SaaS revenue recognition is the process of converting cash from bookings into revenue within your business. It’s an accounting principle for reporting revenue by recognizing the value of a transaction or contract over a period of time as it’s earned.
Put another way, it’s the process where cash generated is officially recognized as revenue which you can use to pay salaries, expenses, and record profit. To be able to recognize cash as revenue, you first have to deliver the goods or services.
This presents special complications for SaaS companies. Customers commonly book a month or year in advance. The cash is in your account but it hasn’t been earned by you.
Before software moved to the cloud, it was much easier to book revenue and recognize it. The transaction would occur and your customers would have full control of the software immediately.
According to the Financial Accounting Standards Board (FASB) there were two stipulations before revenue could be recognized:
1. The customer has the contractual right to take control of the software
2. They’re able to run the software on their own machines or employ a third party (not you) to do it for them.
This is how the transaction would go:
• Someone walks into a store and finds software they like
• They go to the cashier and pay for the CD
• They’re given a receipt and the product.
• The customer can use the software however they please and can only return it within the refund period
In this circumstance, both obligations laid out by the FASB were met so the revenue was booked that month and was recognized as soon as the refund period was over.
Those standards worked well before software moved to the cloud.
Nuances of Saas revenue recognition
Maksym Babych, saas product
expert said that SaaS revenue recognition, the process is different.
The entire point of SaaS software is to make it available all day every day in the cloud while giving your customers constant access to the latest version.
It would defeat the purpose of your business model to allow them to run it on their own systems or contract a third party to do it.
There is no cut and dry period for when the service delivery has been completed.
There are five steps to follow in every contract before revenue can be recognized. Note: someone signing up for your service is a contract.
1. Identify the contract with the customers
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the contract
5. Recognize revenue when your company satisfies performance obligations
What these five steps are saying is you need to have a contract with a customer, a product or service you deliver, clear pricing, and delivery terms. When the delivery terms are met, you can recognize the revenue.
SaaS revenue recognition can seem complicated at first glance but in reality, it reflects how your business works. You deliver value to your customers over time and you’re rewarded with revenue in the same way.
Keep in mind that in order to recognize revenue properly contracts should be taken through the five step process mentioned above.