Mastering revenue recognition: get SaaS rev rec right

Every team, every department, and every function at your company depends on revenue.

This makes revenue recognition one of the most important accounting workflows for any SaaS company.

Failing to get it right can result in large fines, lost revenue, and even legal consequences for you as a CFO.

Read on if you’re ready to get revenue recognition right.

Here’s what we’ll cover

The right way to think about rev rec

You can’t afford to be myopic when you’re thinking about revenue recognition. It’s a highly dynamic workflow and has many moving parts.

These include:

• CPQ quotes in Salesforce
• Service contracts
• Customer invoices and payments
• Internal systems for revenue recognition

That’s a lot to keep straight, and it gets difficult to handle manually as your company scales.

That’s why SaaS CFOs are turning to cloud accounting tools that centralize and connect the different parts of the process.

Next, you need to look at the three pillars of revenue recognition and how they apply to your company’s contracts.

Timing, amount, and uncertainty

Everything in revenue reporting boils down to three crucial factors.

1. Amount: How much revenue are you recognizing on a contract?
2. Timing: When do you officially recognize that revenue?
3. Uncertainty: Will there be problems with revenue recognition? Usually, the uncertainty surrounding the process loops back to the previous two points, amount and timing.

In all three cases, the answers will depend on your performance obligations to the customer.

And to understand what you’re promising the customer, you’ll have to review their contract.

Read your own darn contracts

You’d be surprised at how much you can clarify by just reading your own contracts.

That’s the best way to understand your promises to the customer and your resulting performance obligations. It’s also the only way to know what you’re asking of them in return.

Accounting software equipped with AI can streamline every stage of the contract lifecycle, from contract creation to execution and administration.

Understanding your performance obligations is crucial to SaaS revenue recognition, but it’s just the tip of the iceberg.

The five steps of SaaS revenue recognition

ASC 606 and IFRS 15 require SaaS companies to follow a five-step process for recognizing subscription revenue.

These regulations level the playing field by preventing companies from reporting revenue on goods or services they have yet to deliver.

To recognize SaaS and subscription revenue, follow these steps:

• Identify the contract. At a broad level, what services are you promising the customer? For instance, say your business sells W2 automation software. W2 automation is the broad service you’re promising.
• Identify your performance obligations. How does that break down into specific service transfers?  Let’s say one of your customers signed up for a $50 monthly subscription that lets them prepare 260 W2s. Your monthly performance obligations to that customer are to let them use your software to prep 260 W2s as promised in your contract.
• Determine the transaction price. In our hypothetical example, the monthly transaction price is $50. But as we said earlier, you can’t recognize that revenue all at once, so you need to allocate the transaction price to specific services.
• Allocate the transaction price. Your $50 subscription fee for 260 W2s breaks down into 65 W2s prepared weekly at a transaction price of $12.50 per week.
• Recognize revenue as you satisfy your obligations. You can recognize $12.50 on this customer’s contract every week, for a total of $50 in recognized revenue at the end of the month.

To recognize revenue at a company-wide level, you’d repeat this process for each customer.

However, you need to be crystal clear about your performance obligations.

What’s a DISTINCT performance obligation?

When trying to understand your performance obligations, it’s important to distinguish between point-in-time obligations and ongoing obligations.

In our previous example, your distinct performance obligations were 260 W2s per month.

Let’s say your contract also states that you’ll handle software maintenance for the duration of the customer’s subscription.

This differs from a distinct performance obligation because it happens over time rather than at a specific time.

For recurring revenue companies, this is a crucial distinction to make.

How is it different in a recurring revenue model?

Recurring revenue companies need to be especially careful about understanding and tracking their performance obligations.

You must keep track of your contractual obligations to fulfill them appropriately.

Just as importantly, you need to make sure your contracts obligate customers to pay for the services they’re receiving.

If a subscription to your W2 app includes software maintenance, does that service extend to the customer’s second year using your product?

You can’t promise to continue providing a service unless the customer is obligated to continue paying for it.

That’s why you need to read your own contracts and fully understand what you and your customers owe each other.

Contract review essentials

As crucial as it is, just reviewing your contracts isn’t enough. You need to ask the right questions as you read them.

Below are some of the most important questions to ask when trying to understand your service obligations:

1. What is every explicit promise your company has made in this document?
2. Are your customary business practices performance obligations? Sending a quarterly product usage report could be something your company does regularly, but it isn’t a separate performance obligation unless it’s stated as such.
3. What’s the business model in the contract? Are you selling a license or offering a subscription?
4. Does the contract obligate you to measure up to certain performance standards? If so, how do you measure and track those?
5. Do customers make any advance payments separate from your stated performance obligations?

At scale, that’s a lotto keep straight. Many SaaS CFOs rely on cloud finance tools to help them understand and manage contracts and recognize revenue in compliance with ASC 606.

There are so many moving pieces to revenue recognition, and AI can help you keep everything organized.

Nail your rev rec in 2024 and beyond

For SaaS companies, getting revenue recognition right is non-negotiable.

That’s why 2,000+ SaaS industry leaders, investors, and experts digitally attended the Modern SaaS Finance Forum in June.

Hosted by Sage Intacct, the conference featured talks from finance leaders at some of today’s leading companies exploring what SaaS finance success looks like in 2024.

The event had three learning tracks for CFOs, Controllers, and RevOps Managers at SaaS, high-tech, and AI companies.

We received such great feedback that we’ve made the 20-minute forum sessions available to anyone who’d like to watch or listen.

You can download them here.

You don’t want to miss this “insider’s look” at SaaS finance!