Oh, accounting…unless you are an accountant, or have a rare penchant for number crunching and tax returns, accounting is probably one of your least favorite aspects of running your SaaS business.
Accounting is traditionally perceived as tedious and time-consuming – a great software solution such as Quaderno that helps you automate many tasks is a godsend here. A tool can only ever be as good as the person using it, though, and that’s what makes familiarizing yourself with GAAP (Generally Accepted Accounting Principles) such an asset for your business.
Don’t worry, you don’t need to become an accounting expert. A solid understanding of some key concepts, however, will benefit your business significantly in the long run.
As an SaaS business owner, you are probably familiar with SaaS metrics such as MRR, ARPU, or CLTV. GAAP principles might seem a little more daunting, but here is where our handy accounting primer comes in.
Let’s look at bookings, revenue, cash collections (or billings) as well as MRR from an accounting perspective. What are the differences between these concepts? Why should you track these metrics? Follow me, please.
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Bookings are where it all begins, kind of like a “big bang” that sets your accounting universe in motion. A booking means that a customer has agreed to spend money for your product or service.
Yay, right? Money is coming in! Yes, eventually, but not just yet. When a customer makes a booking, it’s like you and them sign a contract: You commit to providing them with a product or service, and they commit to paying for it. For instance, a customer has booked one year of using your software. You thus commit to providing them with access to your software for one year, and they commit to paying the annual price you charge for that access e.g. $12,000.
So far, you haven’t delivered that product or service yet, and your customer hasn’t handed you any cash for it. Those are different events, tracked with different metrics, and they don’t necessarily occur at the same time.
So what counts as revenue, then? Revenue occurs when you provide your customer with the product or service they ordered. For SaaS businesses using a subscription model, this happens in several installments, e.g. on a monthly basis. For a booking with a value of $12,000 and monthly delivery over one year, this translates to a monthly revenue of $1,000. Your revenue reaches the full $12,000 at the end of the delivery term, in this case one year. This attribution of revenue comes from an accounting method called accrual accounting.
Accrual accounting records revenue and expenses when they are incurred, not when cash is exchanged. This method is used by most businesses and can even be compulsory for some companies, depending on their nature and location.
The main advantage of accrual accounting, as opposed to cash-based accounting, is that it provides more accurate profitability information and thus a better basis for management decision-making.
To learn more, read on about why accrual accounting is necessary for SaaS and subscription businesses.
CASH COLLECTIONS (OR BILLINGS)
Now it’s finally time for the Scrooge McDuck dive into your coin pile: Cash is coming in! This can occur at any time and solely depends on the terms on which you and your customer have agreed. For instance, you might charge them at the beginning or the end of their contract, or at regular intervals throughout.
It is important to remember that cash collections and revenue are not the same thing. Cash collection can occur before revenue, and vice versa. If you have received the cash your customer promised you, but haven’t yet delivered the product or service you promised them, you have not realized any revenue yet.
MRR (Monthly Recurring Revenue)
MRR, or ARR (annual recurring revenue), is not technically part of GAAP, but used very widely, so we’ll take a quick look at this.
MRR / ARR tracks the revenue your customers have agreed to spend with you on a monthly or yearly basis. This means that MRR / ARR are more similar to bookings than any other GAAP metrics, and they also provide you with a more accurate picture of your momentum as an SaaS business. Bookings and revenue will not provide the same kind of insight, as they will not allow you to see subscriptions to your products/services build over time in the same way.
That wasn’t so bad, was it? The core GAAP principles are actually quite easy to understand, and mastering them will help you make significantly better business decisions. More than worth the effort, don’t you think?
If you want to take it a step further, read on about a few tips to increase your tax returns each year.