The deals in SaaS businesses start with bookings. That is when accounting processes sets to roll. When a client books your product or service, he or she agrees to buy it.
It seems that now it is time to celebrate. Well, not so soon, it is only a beginning. When a client books it can be considered as signing a contract. This contract means that once the customer has your product delivered, he or she commits to paying for it. Hypothetically, if a customer has booked one year of using your product, you commit to providing him or her with an access to it for one year, and the customer commits to paying the annual price you charge for that access, let’s say $5,000.
But while you haven’t provide your customer with a product, hypothetically these $5,000 are still not yours.
So what can be considered to be a revenue, then? Revenue occurs when you provide your customer with the product or service they ordered. If a SaaS business uses a subscription model, this happens in several installments, e.g. on a monthly basis. For a booking with a value of $12,000 and monthly delivery over one year, this translates to a monthly revenue of $1,000. Your revenue reaches the full $12,000 at the end of the delivery term, in this case one year. This attribution of revenue comes from an accounting method called accrual accounting.
Accrual accounting records revenue and expenses when they are incurred, not when cash is exchanged. This method is used by most businesses, and can even be compulsory for some companies, depending on their nature and location.
In contrast to cash-based accounting, accrual accounting allows to get more accurate data on profitability. This is one of the main advantages of accrual accounting and the main reason it is important for management decision-making.
Now, ladies and gentlemen, this when long-awaited moment comes! Watch out, cash is there. Billings can occur at any time and solely depend on the terms on which you and your customer have agreed. Usually, you charge your client at the beginning or the end of their contract, or at regular intervals throughout.
Do not forget that cash collections and revenue are not the same thing. Cash collection can occur before revenue, and vice versa. Even if you have received the cash from your customer, but haven’t delivered the product yet, you still have not realized any revenue.
MRR, or ARR (annual recurring revenue), technically, is not a part of GAAP. It is rather widespread and worth closer look.
Saas product expert Maksym Babych says that MRR / ARR tracks the revenue your customers have agreed to spend with you on a monthly or yearly basis. This means that MRR / ARR are more similar to bookings than any other GAAP metrics. They will also give you the most accurate data as to the current status of your SaaS business. Bookings and revenue are not able to give the same kind of information, since they will not allow you to see subscriptions to your products/services build over time in the same way.
Generally Acceptable Accounting Principles may seem to be hard to understand at first. But the information below will help you to deal with them. The accounting principles will ease a decision-making process.