June 16, 2020

A Look at SaaS Accounting

A Look at SaaS Accounting

A Look at SaaS Accounting: For bootstrapped SaaS startups, those newly flush with venture capital, and every company in between, SaaS accounting can be full of confusion and challenges.  

Before the rise of the subscription-based model, revenue was generally projected based on previous sales. So, if Company A sold 10,000 sealed boxes of a specific software or computer program last year at Best Buy and similar stores, it might report that it anticipates selling 11,000 in the coming year. Revenue projection, check. 

SaaS business models, however, are dynamic. Their revenues are calculated based on current and anticipated subscription fees. With varying subscription terms and churn, not to mention the cost it takes to capture a new customer and continuously maintain their loyalty, revenue projection is a bit hazier.

Metrics give leaders a sense for their business’s momentum or lack thereof. However, confusion about what metrics to track and how to calculate them at SaaS startups often results in disjointed spreadsheets that supplement accounting software. This is troublesome because not only are real-time, accurate numbers crucial for investors, they are vital for data-driven decision making.

Here are the key metrics that all SaaS startups should track and how to capture them when taking a look at SaaS Accounting

1)     Monthly Recurring Revenue (MRR)

MRR measures how much predictable, recurring revenue is expected every month. MRR is crucial for SaaS businesses, which rely on consistent revenue from subscriptions. 

MRR is calculated by taking the sum of all recurring charges in a given month. For example, Company Z has three subscribers, the first paying $20 per month, the second paying $30 per month, and the third paying $50 per month. In this case, the total MMR would be $100. 

Why is MRR so important? First, it allows SaaS startups to accurately forecast growth and therefore, make informed business decisions. For example, once a startup knows its MRR, its founders can honestly assess whether it is covering expenses or not. If there is unspent MRR, should the startup spend it on a new hire or marketing in an effort to reach more customers?

Second, MRR allows startups to accurately measure financial growth month-to-month by providing consistent numbers, regardless of subscription type.  

Getting MRR right is crucial in part because so many other metrics are dependent on it. Common mistakes when calculating MMR include counting one-time-payments (that aren’t recurring monthly), including discounted subscriptions at full-value, including trials as paying customers, and subtracting transaction fees.

2)     Annual Recurring Revenue (ARR)

ARR expands the MRR calculation to include all recurring charges in a calendar year. Again, say Company Z has one paying subscriber who purchased a three-year subscription for $300 paid upfront. In this case, the ARR for each of the three years would be $100.  Note that ARR is most effectively used as a metric when term agreements are a minimum of one-year. 

3)     Average contract value (ACV)

ACV is the average annual contract value of a customer subscription. Similar to ARR, this is typically used by SaaS businesses that have a minimum term of one-year. 

4)     Customer Lifetime Value (CLV)

Customer Lifetime Value is an estimate of the revenue that one customer will deliver before ending their subscription at some point. Knowing how much value a customer provides over time can help business leaders to make spending decisions and tailor subscription offerings, specifically as they relate to customer acquisition. 

5)     Customer Lifetime Value (CLV)/ Customer Acquisition Cost (CAC) Ratio 

This CLV/CAC ratio indicates whether a startup is spending more to acquire customers than those customer will deliver in revenue over time. Generally, a startup’s CLV should be higher than their CAC. Having a CLV that is higher than your CAC generally indicates that your SaaS business is operating in a sustainable way. 

6)     Churn

Churn is generally a measure of loss. Typically churn rates refer to customers who choose to no longer subscribe, but churn can also measure ARR, MRR, GAAP revenue, or loss otherwise. 

7)     Cohort Reports 

Cohort reports are a measure of the performance of a specific grouping that gives an assessment of a specific end, such as the success of a product or a marketing effort. Cohorts are groups with shared characteristics, like specific price groupings. Cohort reports can provide evidence to firmly state that a retention is higher or lower at a specific price point, as an example. 

Having accurate basic metrics can lead to even more variations of data that tell you what you need to know.  

For example: New ARR/MRR indicates new sales to new customers, Expansion ARR/MRR indicates existing customers who expanded their subscriptions, and Contracted ARR/MRR indicates existing customers who downgraded their subscription.

The bottom line for SaaS founders is that easy access to up-to-date financials are crucial for both making business decisions and raising capital. Even if startups don’t have the most robust accounting systems, consistently capturing solid, basic metrics is a good place to start.

Questions about what A Look at SaaS Accounting means for your company? Bigfoot Capital is here to help. Let’s talk. Sign up for our newsletter to make sure you get the latest.

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