Introduction To Accounting For Subscription Companies
Whatever the motivations behind your decision to launch a subscription business, your company's bookkeeping and accounting should be a major priority.
And yet, it's essential to properly manage your business.
You need to study all the fundamentals of accounting if you want to build a successful company and remain legal.
However, bookkeeping and accounting are more difficult than you might imagine. You should know how to accomplish it in the most efficient method if you want to have a precise understanding of the financial health of your company.
What Is Subscription Revenue?
When customers have to choose whether to renew their subscriptions, recurring yet predictable income streams like subscriptions result in higher customer retention.
A separate financial model governs businesses that provide subscription-based solutions as opposed to companies that only offer one-time products or services. Subscription revenue isn't clear; it comes in the form of payments for future services.
Recognizing subscription revenue is only a small portion of revenue recognition generally. When the process of generating revenue is finished or the income is earned, revenue recognition is the act of registering the revenue.
How To Record Subscriptions In Accounting?
The initial fee for a subscription service is often charged to a deferred revenue account or listing when using subscription revenue recognition. The performance obligation is met during each subscription billing cycle. The remainder of the upfront fee for that period might then be recorded as accrued or recognized revenue.
What Makes Subscription Accounting Different?
Subscription Accounting Advantages Involves:
The following are the main benefits of subscription accounting:
Revenue predictability:Long-term contracts won't have much of an impact, but as more customers are acquired under this model, revenue will increase over time and become more predictable.
Possible lesser discounts:Because a customer might be entitled to certain unforeseen future benefits, they might consider that right to be valuable. In the beginning, this may serve to give a negotiation advantage, which could lead to cheaper discounts.
Reduced risk:Reducing the revenue from the start decreases the probability of recognizing too much revenue too soon only to restate later, especially if a corporation tends to offer concessions or future undetermined features to a customer.
Why Is Trustworthy Accounting Is Vital For Businesses That Rely On Subscriptions
Last but not least, maintaining precise accounting practices helps avoid unintended tax violations and unexpected tax bills. Financial records are necessary for state and federal tax filings. Additionally, keeping meticulous financial records enables businesses to take full advantage of R&D tax advantages.
Automate Your Bookkeeping For Your Subscription Business
The cloud solution saves money for businesses. With the cloud, you don't need to purchase extra hardware to ensure that your capacity is adequate; instead, the server just detects a requirement and either immediately or quickly provides you with additional room.
Your financial information is stored in the cloud when you use cloud-based accounting software, which is a subscription-based online service you sign up for. Simply said, without it, you cannot automate your bookkeeping.
You may optimize numerous company procedures with the program and manage your financial data across all of your devices. Let's examine five factors that will ensure that cloud-based accounting software maintains its dominance in 2022.
You will save time by eliminating repetitive and normal chores with cloud-based accounting software. You can automate the following tasks with the software:
- Paying vendors
- Sending invoices
- Following up on overdue payments
- And much more
Accuracy will rise whenever technology is introduced and human involvement is reduced. And cloud-based accounting software does just that. The software will check for duplicate entries and other typical accounting errors in addition to reconciling your accounts in real-time.
And to help you understand where your money is going, your transactions are automatically categorized. Additionally, you'll get through data on your company's inventory, earnings, and costs. Additionally, there are no time-consuming updates to do because the program is hosted on the cloud.
You can access your financial data using cloud-based solutions from any device. Additionally, you may access the data at any time and from any location, which is crucial because so many individuals work remotely, creating their schedules and maintaining productivity.
You can readily access your financial information if you, your partners, or your employees have an internet connection and access to a phone or laptop. This makes it simpler to manage your company's finances and make wise business decisions.
The way accounting and bookkeeping are done has altered as a result of cloud-based technologies. Because of this, more than 50% of large businesses use cloud-based accounting.
Therefore, if you haven't switched yet, it's likely that your rivals have. Cloud-based accounting is the way to go if you're searching for a means to automate your bookkeeping and decrease duplication in your firm. You may handle accounts receivable, pay vendors, and optimize your accounting process by making use of cloud-based accounting techniques.
Subscription-Based Accounting System Infrastructure
Cash vs Accrual Accounting
Many firms begin by adopting cash basis accounting to track their finances. Cash accounting involves tracking revenue as it is received in cash and deducting costs from that total.
Although this approach is simple to use and maintain, it is not advised for SaaS companies. It is ideal for small firms or those with a limited customer base or inventory. Regardless of the amount of cash on hand, accrual method accounting does not count revenue until cash is earned.
Although this way of accounting is more complex, it is ideal for large organizations and SaaS companies that generate revenue through subscriptions. Additionally, accrual accounting may be mandated by investors and government regulators, so it's a good idea to get ahead of these requirements.
GAAP-Compliant Financial Management
The term "Generally Accepted Accounting Principles" (GAAP) refers to a set of rules, laws, and standards for accounting that are intended to harmonize business accounting practices across industries.
The purpose of GAAP is to ensure consistency and openness in financial reporting across all organizations. Although GAAP accounting standards are not needed for companies, doing so from the beginning has advantages. Your forecasting, financial modeling, and financial analysis are more accurate and dependable since GAAP calls for your financial activity to be set up consistently and similarly.
Working with precise and current financials is essential for SaaS organizations, which significantly rely on financial projections to guide important business investments and choices. In addition, GAAP will be used by accountants, lenders, and investors to assess your company's financial position. Having this in place will save time and effort if your company needs to re-state financial data while seeking investment or a loan.
Subscription-Based Financial Reporting & Metrics
In this way, their revenue is consistent, sustainable, and to some extent predictable. This demonstrates how crucial it is to monitor subscription business indicators to guarantee a consistent flow of money.
You'll discover the analytics for your subscription business in this article. But first, let's define subscription business KPIs and examine their significance.
Monthly Recurring Revenue
MRR stands for monthly recurring revenue, which a company derives via a variety of subscriptions.
One of the key indicators for any subscription business is this one. This is because it displays the total monthly revenue from active subscriptions. It's the KPI that recurring businesses use most frequently.
By dividing the total number of your clients by the average monthly subscription rate, you may get your MRR.
This also applies to subscription plans that are annual, quarterly, and semiannual. In these circumstances, dividing the total rate by the number of months will yield the monthly rate.
Other monthly metrics, including new accounts, upsells, downsells, and churn, can be tracked in addition to MRR.
These comprise fees such as:
- Set-up fees
- Suspended subscriptions
- One-time activation fees
Average Revenue Per Account (ARPA)
This is one of the subscription business metrics that keep track of how much money each user account is bringing in for your company. When compared to monthly recurring revenue, it is a more precise method of analyzing revenue, especially for tiered subscriptions. This is so that you may determine more precise numbers by basing ARPA analysis on each package.
You divide your whole subscriber count by your total monthly recurring revenue to arrive at ARPA. This includes any freemium users you may have. ARPA aids in determining how many of your subscribers are from pricey versus inexpensive packages. For instance, a rise in your ARPA may signal a rise in the number of premium subscriptions you have.
This indicator also assists in determining whether, if any, your free plans can be maintained by the revenue from your paid subscriptions to achieve sustainable growth. Or if enough people sign up for your free plans to make them financially viable.
Average Revenue Per User (ARPU):When companies provide various subscription levels, average revenue per user (ARPU) provides a clear picture of how much money a firm is making from each subscriber over a specific time frame, like a year. Any subscription business wants to raise ARPU by promoting add-on sales, upgrading basic members to premium tiers, and/or both.
Churn rate:It is a measurement of how quickly a company is losing subscribers and relates to the number of consumers who have canceled their subscriptions over a specific period.
Cost of acquiring new clients (CAC):No matter how many consumers a company has, it's critical to make sure they aren't costing the organization more than they are earning. Another concept that intersects with other business models is the customer acquisition cost (CAC), which can be computed by dividing the sum of money spent on acquisition activities over a certain period by the number of new customers gained from each action over the same period.
Client Lifetime Value (CLV):One of the most crucial metrics for subscription-based businesses to track is the customer lifetime value (CLV), which determines how much money a specific client is likely to bring in throughout their whole relationship with the company.
Of course, the objective is to make sure the CLV is substantially greater than the CAC, and businesses may use this figure to target their sales and marketing expenditures to foster profitable, long-lasting client relationships.
How Can Subscription Businesses Manage Bookkeeping & Accounting The Easiest Way Possible?
If asking around doesn't help you find somebody, look into the local accounting firms. Check on their website to discover as much as you can about their specialty and experience. You can also seek for client reviews to get a sense of their reputation.
It's crucial to comprehend the two primary groups into which accountants fall when conducting your research:
CPAs:Because they are held to a greater standard of accountability than unlicensed bookkeepers, CPAs will charge more. The level of risk associated with engaging CPA firms is decreased by the fact that they are subject to oversight from a state agency. You have options if they perform work for you incorrectly.
Bookkeepers:Hiring a bookkeeper can save you money, but you won't have the same level of security. They might still perform an excellent job, but there won't be a neutral party to hold them responsible if they make a mistake, which could leave you with more severe repercussions.
Some Useful Tips To Stay On The Top Of The Bookkeeping & Accounting:
Maintain Accurate Records of Income and Expenses:This is among the most crucial aspects of business accounting. It's how you'll monitor your company's profitability and gather the data you need to provide the IRS with your business's income and outgoing costs. Decide which system suits you the most in this situation.
The most crucial thing is to make sure you keep track of everything, not how you do it. If you're old school and prefer spreadsheets, you can use them; if you want a simpler choice, you can invest in good accounting software.
Separate Personal and Business Spending:Having a company bank account makes it easier to keep track of your personal and business expenses, which in turn helps you keep your personal and business expenses apart. The majority of banks and credit unions allow you to open a business bank account.
Look around to see which local banks have the finest features and lowest costs for business accounts. You can even open a business account at the same institution as you conduct your personal banking if you prefer convenience.
Establish A Well-Ordered System For Tracking Income & Expenses:One of the most crucial aspects of corporate accounting is to do this. It's how you'll monitor your company's profitability and gather the data you need to provide the IRS with your business's income and outgoing costs.
Decide which system suits you the most in this situation. The most crucial thing is to make sure you keep track of everything, not how you do it. If you're old school and prefer spreadsheets, you can use them; if you want a simpler choice, you can invest in good accounting software.