Accrual basis accounting is generally required for SaaS businesses seeking debt financing as it is the standard accounting method under generally accepted accounting principles.
Cash-basis accounting and accrual-basis accounting are two different accounting methods used to record and report financial transactions in a SaaS business. Each method has its advantages and disadvantages, and the choice between cash and accrual accounting depends on the nature and size of your business — as well as financing or regulatory requirements.
Advantages and Disadvantages of Cash vs. Accrual Basis Accounting
|Cash Basis||Accrual Basis|
|Recording Transactions||Transactions are recorded when cash is exchanged and don’t consider accounts receivable or payable.||Transactions are recorded when they occur (i.e., when an invoice is received), regardless of cash flow, reflecting outstanding payments and liabilities.|
|Revenue Recognition||Recognizes revenue when cash is received.||Recognizes revenue when earned, even if not yet received.|
|Cash Flow||Cash-basis accounting records large, random revenue spikes or large cash flow fluctuations month over month.||Accrual-basis accounting records are more consistent month over month.|
|Expense Recognition||Recognizes expenses when cash is paid.||Recognizes expenses when incurred, irrespective of cash.|
|Financial Reporting Accuracy||May not provide an accurate representation of a company’s financial position and performance because it only considers cash inflows and outflows, disregarding other crucial financial events that impact a business’s financial health||Provides a more comprehensive and accurate view of a company’s financial position and performance.|
|Compliance||Less likely to meet accounting standards and may not satisfy external reporting requirements.||Generally compliant with accounting standards and meets external reporting requirements for larger firms.|
|Complexity||Simple and easy for small businesses.||More complex due to matching revenue and expenses.|
|Decision- Making||Limited in analyzing business trends and growth.||Supports strategic decision-making with better insights.|
|Long-Term Perspective||Limited insight into long-term financial obligations.||Provides a better overview of long-term commitments.|
Key Differences Between Cash-Basis and Accrual-Basis Accounting
In cash-basis accounting, transactions are recorded, and revenue is recognized when cash is received or paid out. It is commonly used by small businesses as it provides a simple way to manage finances. However, cash-basis accounting doesn’t provide an accurate picture of a SaaS company’s financial health since it doesn’t consider accounts receivable, accounts payable, or any outstanding liabilities.
In accrual-basis accounting, transactions are recorded when they occur — regardless of when cash is exchanged (i.e., revenue is recognized when it is earned, and expenses are recognized when they are incurred).
This method provides a more accurate representation of a SaaS company’s financial performance since it considers all economic events, even if cash has not yet been exchanged.
|Activity||Paid for cloud hosting, account manager, and||Received payment for work done in Q1.|
Net Income: $25,000
Net Income: $0
Net Loss: ($25,000)
Net Income: $50,000
What is the Best for SaaS Companies?
Accrual-basis accounting is generally required for SaaS businesses seeking debt financing as it is the standard accounting method under generally accepted accounting principles (GAAP) in many countries. Venture debt providers also prefer accrual-basis accounting as it provides a more accurate view of the following:
Recurring Revenue Recognition
SaaS companies generate revenue through subscription models, where customers pay for ongoing access to the software. Accrual accounting aligns revenue recognition with the actual delivery of services, allowing companies to recognize revenue over the subscription period rather than at the time of cash receipt.
Since SaaS companies often enter into long-term contracts with customers, accrual accounting allows for the proper recognition of revenue and expenses associated with these contracts on a monthly basis — even if the customer pays annually — providing a more accurate view of the company’s financial position and performance.
For example, if you sell a one-year subscription to a software product in January, cash-basis accounting would recognize the entire 12-month subscription cost in January, whereas accrual-basis accounting would recognize one-twelfth of the subscription revenue in January, one-twelfth in February, one-twelfth in March, and so on for the entire year. This provides a more accurate representation of the company’s financial performance over time.
Matching Revenue and Expenses
Accrual accounting matches revenue and the related expenses incurred to generate that revenue. It enables SaaS companies to show a clearer picture of their profitability, as expenses are recognized when incurred, even if cash payments are made at a different time.
For example, if you pay a hosting company $12,000 per year in annual hosting fees in January, cash-basis accounting would recognize the entire $12,000 expense in January, whereas accrual-basis accounting would recognize $1,000 per month for the year.
Accrual accounting provides a more accurate and reliable view of a SaaS company’s financial health, making it easier for investors, lenders, and stakeholders to assess the company’s performance, growth, and potential risks.
Compliance and Reporting
In many jurisdictions, including those that follow accounting standards like GAAP or IFRS, SaaS companies are required to use accrual-based accounting for financial reporting. Using accrual accounting ensures compliance with these regulations and industry standards.
Valuation and M&A Transactions
SaaS companies are often valued based on recurring revenue streams and customer base. Accrual accounting provides a more realistic representation of these metrics, making it easier for potential investors or buyers to assess the company’s value.
Many SaaS companies work with fractional or full-time CFOs or experienced accountants and use accounting software specifically tailored to the needs of subscription-based businesses to adopt accrual-based accounting and manage their finances effectively.
Making the Switch from Cash to Accrual Before Financing
Financing decisions are based on the accuracy and reliability of your financial statements. Accrual-based accounting provides a more accurate representation of your company’s financial performance and position, which is essential for lenders like TIMIA to assess your creditworthiness and make informed decisions.
We understand that converting from cash to accrual accounting can be complex and time-consuming. It involves adjusting past transactions, recalculating revenue and expenses, and potentially reevaluating your financial records.
Seek guidance from professional accountants or financial advisors to ensure a smooth and accurate conversion process. Doing so before seeking financing will give you the time and space to complete the process more thoroughly and put you in a better position to access the funding you need.Back to top