Without proper tools, revenue recognition is time-consuming and error-prone, especially for SaaS businesses, due to the nature of subscription-based invoicing methods. In this blog, we will discuss how revenue recognition works in SaaS business compared to traditional business and how with the right tools you can get hold of your revenue recognition in SaaS and automate them.
What RevRec Is and Why It Matters
Revenue recognition simply means the process when the actual sales are being recognized as part of revenue. According to accounting rules, this happens when the actual product or service is being delivered to the customer.
Revenue recognition is a fundamental function for companies. Revenues must be recognized in the company’s financial reporting accurately, at the right time, and in the right way according to accounting standards such as Generally Accepted Accounting Principles (GAAP) GAAP and International Financial Reporting Standards (IFRS).
Doing revenue recognition manually is time-consuming, error-prone, and may in the worst case even be the spoke in the wheel of bringing new great offerings to the market due to the increased workload.
Through automation, finance teams can instead focus on the key business that actually matters.
How RevRec is different for Service companies?
For companies that sell services and products as a one-time deal, revenue recognition is fairly simple as it can be done immediately. However, SaaS companies typically use subscription-based pricing models and may charge part of the overall fee (such as the base fee) in advance of the agreed period – which can be anything from several months and onward.
Revenue recognition is simple when the sale and delivery happened during the same accounting period. How about when a SaaS business customer pays the whole following year in advance?
In this case, the SaaS company must count the received money in advance as deferred revenue and month by month, piece by piece, recognize it as revenue. The example calculation below describes in short, the above-mentioned issue.
A one-time deal with a customer for services worth 120€. The service will be delivered to the customer. In this case, the revenue recognition can be done immediately and the whole 120€ can be recognized as revenue.
A customer orders a one-year subscription to SaaS services on the 1st of January, which costs 10€/month. The customer is billed the full year in advance with 120€ (12 months * 10€/month = 120€ total cost). In this case, the company can recognize 10€ of the total amount as revenue, and the remaining 110€ must be handled as deferred revenue. In February, the company can once again mark ten (10€) additional euros as recognized revenue meanwhile deferred revenue drops to 100€.
Imagine you have hundreds, perhaps thousands, or even tens of thousands of customers with many kinds of invoicing periods and prices. How much time-consuming and error-prone work is there?
What happens then in a downgrade situation? If customers downgrade their subscriptions, you will have to adjust already-done deferrals. In an upgrade situation, you need to make additional bookings to revenue recognition either by billing the customer on the difference or crediting the future periods already invoiced and issuing a new invoice to reflect the upgraded subscription.
As revenue cannot be recognized before the service is delivered to the customer, the fee charged in advance becomes a liability in accounting. Month by month the company must gradually recognize the corresponding revenue at the time of delivery, leading to increased manual and error-prone work, especially for companies that have a large number of customers with different kinds of invoicing periods and price plans.
Automate Your Revenue Recognition Process
So why not automate Revenue Recognition as a part of your overall end-to-end subscription management process and enjoy the benefit that Good Sign’s Subscription Management can offer to you? Feel free to take us to the test! We will gladly take on your challenge and prove to you it can be done, and that the new world lies beyond just subscriptions.
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