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How a good billing system can transform a SaaS business

How good billing software can transform a SaaS business

As a Software as a Service (SaaS) company grows, its billing software is often playing catchup. Many early-stage SaaS companies rely on simple billing systems – such as spreadsheets – with key information on customers, contract renewals, and billing cycles spread across individual employees or other systems.  The limitations of such a system become apparent as the company grows and when the billing terms become more complicated, such as adding discounts, pausing and starting a service, or adding consumption or usage-based billing. Having the right billing system in place from the start can do more than ease growing pains for a SaaS company: it can transform the SaaS company through key insights into customer behavior and revenue metrics. The best billing system for a SaaS company would allow revenue recognition capabilities, provide key revenue metrics, and tie into the contract.

Why spreadsheets won’t work for SaaS billing

A spreadsheet system may seem to make sense in the early days of a SaaS company, when the business is trying to keep overhead costs down. However, spreadsheets are typically updated by hand, which makes them rife for errors. In addition, spreadsheets cannot handle the complex financials of a SaaS company, including:

  • Subscription arrangements that involve complex billing (including renewals)
  • Calculations required to determine a product’s Standalone Selling Price (SSP)
  • Audit capabilities necessary to support complex Revenue Allocation or Carve Outs
  • Complex billing or revenue recognition based on milestones or percent completion
  • Math involved in contract renewals or renewal co-termination
  • Complex pricing or pricing that involves frequent modifications

A spreadsheet is not capable of meeting the controls and other requirements of ASC 606 / IFRS 15, which can be problematic for a SaaS billing system. A SaaS company must follow the five-step process of revenue recognition outlined by ASC 606 / IFRS 15:

  1. Identify the contract
  2. Identify the performance obligations
  3. Determine the transaction price
  4. Allocate the transaction price
  5. Recognize revenue when or as the entity satisfies a performance obligation

Where ASC 606 / IFRS 15 gets difficult for SaaS companies relying on a spreadsheet include:

Complexity in Identifying Performance Obligations

  • Multiple Performance Obligations occur when the SaaS company bundles software licenses with implementation services, updates, customer support, and other services. ASC 606 / IFRS 15 requires the SaaS company to identify distinct performance obligations within a contract, and the SaaS company must figure out whether services should be accounted for as one combined performance obligation or multiple separate ones. In the latter case, an unbundling of these distinct performance obligations must occur before revenue is recognized.

Variable Consideration

  • SaaS companies frequently have contracts with variable considerations like discounts, rebates, or tiered pricing based on usage, which complicates the revenue recognition process. SaaS companies need to determine the amount of revenue to recognize considering these variations, and this process requires good judgment and strong estimation processes.
  • Customer Renewals and Upgrades: Any change to a customer contract will impact the revenue recognition under ASC 606 / IFRS 15, and these changes need to be captured in real-time and have the associated revenue recognition changes accounted for.

Timing of Revenue Recognition

  • Over Time vs. Point in Time: SaaS companies often deliver services over a period of time, and timing plays a role in when revenue is recognized.  Determining whether revenue should be recognized over time (as services are delivered) or at a point in time can be challenging, especially if charges implementation services are involved.
  • Deferred Revenue: Upfront payments for long-term contracts need to be spread over the duration of the contract, making careful tracking and management of deferred revenue a necessity.

A Billing Solution that Reports Key SaaS Metrics

For a SaaS company, having a billing solution shows key metrics associated with recurring revenue is essential for a pulse on the company’s financial health, understanding customer behavior, and growth planning. The ideal SaaS billing system should be able to provide reports on:

  • Monthly Recurring Revenue (MRR): The billing system should show the amount of predictable revenue a company expects to earn monthly from active subscriptions.
  • Expansion MRR: The billing solution should report any additional MRR generated from existing customers through upsells, cross-sells, or add-ons.
  • Contraction MRR: Similarly, the system should record changes in MRR due to downgrades, reduced usage, or other factors leading to lower subscription costs from existing customers of a SaaS company.
  • Annual Recurring Revenue (ARR): The billing system should show predictable revenue from a yearly perspective.
  • Average Revenue Per User (ARPU): The system should report ARPU, which is a key SaaS metric that helps to understand the value each customer brings.
  • Customer Lifetime Value (CLTV or LTV): This system should be able to determine this metric, which reflects the total revenue a SaaS company can expect to earn from a customer over the course of the relationship.
  • Revenue Churn Rate: This system should be able to determine the revenue churn rate, which reflects the percentage of recurring revenue lost to a SaaS company due to cancellations or downgrades within a given period.
  • Billings: The system should be able to show the total amount invoiced to customers during a specific period, which can differ from recognized revenue due to timing differences.
  • Deferred Revenue: The billing system should report on deferred revenue, which is revenue that has been invoiced and collected but not yet recognized, typically because the service has not yet been fully delivered.
  • Unbilled Revenue: The system should show revenue that has been earned but not yet invoiced to customers, often due to billing cycles or usage-based billing models.

SaaS billing needs a system that ties into the customer contract

SaaS companies rely on recurring revenue, so having a billing system that ties into the customer contract is essential for timely renewals, reducing customer churn, and measuring KPIs (in addition to recognizing revenue).

Timely renewals

Contract renewals are key for SaaS companies and missed or late renewals mean lost revenue. A survey by World Commerce and Contracting revealed that poor contracting managing costs organizations up to 9% of their annual revenue. The billing system should alert the accounting team when a contract is up for renewal with enough time for contract review / revisions before re-signing.

Reducing customer churn

SaaS companies have a business model that relies on recurring revenue, so any customer churn is problematic. Customers are wanting more in their contracts, with KPMG Law’s World Commerce & Contracting reporting that customers are increasingly demanding flexibility and new ideas in contract terms and commercial practices. The billing system provides a view into customer expectations through its ties to a contract, and SaaS companies should make sure that the terms are satisfied with the billing cycle to keep customers satisfied.

Monitoring KPIs

A SaaS company’s customer contract typically includes commitments and Key Performance Indicators (KPIs) and both should be monitored for meeting the contractual obligations and reducing churn. The contract likely includes a Service Level Agreement (SLA) and performance metrics, which require monitoring. In addition, detailed contract data allows the tracking of KPIs related to contract performance, such as renewal rates, average contract value, and customer lifetime value.

SOFTRAX RMS for SaaS Billing

SOFTRAX Revenue Management System (RMS) is designed for SaaS companies, allowing them to automate and innovate all subscription and recurring billing. SOFTRAX RMS deploys easily for simple and complex subscription and recurring billing models and allows for tight integration with revenue recognition processes, including compliance with ASC 606 / IFRS 15. With SOFTRAX RMS, SaaS companies can handle change events and run reports tied to key KPIs.

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