaaS-specific KPIs such as Customer Acquisition Cost (CAC), Customer Lifetime Value (CLTV), and Monthly Recurring Revenue (MRR) to gain deeper insights into your financial performance.
Industry Benchmarks: Compare your financial metrics to industry benchmarks to identify areas for improvement and stay competitive.

How to Handle SaaS Taxes

Regarding a SaaS provider, ensuring you have the best idea to avoid making grievous mistakes is exceedingly important. The domain of SaaS taxes can be very difficult; hence, we are here to give you a comprehensive guide.

Physical software is absent, and this mix makes it difficult to determine when to collect the taxes. The taxation system tends to change from one state to the other. For example, in places like New York and Arizona, it is regarded as sold in software, while for places like California and New Jersey, it is a non-taxable service.

Sometimes, many states do not collect sales tax on SaaS, but at the same time, the cities within them have different specifications and require one to collect the sales tax. These include places like Illinois as well as Chicago. The situation becomes more difficult for companies operating in multiple states, and you need to follow a nexus. The interpretation, as well as the standardized definition of the term nexus, has changed, and this has happened especially after the advent of internet-based commerce in a more holistic manner.

Some states already have a very comprehensive "affiliate nexus" law. What is it all about? The major saying of this law is that all those businesses that are out of state and yet tend to maintain an in-state connection need to make sure that they collect the sales tax. Some other options have also come forth with the "economic nexus."

Here, the major focus is that companies need to collect the sales tax once they have reached the limit for the sales tax revenue. In simple terms, you need to reach up to that volume of sales, and then it will be mandatory for you to pay the sales tax. If you have any doubts about the entire taxation system, let us know, and we will help you work through the same at Profitjets.

Tracking Metrics for SaaS Companies

Revenue and Growth Metrics

The significance of MRR and Net New MRR is to track the recurring subscription revenues that SaaS companies earn monthly from customers. It is important to break down the MRR and its various sources.

New MRR: The revenue a SaaS company generates from subscriptions of new customers.

Expansion MRR: This is the additional revenue that a SaaS company generates from its existing customers. And this includes upselling, cross-selling, service add-ons, etc.

Churned MRR: This is the revenue loss of a SaaS company because of customers canceling their subscriptions.

Contracted MRR: This is the revenue loss of a SaaS company because customers are downgrading their subscriptions.

The Net New MRR shows the additional MRR of a SaaS company after considering the lost MRR. The Net New MRR is more useful for early revenue-generating companies as the % growth measure may need clarification. It would be best to compare the New MRR with the Expansion MRR to understand the attributable growth of new vs. existing customers.

Computation Mechanism of MRR and Net New MRR

Net New MRR = New MRR + Expansion MRR – Churned MRR – Contracted MRR
Net MRR = BoP MRR + New MRR + Expansion MRR – Churned MRR – Contracted MRR

ARR is a SaaS company’s recurring subscription revenues in one year.
ARR is useful for companies that primarily run annual subscriptions.
ARR is also considered the annualized run rate of MRR
You can also break it down into New ARR, Expansion ARR, Churned ARR, and Contracted ARR.

Computation Mechanism of ARR

Exit ARR = MRR X 12
Net ARR = BoP ARR + New ARR + Expansion ARR – Churned ARR – Contracted ARR

The growth rate measures the performance of your business and its scale-up time.

Computation Mechanism of Growth Rate

Growth Rate= (Current year MRR – Previous year MRR)/Previous year MRR

Benchmark for Growth Rate: 5 – 10 % MoM growth if a SaaS company wants to raise a Pre-Series A round.

Computation Mechanism of Growth Rate

Growth Rate= (Current year MRR – Previous year MRR)/Previous year MRR

Benchmark for Growth Rate: The Growth rate should be 100 – 200% if the ARR is less than USD 5 mn, and it is 50% + if the ARR is more than USD 5 mn.

Gross margin is important to identify direct costs and if there is any reduction over time.
Direct costs are incurred due to customer onboarding, support, use of technology, software licensing, and hosting.
A low gross margin indicates the contribution of service elements to the revenue. This may indicate that the business may need help to scale up quickly.

Computation Mechanism of Gross Margin

Gross Margin = (Revenues – Direct costs)/Revenues

Benchmark for Gross Margin:
> 70% from the second or third year onwards

ARPA is the average revenue contribution of a single customer in a month.
ARPA helps to understand the customers required to achieve the desired/projected revenue numbers.
ARPA is useful for tracking revenue generation on a per-unit basis.

Computation Mechanism of ARPA

ARPA = MRR/Total Customers

LTV is the measure of the revenue generated by each customer during its entire tenure.
LTV acts as a guide on how much a company should spend to acquire new customers.

Computation Mechanism of LTV

LTV = ARPA/Churn rate

The quick ratio compares a company’s growth in terms of its revenue generation against the revenue lost in the same period.
The quick ratio indicates how well your Saas product will be able to scale up in the future.
It also indicates how well your business can retain its existing customers.

Computation Mechanism of Quick Ratio

(New MRR + Expansion MRR)/(Churned or Canceled MRR + Contraction MRR)

Quick Ratio Benchmark :
The quick ratio benchmark is > 4X. If it is more than 4X, it signifies healthy business growth with a low churn rate.

Under the rule of 40, the revenue growth and profit margin should be a minimum of 40 and above for a company to grow sustainably.
It helps determine the correlation between a company’s profitability and growth.
Rule 40 may not be applicable for companies in their early stage with high CAC and other costs as the focus of rule 40 is only its growth.

Computation Mechanism of Rule 40

Growth rate + EBITDA margin

Rule of 40 Benchmark: The rule of 40 benchmarks is > 40% at scale.

ACV is the value of a customer’s contract in 12 months. For example, if a customer goes for a 3-year contract with a bill value of USD 75,000, then the ACV = USD 75,000/3 = USD 25,000.

Revenue Concentration

Revenue concentration is the measure of total revenue contribution by the top few customers of a company.
Revenue concentration also shows a company’s dependency on the top few customers for business sustainability.

Expenditure Metrics

CAC is the cost that a company incurs for acquiring new customers.
CAC is important to identify the scalability and sustainability of a business operation.
CAC ensures that the consistency between sales operations and GTM is recognized.
The CAC payback period indicates sales efficiency and checks when the company can recover CAC from customers.

Computation Mechanism of CAC

CAC = Total cost of sales and marketing/number of new customers
CAC payback = CAC / (ARPA X Gross margin)

CAC Benchmark

CAC payback period: 12 to 18 months
LTV: CAC ratio more than 3X

S G & A Expenses indicate the investment required for a company’s growth.
S G & A Expenses help in identifying the efficiency of a business’s GTM strategy.

Computation Mechanism of S G & A Expenses

S&M % = Total cost of sales and marketing / Total revenue
G&A % = Sum of general and administrative cost / Total revenue

S G & A Expenses Benchmark

S&M %: 20 – 25%
G&A %: 10 – 15%

Gross Burn: Gross burn is the monthly amount of money a company spends to run its operations.
Net Burn: Net Burn is the net cash flow of a company in a month after considering the revenue generated.
If a company shows a high burn rate against its revenue earning potential, it depicts that it may only sustain itself for a short time.
It indicates when a startup company should start raising its next round of funding.

Computation Mechanism of Gross/Net Burn

Net Burn = Gross Burn – Revenue

Gross/Net Burn Benchmark: After a company stabilizes, a negative benchmark after 3 – 4 years.

Sales Efficiency

The magic number is important to track the efficiency of a company’s sales team.
The magic number indicates the ARR generated in a company against every dollar spent on sales and marketing.
If the magic number is 1.0, the company has paid back the customer acquisition cost within one year.

Computation Mechanism of Magic Number

(Recurring revenue of current quarter – Recurring revenue of previous quarter) * 4 / Sales and marketing costs of the previous quarter

Magic Number Benchmark

0.75X
If it is more than 0.75x, a company can invest more in sales and marketing to achieve business growth.

Conversion rate is the rate at which leads generated through marketing campaigns convert to paid customers.

Computation Mechanism of Conversion Rate

No. of new customers / No. of qualified leads

Conversion Rate Benchmark

2 – 5% if leads generated via digital marketing

FTE efficiency is the revenue generated by one full-time employee.
You may consider the employees in the sales team and other employees who work on the product directly.

Computation Mechanism of FTE Efficiency

FTE Efficiency = Revenue generated / No. Of employees working directly on the product

FTE Benchmark

If ARR is USD 0.5 – 1 mn, It must be USD 40,000 per employee
If ARR is USD 1 – 2.5 mn, It must be USD 60,000 per employee

Customer Metrics

It is the proportion of revenue loss because of canceled and contracted subscriptions.
Gross revenue churn indicates how well a business can retain its customers.

Computation Mechanism of Gross Revenue Churn

MRR loss in a given period / MRR at the beginning of the period

Gross Revenue Churn Benchmark

Annual churn: 10%
Monthly churn to target:

SMBs: 2 – 3%
Mid-market customers: 1 – 2%
Enterprises: 0.5 – 1%

Net increase or decrease in the MRR after considering the churned/contracted MRR and MRR earned from upselling to existing customers.
Negative churn shows a higher growth from existing subscriptions/customers, and the MRR lost due to upselling MRR offsets.

Computation Mechanism of Net Revenue Churn

(Lost MRR in a given period – MRR from expansion in the same period) / MRR at the beginning of the period

Net Revenue Churn Benchmark

Negative net churn in the third or fourth year after the stabilization of the company

Logo/ Customer Churn represents the number of customers lost due to canceled subscriptions in a given period.
Logo/ Customer Churn is a key indicator of customer satisfaction and the stickiness of a product.
A higher churn indicates the company needs to analyze the dissatisfaction factors and how to improve them.

Computation Mechanism of Logo/ Customer Churn

Number of customers lost in a given period / Number of customers at the beginning of the period.

Logo/ Customer Churn Benchmark

< 10%

The amount of money churned in any given month is a percentage of all that is churned.
Contrary to earlier turnover metrics, discretionary churn does not include customers locked into annual contracts. They can only terminate them after their terms expire, even if dissatisfied or disengaged.
The company will forecast a lower churn rate if such consumers (obligated by annual contracts) are considered in the churn calculation.

Computation Mechanism of Discretionary Churn

Customers lost in a given period /Number of eligible customers for churn at the beginning of the period.

Logo/ Customer Churn Benchmark

< 10%

The customer retention rate measures the no. of customers who renew their contracts.
Customer retention rate indicates customer satisfaction and product stickiness.

Computation Mechanism of Customer Retention Rate

No. of customers who renewed their contracts in a given period / No. Of customer contracts that are due for renewal.

Customer Retention Rate Benchmark

> 75%

Net dollar retention rate measures a company’s revenue percentage from the previous year after accounting for upgrades, downgrades, and churn.
The company must improve customer satisfaction if the Net dollar retention rate is < 100%.

Computation Mechanism of Net Dollar Retention Rate

(BoP Revenue + Upgrades – Downgrades – Churn) / BoP Revenue

Net Dollar Retention Rate Benchmark

110%
If it’s more than 100%, growth from the existing customer base can offset the losses (if any) from that customer base.

Balance Sheet for SaaS Company- Example

Understanding your financial standing is crucial for any business, and a well-crafted balance sheet is a vital roadmap for SaaS companies. It paints a clear picture of your assets, liabilities, and shareholder equity at a specific time, offering valuable insights into your financial health and growth potential.

Assets

Current Assets:

Cash & Cash Equivalents: $1,200,000
Accounts Receivable: $650,000
Prepaid Expenses: $100,000
Inventory (if applicable): $50,000
Total Current Assets: $2,000,000

Non-Current Assets:

Property, Plant & Equipment (net): $300,000
Intangible Assets (e.g., software development costs, patents): $500,000
Deferred Tax Assets: $200,000
Goodwill (if acquired): $100,000
Total Non-Current Assets: $1,100,000

Total Assets: $3,100,000

Liabilities & Equity

Current Liabilities:

Accounts Payable: $300,000
Accrued Expenses: $150,000
Deferred Revenue (unearned subscriptions): $1,000,000
Current Portion of Long-Term Debt (if applicable): $50,000
Total Current Liabilities: $1,500,000

Non-Current Liabilities:

Long-Term Debt: $400,000
Deferred Tax Liabilities: $100,000
Total Non-Current Liabilities: $500,000

Total Liabilities: $2,000,000

Shareholder’s Equity:

Common Stock: $500,000
Retained Earnings: $600,000
Total Shareholder’s Equity: $1,100,000

Total Liabilities & Equity: $3,100,000

By analyzing your balance sheet regularly, you can gain valuable insights into your financial stability, resource allocation, and areas for improvement, driving informed decision-making and fueling sustainable growth for your SaaS venture.

Overcome SaaS Accounting Challenges With Accounting Software

When it comes to accounting in this particular domain, there is no doubt that you need experience and knowledge to excel. However, many SaaS providers still need to switch to professional options and continue to use spreadsheets, which can be very difficult to work with. This will lead to difficulty in the organization accessing the same, as you might make extremely costly mistakes for your business.

How do we work at Profitjets to ensure you avoid facing these problems as one of the top SaaS-based companies? Here, we use an amalgamation of the most modern-day innovations, and this includes incorporating promising accounting techniques as well. It will aid us in maintaining optimum functionality across various domains and is very important to sustain. As a SaaS business, you can streamline financial management tasks. The most important facet here is that automation allows you to streamline the same easily and without any unwarranted mistakes.

Not only that, but you will also be able to get complete detailed financial reports, which is crucial to help you comply with the State, Federal and the standards set up by the international accounting mediums.

Before you even start with this domain, it is extremely important to make sure that you have a complete idea about this field. If not, working with compliance across tons of different rules can become extremely difficult and, at the same time, overwhelming as well. Working in aid with a partner who knows the same makes it much easier and more promising for you.

At Profitjets, we have tried to get the most comprehensive services, allowing us to help you with a wide spectrum of options. We have completely automated the process, ensuring that you will never miss a taxation deadline in the future. You will also see that the system gives you complete access to the various updates, records, and posts you need to know about. With the automatic resources, we have ensured we can bid farewell to the manual options completely, and that too for the long run! It will help us eliminate errors; in this field, making errors can be catastrophic for the company.