Founders, as you embark on your journey of starting your SAAS-based business one thing that will come up time and time again will be the concept of ‘Revenue Recognition.’
What is revenue recognition you may ask?
Revenue recognition is the process of recognizing revenue received from customers in the right time periods for financial statement purposes.
Let me start with an example:
Tagore, Inc – a SAAS-based business signed a customer on January 1st, 2021 for $12,000 for an annual contract to use their platform. On that date, they paid Tagore, Inc. $12,000.
The question becomes when should Tagore, Inc. recognize this revenue? On a cash basis of accounting, the revenue would be recorded in January 2021,
|January 2021||$ 12,000.00|
|Total Contract||$ 12,000.00|
On an accrual basis of accounting and here’s the tricky part – this revenue needs to be spread over the life of the contract which would be $1,000 each month for 12 months
|January 2021||$ 1,000.00|
|February 2021||$ 1,000.00|
|March 2021||$ 1,000.00|
|April 2021||$ 1,000.00|
|May 2021||$ 1,000.00|
|June 2021||$ 1,000.00|
|July 2021||$ 1,000.00|
|August 2021||$ 1,000.00|
|September 2021||$ 1,000.00|
|October 2021||$ 1,000.00|
|November 2021||$ 1,000.00|
|December 2021||$ 1,000.00|
|Total Contract||$ 12,000.00|
So how do you as a founder record this revenue in your books? Well, it takes some accounting background and knowledge and some familiarity with recording journal entries or using a system that is sophisticated enough to record revenue the right way. This can be complicated further due to the sheer volume of contracts your startup may be signing up with your customers.
One of the things that you as a founder need to pay attention to here is the interaction between the Income Statement and Balance Sheet when it comes to deferred revenue. Essentially, Deferred Revenue (the revenue yet to be earned) is reflected on the Balance Sheet. As the contract terms are met, the revenue moves from the Balance Sheet (Deferred Revenue account) to the Income Statement (Revenue account).
In addition to the complexities mentioned above, you should also consider some additional Revenue Recognition Standards as prescribed by GAAP (Generally Accepted Accounting Principles) (ASU) 2014-09, Revenue from Contracts with Customers (ASC Topic 606) – That’s a mouthful.
Essentially this revenue recognition standard provides your company with the steps that should be taken before revenue is recognized.
If your startup is an Enterprise SAAS business you may also find that you have implementation/set-up or non-recurring engineering revenue. ASC-606 must be taken into account when determining how this revenue which is separate from your monthly recurring revenue (MRR) is recorded.
Image Source: More info here: https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/revenuerecognition/downloadabledocuments/frc_brief_revenue_recognition.pdf
There are solutions:
From simple to complex, and from low-cost/labor-intensive or high-cost/setup intensive options. I’ve highlighted a few below for you to consider.
- Microsoft Excel: At an early stage it may be possible to keep track of your contracts using an excel spreadsheet. Adjustments can then be made manually in the accounting software.
- ChargeBee: If you are using ChargeBee for your subscription management – they have an add-on Deferred Revenue module which can be used to automate this. More info here: https://www.chargebee.com/saas-accounting-and-taxes/revenue-recognition-deferred-revenue/?ref=navbar
- Stripe – Revenue Recognition: If your Startup is using Stripe they too have developed a Revenue Recognition module which also helps automate the process. More info here: https://www.chargebee.com/saas-accounting-and-taxes/revenue-recognition-deferred-revenue/?ref=navbar
- SaaS Optics: If you are using SaaS Optics for your subscription management – they have an add-on Deferred Revenue module that can be used to automate this. More info here: https://saasoptics.com/revenue-recognition-2/
Our team loves the nitty-gritty of tackling revenue recognition and we embrace it like a puzzle that needs to be solved, so if you as a founder find tackling revenue recognition to be one less thing on your to-do list please contact us to find out more. We can help you choose the right solution from the ones mentioned above and help you think through the cost/benefit of implementing them depending on the stage of your business growth.