Tracking deferred revenue is crucial for SaaS (Software as a Service) companies because it helps them to accurately report their financial performance and provide reliable financial statements to their stakeholders.

Deferred revenue is a type of liability that arises when a company receives payment for goods or services that it has not yet delivered. In the case of SaaS companies, this typically occurs when customers pay for a subscription in advance (i.e. payments received from customers for services that have not yet been provided).

Here are four key reasons why tracking deferred revenue is important for SaaS companies:

1. ACCURATE FINANCIAL REPORTING/REVENUE RECOGNITION

When a SaaS company receives payment for a subscription in advance, it cannot recognize the revenue as income immediately. Instead, the revenue must be recognized over time as the company delivers the service to the customer. By tracking deferred revenue, SaaS companies can accurately recognize revenue over time and report it on their financial statements, which will reflect the revenue they have earned.

2. REVENUE FORECASTING

Tracking deferred revenue can help SaaS companies forecast their revenue for future periods. By understanding the amount of revenue that is already committed for future subscription periods, a company can better project their revenue and cash flow, which can inform decisions about future investments, staffing, and growth.

3. PERFORMANCE METRICS

Deferred revenue can also provide a useful performance metric for a SaaS company. By comparing the amount of deferred revenue with previous periods, a company can determine the rate of revenue growth, which can inform decision-making around investments in marketing, sales, and product development.

4. INVESTOR CONFIDENCE

Investors typically look at deferred revenue as a key performance metric for SaaS companies. A healthy deferred revenue balance indicates that the company has a reliable revenue stream and predictable cash flow. This can instill confidence in investors and potentially lead to more funding opportunities.

SO, HOW DO YOU DO IT?

1. MANUALLY

Track all revenue-generating annual transactions in a spreadsheet and then create formulas to ensure the transactions are divided by the specific number of months the product/service is provided. A row for each annual transaction is a good idea, broken down by month, with a sum at the bottom.

Creating a repeating journal entry that you can edit monthly to capture the correct monthly revenue in your accounting system can further automate the process.

2. SOFTWARE

You can connect your accounting system (Xero or QBO) to the Flowrev app and then map accounts and create schedules so that revenue is automatically populated in your accounting system based on the periods related to when services are rendered.

3. OTHER ONLINE TOOLS

We’re big fans of Za pier! Depending on which portal you’re using for your SaaS product - you can try to automate deferred revenue rows and schedules into a Google Sheet where formulas then pick things up from there. Your formulas can then be used to create entries in your online accounting system to account for accurate revenue and deferred revenue balances.

FINAL THOUGHTS

It is critical for scaling SaaS companies to start thinking about deferred revenue and its implications to financial reporting and stakeholders. Setting up proper systems and processes to ensure that actual revenue earned is key to understanding sales growth since only services/subscriptions provided should be recognized as revenue. There are many ways to account for deferred revenue and we’d be happy to chat with you if you have questions on accounting for this often-overlooked KPI.

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