SaaS Accounting Tips
SaaS accounting is probably not every SaaS founder’s favorite topic. However, as you scale, it is critical that you implement an accounting framework that will provide you and your team the necessary data to manage your business. In this post, I offer several actionable SaaS accounting tips for founders and their accounting teams.
When Should Accounting be a Focus?
Always (I’m biased, of course), but….in speaking with SaaS founders about the challenges they face in understanding their SaaS economics from the reporting side, it usually boils down to how they have set up their accounting system. This is understandable. Early in a startup’s life, you are more concerned about product/market fit (Phase 1 per David Skok), watching cash balances, and producing basic financials for your tax accountant.
You don’t really have enough customer and financial data to produce accurate and meaningful SaaS metrics. As you scale, though, this data becomes more important and is necessary to manage your performance.
What’s the ARR Tipping Point?
It appears to me that the $1-2M ARR point is a good time to take a look at your accounting and financial reporting process.
As you scale past $1M in ARR and enter Phase 2 (scalable business), you are now thinking about adding sales and marketing heads, for example, and its impact on your financials, metrics, and cash. Without a proper accounting framework, it is very difficult to calculate these metrics.
Before you can calculate these metrics, your financial data must be coded correctly to your general ledger (GL). Now is the time to review your chart of accounts with your accountant or advisor.
Chart of Accounts (COA) and Expense Coding
A chart of accounts is simply an organized listing of the general ledger accounts in your accounting system. There are general ledger accounts for your balance sheet (i.e. 10000 – Cash) and your P&L (i.e. 40000 – Subscription Revenue, 60000 – Employee Wages).
Each month your bookkeeper or accountant is posting journal entries to these accounts so that you can produce financial statements. However, what I find is that most early-stage SaaS companies are not coding expenses to the department level (i.e a cost center). Posting expenses to a GL account AND department or cost center is critical to produce the reports that will help you understand the economics of your business.
Without department level coding, you don’t know how much wage expense you have in sales versus your development department, for example. Without this, you cannot accurately calculate SaaS metrics, because your expenses are sitting in one big bucket.
Suggested Departments
I like to see the following departments in your chart of accounts. When you code expenses to these departments, you will have enough data to calculate metrics relevant to your business, and you’ll be able to assemble proper financial forecasts. You’ll also be able to compile what I call a “software P&L.” Also, without department coding, it’ll be very difficult or impossible to calculate your overall gross margins and gross margins by revenue type.
- Field Services
- Customer Success
- Technical Support
- Cost of Operations
- Development
- Sales
- Marketing
- Corporate Administration (HR, accounting, executives)
- IT
What about Revenue?
I’m more flexible on how you should code revenue, but you need to be able to differentiate between subscription and service revenues. You also need to differentiate revenue by product line.
The distinction between subscription and service revenues is typically handled by unique GL revenue accounts. For example, 40000 – Subscription Revenue, 41000 – Field Service Revenue. To handle product line revenue, you could create another GL account (40000 – Product A Subscription Revenue, 40010 – Product B Subscription Revenue).
Another approach to product revenue coding is to code revenue to a profit center, a department reserved for revenue entries (opposite of a cost center or department expense coding), along with the relevant GL account.
Then, there is no need to create multiple subscription revenue GL accounts. You just need to code Product A revenue to 40000 – Subscription Revenue and to Product A’s profit center. Your reporting and analytics will be much cleaner and easier.
Conclusion
If you are a SaaS business with $1-2M in ARR, your key takeaway is to ask your bookkeeper or accountant if they are coding expenses to the department level. And if you are, great! Then ask what departments are being used.
Without the proper SaaS accounting framework, you’ll be running blind as your business becomes more complex. Even the best financial analyst wouldn’t be able to produce meaningful SaaS metrics and financial forecasts from one bucket of expense data.
But you have a chance to start now, and before you know it, you’ll have six months of historical data that will provide amazing insight. If you have any questions, please post them below or contact me.
I have worked in finance and accounting for 25+ years. I’ve been a SaaS CFO for 9+ years and began my career in the FP&A function. I hold an active Tennessee CPA license and earned my undergraduate degree from the University of Colorado at Boulder and MBA from the University of Iowa. I offer coaching, fractional CFO services, and SaaS finance courses.
Pleas provide an example of posting to a profit center.
Hi Bone,
Posting revenue to a profit center follows your normal journal entry process but you also code the entry to an additional “dimension.” In this case the dimension is the profit center. The coding might look like this: 100-40000. 100 is the profit center. Really, no different than a department. 40000 is the sample revenue account. This allows additional reporting flexibility.
Ben
I am not as good as others in accounting. Thanks for sharing this tips. This article is very knowledgeable. I really enjoy reading this.
Hi Ben,
My expenses and revenues are currently both being separated by product. For example all payroll and other directly attributable expenses for product 1 are being coded to the “001” department. All other expenses that aren’t directly attributable to a product go to a “G&A” department. This way I can create separate P&Ls for each product. I realize that in order to create the metrics you mentioned I need to separate these departments into cost centers such as sales, marketing, etc, but I’m wondering if there’s a way to have these cost centers but keep them separators by product. How would you go about this, and is it even worth it?
Hi Daniel,
Great question! It just depends on the size of your company. You might consider coding expenses by department AND product, but making sure 100% of your expenses are coded to a department. Then code a majority of the expenses to a product line and then just allocate the rest when creating a product P&L. I’ve created product P&L’s but I had my expenses coded to a department and then ran an allocation to split by product.
Ben