From Booking to Revenue: the What, Why, and How of SaaS Revenue Recognition
When you are scaling a fast-growing SaaS company, your first and foremost focus is - and rightly so - increasing your revenue. When you see all the sales bookings rolling in, it’s naturally exhilarating. But the actual cash that hits your books is another story altogether.
Given its recurring revenue model, SaaS revenue recognition can be an accounting nightmare. So, it helps to understand a few key top-line metrics like bookings, billings, and revenue.
Revenue recognition is the process of converting cash from ‘bookings’ into ‘revenue.’
There are structured rules around how businesses should calculate and report revenue. Since these are important indicators of your growth, investors are going to keep a close eye on them as well. So, understanding the nuances of revenue recognition in SaaS is necessary, because you don’t want to give the wrong picture to your stakeholders and misreporting your recognized revenue can get you into unwanted tax compliance issues.
Here’s what every SaaS business needs to know about revenue recognition and compliance to standards like ASC 606.
What are Bookings, Billings, and Revenue in SaaS?
Bookings, billings, and revenue in SaaS are all closely related to each other. But they’re not the same. Let’s first understand what these terms mean and how to calculate them.
Bookings are when your customer goes, ‘heck yes, I want to buy your product.’ It indicates the value of a contract signed with a prospective customer for a given period of time. For a particular month, your bookings comprise the sum of all deals closed in that month. Total bookings (including renewals and expansion) can help in tracking how much revenue can be recognized in the future, once the sales team converts the opportunity into a paying customer. Bookings cannot be recognized as revenue until the service is rendered.
Billings, on the other hand, are the invoices sent to your customers. This can be over different time periods, like a monthly or an annual invoice. Simply put, billings are when you actually collect money from your customer and it directly impacts the cash flow of a business. If the billings are low while bookings remain healthy, there are chances of facing cash flow problems. For more tips on cash flow, here are 8 cash flow mistakes to avoid.
Revenue is the actual income earned when you deliver on the promised service to your customers. Relying only on bookings and billings can lead to an inaccurate picture of the state of a business. So every month, you recognize revenue only for the service that has been delivered. This is according to US GAAP accounting standards, which state that revenue can only be recognized once it is “earned.”
For example, if a customer signed up for an annual plan of $12000 (billed monthly) in the month of January:
Bookings for January are: $12000
Billings for January are: $1000
Revenue recognized for January are: $1000
You can find a detailed example with calculations of bookings, billings, and revenue here.
The Importance of Accounting Standards
The rules and guidelines for financial accounting and reporting are enlisted by accounting standards. Revenue recognition is one of the principles of the Generally Accepted Accounting Principles (GAAP US), which is regulated by the Financial Accounting Standards Board (FASB). The alternative for most other countries is the International Financial Reporting Standards (IFRS), which is regulated by the International Accounting Standards Board (IASB).
Accounting standards exist to:
Eliminate variations in the way businesses across industries handle accounting for similar transactions by bringing standardization and transparency in financial reporting across companies and industries.
Make it easy for investors and stakeholders to comprehend and compare the financial statements across companies and industries.
ASC 606 Guidelines and What They Mean for SaaS
According to FASB which governs the US GAAP, revenue recognition requirements of IFRS lacked sufficient detail and the accounting requirements of U.S. GAAP were considered to be conflicting in certain areas.
To overcome these shortcomings, FASB (which governs US GAAP) and IFRS joined hands to establish a new revenue recognition standard, called the ASC 606.
ASC 606 has an overarching framework that covers all bases for SaaS revenue recognition. This cleared up the clouds of confusion that loomed over SaaS accounting due to inconsistent and unclear practices. This model is aimed at directing businesses about how much and when to recognize revenue.
The 5-step process for revenue recognition under ASC 606 is:
Identify the contract with a customer
Identify the performance obligations in the contract
Determine the transaction price
Allocate the transaction price
Recognize revenue when (or as) the performance obligation is satisfied
SaaS Revenue recognition gets complicated because of the dynamic nature of costs incurred by the customer at each stage, such as implementation costs, training, add-ons, discounts, upgrades, downgrades, and so on. Omitting or incorrect reporting of these costs can create a lot of confusion in SaaS revenue recognition. ASC 606 takes this lifecycle of the customer into account and helps drive that much needed accuracy in the revenue recognition.
Revenue Recognition for SaaS
Revenue recognition is different for SaaS businesses because the business model demands to charge customers upfront for services that will be delivered over a period of time. SaaS businesses have to track the money that flows in their account, and how much of it is actually recognized.
In the case of upfront payments, the revenue can’t be recognized until the said service is delivered as promised. So the upfront payment received before the delivery of the service or product is considered deferred revenue and listed as a liability on the balance sheet.
Let’s assume that a customer has opted for the annual plan priced at $12000 per annum starting from January and is billed $1000 per month. Even if they are charged the entire $12000 upfront, only $1000 gets recognized for the services provided in January. The remaining $11000 is recognized as deferred revenue.
Complexity of SaaS revenue recognition increases with different subscription scenarios.
For example:
Pausing or cancelling the subscription
Plan upgrades
Plan downgrades
Inability to pay for the services rendered
It doesn’t stop there, the bundling of these features in SaaS adds another layer of complexity:
Set-up fees
Support fees
Consultation services
Customization
Revenue recognition in such scenarios needs to be prorated and recalibrated. But fret not! Head here for a comprehensive list of SaaS revenue recognition scenarios, examples included!
Often in a SaaS business, the entire contract value for an account isn’t the revenue you can recognize. After accounting for revenue leakage from coupons, credit notes, failed payments, and cancellations, you will notice that your realized revenue turns out to be much lesser. Having a robust SaaS billing analytics platform in place is crucial to finding and plugging these leaks.
Forecast MRR vs Actual MRR
Revenue Leakage by Coupon
With the help of the analytics dashboard, you can compare your forecast MRR with actuals, and also zero in on the impact of coupons and discounts on your revenue. Struggling to perfect your dashboard? Check out KPI Sense’s 5 tips to creating an effective KPI dashboard for your company.
If you are new to SaaS and need help keeping track of your data - we are here for you. We build customized dashboards and models to maximize your potential. Explore how KPI Sense can help here.
Revenue Recognition Pitfalls you Want to Avoid
Bookings are not revenue - understand the nuances when you account for your bookings and revenue.
As your transactional volumes increase, the gap between actual and improper revenue recognition becomes more apparent. Using spreadsheets for accounting at a stage of rapid growth is a slippery road you want to avoid.
Using cash basis accounting is allowed, but not recommended for SaaS. SaaS accounting includes recognized revenue and maybe deferred revenue, along with cash collections. It is helpful to use accrual accounting as it tracks along with the MRR and gives a true representation of the business and its growth potential. Read more on how switching to accrual accounting can save you big $$ on your taxes this year.
Don’t forget about compliance with standards like ASC 606.
It doesn’t have to be as daunting as it sounds. Check out this all-you-need-to-know guide about SaaS revenue recognition to ease all your accounting concerns!
Making Revenue Recognition Simple
Recurring billing is at the heart of every SaaS business and that’s why revenue recognition needs to go hand in hand with that. Having multiple sources of truth can be very time-consuming and tedious. And no accounting team wants more of that, right?
Nupura Ughade
Nupura is a SaaS enthusiast and a Content Marketer at Chargebee. She’s passionate about storytelling through content. In her free time, she can be found painting or reading in a nook.
Chargebee is a subscription management platform that not only helps manage recurring billing but also ensures globally compliant revenue recognition. Chargebee’s billing platform becomes the single source truth, and enables seamless management recurring billing along with revenue reporting.
If you have any questions, feel free to reach out below or leave a comment, happy to help.