A subscription-driven economy
Few factors have impacted today’s economy the way subscriptions have. The trend started in our homes, as Netflix transformed the way we streamed movies and TV shows. Today, everything from clothes to pet food can arrive at our door on a set day every month, thanks to subscription models. In fact, by 2023, it’s expected that 75% of direct-to-consumer brands will have subscription offerings.
Of course, we’ve seen the rise of subscription-based offerings in the B2B sector as well, spurred by cloud migration. Rather than outright sell their customer a piece of software, SaaS companies can offer a subscription to a cloud-based solution. This reduces the end user’s acquisition expenses — no storing the software in on-prem servers — and allows for software updates with fewer business interruptions.
While the cloud makes software delivery far more convenient, the SaaS model does come with new wrinkles for how you run your business. Take recurring revenue, for instance: because you’re no longer pocketing the customer’s entire purchase cost upfront, you’ll need to track your revenue differently. Offering add-ons such as product support can make things even more complicated.
Here are a few considerations to make when determining how to manage your recurring revenue model:
Earned vs. deferred revenue
As you launch a SaaS offering, remember that a subscription of $100 paid on the first of the month doesn’t necessarily mean you’ve made $100 immediately. You’ve essentially sold a promise that your software will be accessible. You could be on the hook for a refund if, for instance, your cloud servers were down for a day or two.
SaaS revenue is often referred to as earned vs. deferred revenue for this reason. For example, a $100 fee paid on April 1 is classified as deferred in financial documentation, then moved to the earned column at the beginning of May. But it’s possible to look at deferred revenue from a deeper perspective, down to how much deferred revenue converts to earned by the day or hour. The process of calculating how much revenue is earned vs. deferred at any given time during the month is called revenue recognition, or “rev rec.”
Revenue recognition can be a different process based on the subscription structure a customer selects, and as SaaS brands onboard hundreds or even thousands of customers, spreadsheet-based approaches to the rev rec process are inefficient, to say the least. It’s important to select a billing solution built for the recurring model, allowing you to track each subscription, set rules for how deferred revenue is defined for that account, and understand exactly how much of your revenue is already earned.
Additional charges outside the subscription
Rev rec is a complicated process when calculating revenue from the core subscription alone. But maybe your SaaS offering comes with add-ons. Perhaps you’re offering different tiers of support with one level providing 24/7 phone/online support, and another providing in-person support.
Now you have customers with multiple subscriptions across different tiers, further impacting what revenue is considered earned for each account. Offering hardware for rent, as opposed to a one-time fee, is an additional consideration – and you’ll need to determine how revenue is impacted if a customer receives a defective item.
Again, legacy methods of accounting often aren’t set up to track this dynamic billing process. The more layers involved in your SaaS offering, the further segmentation you’ll require during the rev rec process. In addition, when it comes time to invoice customers at the end of the month, you might struggle to make sure each customer is receiving the right bill for their specific subscriptions. All of a sudden, the subscription model you set up to make life more convenient for both you and your customers has become a headache.
Integrate billing with cloud management
With today’s cloud management solutions, there’s no reason for manual accounting processes to slow down business. That’s just one of the reasons why we developed ArrowSphere, a single platform for managing your cloud services. The platform includes comprehensive subscription management, designed to reduce the rev rec and invoicing challenges caused by older revenue tracking solutions.
ArrowSphere can help you see earned revenue at a granular level, so that no matter the hour or day, you understand how much revenue is still deferred. In addition, our predictive analytics dashboard helps you understand revenue forecasts and month-over-month trends.
Best of all, your accounting is integrated with all the functions required to run your cloud services. You have one platform to visit for quoting, ordering, provisioning, billing and invoicing, all protected by superior identity and access management standards.
If you’re launching a new SaaS offering, or you need a simpler way to understand your rev rec and billing processes, contact us to learn more about how Arrow can help.
This article was originally published in April 2021 and has been updated for relevance.
