If you are a SaaS business, you must read this article to understand:
- What is SaaS P&L Statement?
- What are the Components of the SaaS P&L Statement?
- How to Create SaaS P&L Statement?
SaaS businesses are becoming more mature over a period of time. As a result, the implementation of the enterprise SaaS projects is also becoming huge in terms of scale and scope.
In fact, SaaS accounting and finance has turned out to be complicated, and the effects of getting it wrong have gone up substantially.
Note that SaaS companies need to be managed differently relative to the traditional on-premise companies. There are five key areas that define the business model dynamics of SaaS-based companies.
These include product and pricing, sales and marketing, service and support, finance organization, and compliance.
For instance, SaaS businesses have to invest a huge amount of capital in hosting and system management in order to provide an enhanced customer experience. Then, the sales cycle of a SaaS business is typically short as compared to the traditional software business. This is because the upfront costs in the case of a SaaS business are low. Also, SaaS businesses directly reach out to the customers of the on-premise software solutions. They present such customers with aggressive pricing comparisons that demonstrate the benefits of owning a SaaS product.
Thus, all these variations in a SaaS-based business have a huge impact on its financials. For instance, the SaaS P&L statement demonstrates key SaaS metrics that are separate from those reflected in the statement of operations of a traditional software business.
In this article, we are going to learn what is SaaS P&L and how is it different from the income statement of a traditional software business.
What is a SaaS P&L?
SaaS P&L refers to the income statement of a SaaS-based business demonstrating its profitability and performance over a given period of time. The metrics used to assess the performance and profitability of a SaaS business are separate from those of a traditional software business. This is because a SaaS-based business has a unique business model.
Thus, SaaS P&L is a financial tool that helps in evaluating the accurate financial and operational health of a SaaS business. It is important for SaaS business owners to understand the growth drivers and the underlying components relevant to SaaS business.
It is important to note that SaaS businesses are based on recurring revenue models. Hence, it takes a long period of time for SaaS businesses to derive returns on their investment as compared to traditional software companies. Moreover, SaaS businesses have to burn cash rapidly in acquiring customers as they scale up their business. As a result, the recovery is slow which in turn may lead to cash flow problems.
This means it is important for SaaS companies to maintain a balance between longer-term economics with shorter-term profitability. And the only way to do this is to assess the relevant SaaS metrics at each stage of their growth.
The following section charts out the components of a SaaS P&L and the underlying drivers to evaluate the growth and profitability of a SaaS business.
SaaS Income Statement Components
Typically, a SaaS business derives its revenues primarily from two sources: subscription and support revenues and related professional services.
I. Subscription Revenue
Subscription and support revenues refer to the subscription fee received from customers in return for accessing a SaaS business’s cloud-based services.
Cloud-Based services allow customers of a SaaS business to use its multi-tenant software without acquiring or purchasing the software itself. Further, such revenue accrues and is recognized over time in the books of a SaaS business.
Subscription revenue also includes professional services contracts. Such contracts can either be on a time and materials, fixed fee, or subscription basis. These revenues are recognized as the services are rendered for time and materials contracts, on a proportional performance basis for fixed-price contracts, or ratably over the contract term for subscription professional services contracts. Training revenues are recognized as the services are performed.
Then, there can even be contracts with multiple performance obligations. These are the contracts that a SaaS business may enter into with its customers to promise transfer multiple Cloud Services, software licenses, premium support, and professional services.
A SaaS business must evaluate its revenue by tracking revenue drivers like bookings, calculated billings, recurring revenue, deferred revenue, and backlog.
Bookings in the case of a SaaS business refer to the sum of all the closed deals in a particular year. In case a SaaS business tracks financials on a monthly basis, then booking refers to the sum of all the closed deals in a given month. Note that Bookings is a contracted value. Thus, it showcases the deals closed with different prices and durations.
b. Calculated Billings
Calculated Billings refers to the sum of revenue generated during a period (i.e. a quarter) and the change in the deferred revenue from the prior quarter to the current quarter. Investors track calculated billings rather than revenue as they believe it is a better forward-looking metric with regards to the health of a SaaS business.
For instance, if the bookings of a SaaS business increase either through renewals, upsells, or new business, it will lead to an increase in billings as well.
Thus, as per investors, a SaaS business can showcase a more stable revenue over a period of time. This is because a SaaS business can adjust the Billings Backlog from the total bookings and showcase a more healthy business.
Note that customers can make payment against SaaS billings in advance or over the life of the contract.
c. Recurring Revenue
Recurring Revenue refers to the amount of revenue that a SaaS business collects over a stated period of time. In SaaS businesses, recurring revenue refers to the revenue generated in the form of the subscription fee for accessing the software as well as cloud-based services. Such services may include upgrades, maintenance, and support offered by the SaaS provider. Note that recurring revenue can be collected annually, monthly, or quarterly.
Accordingly, Monthly Recurring Revenue (MRR) is a growth metric that enables SaaS or subscription-based companies to forecast their expected revenue for a given month. It is a measure of how much revenue a business generates from the subscription payments that subscribers or customers pay each month.
Likewise, Annual Recurring Revenue (ARR) is a key performance revenue-based metric that measures the amount of recurring revenue to be collected by a SaaS business over a period of one year. In other words, it measures the annual run rate of recurring revenue from the current install base.
Note that recurring revenue is important for a subscription-based business such as SaaS. This is because it showcases the value of contracts and business as a whole.
Also, there can be cases where a SaaS business undertakes upfront billing without recognizing the revenue. Such a business treats the unrecognized portion of the billing as deferred revenue.
Deferred revenue refers to the services that the SaaS business has booked and billed but not yet rendered to the customers. This is a component that a SaaS business can control. Hence, such revenue sources can provide a steady source of sales to the SaaS business in the shorter term.
Note that SaaS business records Deferred Revenue as a liability in its balance sheet. As a result, when such revenue is recognized over time, it reduces the deferred revenue.
d. Average Revenue Per User (ARPU)
Average Revenue Per User (ARPU) is another key SaaS metric that measures the average amount of revenue that each user generates over a given period of time. Such a financial metric enables businesses to analyze their growth potential on a per-customer basis. Further, ARPU helps businesses to develop a financial model that enables them to determine their revenue generation capacity.
Backlog refers to the deferred revenue from Bookings that a SaaS business has not yet recognized in its books of accounts. It includes the percentage of annual revenue recognized from contracts at the beginning of the year and the percentage of the quarterly revenue recognized from the contracts at the beginning of a quarter.
f. Annual Contract Value
Annual Contract Value (ACV) refers to the average of the Annual Contract Value of all the subscription agreements that a SaaS business has entered into. Thus, both ACV and Bookings are key SaaS metrics that help a SaaS business in predicting its future revenue growth.
Note that a SaaS business analyzes Bookings as an annualized number. This is because Bookings may relate to contracts with varying durations, that is, monthly, annually, or multi-yearly.
Also, a SaaS business may look into the following components when analyzing its ACV.
- New ACV: ACV from new customer contracts
- Upsell ACV: These include additional sales made to the existing customers.
- Recurring ACV: ACV from existing subscription contracts
- Churn: Loss of customers or revenue during a period of time
- Downsell: Portion of bookings that downgrade or reduce the scope of their current subscription
- Net ACV: ACV from new and existing customer contracts for a particular year adjusted for the lost ACV due to customer churn.
- Number of New Customers: Number of new customers acquired over a given month.
- Number of Lost Customers: Number of customers lost over a given month.
II. Cost of Revenue
The cost of revenue of a SaaS business represents the cost of subscription and support revenues. These are the expenses that relate to delivering SaaS service and providing support to the subscribers. Such costs may include costs of data center capacity, fees paid to third parties for the use of their technology, services and data, and employee-related costs such as salaries and benefits.
Likewise, the cost of revenue also includes the cost of professional services. Such costs primarily consist of employee-related costs associated with these services, including stock-based expenses, the cost of subcontractors, and certain third-party fees.
A SaaS business may have to track key cost of revenue metrics to analyze its profitability. One of the key determinants of SaaS profitability is Customer Acquisition Cost (CAC).
CAC refers to money that a business spends to acquire a new customer. This includes costs associated with marketing and sales that e-commerce businesses incur in order to attract potential customers to purchase their products. Some even define Customer Acquisition Cost more broadly by including even the cost of the customer experience in CAC. This is done as it is considered that consumers choose a product because of how they are treated throughout their entire experience.
Note that this Customer Acquisition definition can overstate CAC. This is because not all sales and marketing expense is dedicated solely to acquiring new customers. It may include other forms of acquisition costs like freemium offerings, hardware subsidies, promotions, and installation costs.
Another important cost component that impacts the profitability of a SaaS business is Cost To Serve (CTS). If a SaaS business wants to effectively manage this metric, then it needs to have in place proper product and database server architecture.
It is important to note that a complex and ineffective architecture can act as an impediment to achieving benchmark gross margins for a SaaS business.
III. Operating Expenses
The operating expenses of a SaaS business refer to the expenses that help the business to run its normal day-to-day operations. Such expenses may include selling and marketing expenses, research and development costs, General and Administrative Expenses.
a. Research and Development Cost
Research and development expenses consist primarily of salaries and related expenses, including stock-based expenses and allocated overhead.
Thus, costs spent on R&D as a percentage of Sales is a metric that helps a SaaS business in comparing its strength. This is because such a metric reveals the effectiveness of research expenditure as compared to the overall sales of the SaaS business.
b. Sales and Marketing Cost
Marketing and sales expenses primarily consist of salaries and related expenses, including stock-based expenses and commissions, for the sales and marketing staff of a SaaS business.
It also includes payments made to partners, costs spent on marketing programs and allocated overheads.
Marketing programs of a SaaS business may consist of advertising, events, corporate communications, brand building, and product marketing activities.
Accordingly, Sales Cost and Marketing Cost as a percentage of Annual Recurring Revenue (ARR) of a SaaS business showcases the relative amount of its sales and marketing expenditure to its ARR.
c. General and Administrative Expenses
General and administrative expenses consist primarily of salaries and related expenses, including stock-based expenses, for finance and accounting, legal, internal audit, human resources, and management information systems personnel, and professional services fees.
IV. Income Tax
This section represents the current and deferred tax amounts of a SaaS business. Assets or Liabilities arising under tax are recognized as amounts payable or receivable from or payable to the tax authorities.
Deferred tax assets and liabilities are determined based on temporary differences between the financial statement and the tax basis of assets and liabilities. Further, the tax rates used to calculate deferred tax assets and liabilities refer to the year in which the differences are expected to reverse.
Thus, current tax assets and liabilities for the current and prior periods are measured at the amount expected to be recovered from or paid to the taxation authorities.
Likewise, deferred income tax of a SaaS business represents the temporary differences at the balance date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes.
Also, a SaaS business may establish valuation allowances when necessary to reduce deferred tax assets to the amounts that are more likely than not expected to be realized.
V. Other Income and Expenses
Other expenses primarily consist of interest expense on debt that a SaaS business may have undertaken. It also includes operating and finance leases that are offset by investment income. The investment income may include interest received on marketable securities.
Likewise, the Other Income of a SaaS business may include gains on strategic investments that the business may have made. The strategic investments may include acquisitions or investments made in complementary businesses services, technologies, and intellectual property rights to complement the core development of the SaaS product.
How is SaaS Profit Calculated?
SaaS gross margin is one of the key SaaS metrics that refers to the percentage of revenue left after taking into account the cost of servicing such revenue. The cost of servicing the revenue generated as a result of delivering SaaS services to customers may include costs like costs for hosting, onboarding customers, customer service costs, and third-party costs.
Thus, the above components demonstrate that different businesses may have different gross margin profiles. These gross margin profiles may be driven by infrastructure costs, customer support costs, services vs software split, and many other factors.
The following is the SaaS Gross Margin Formula:
Gross Margin = (Subscription revenue – subscription COGS) / Subscription revenue
As mentioned in the SaaS Gross Margin Formula above, Gross Profit is the difference between the subscription revenue and cost of subscription revenue. Such a difference as a percentage of sales is Gross Margin for a SaaS business.
SaaS P&L Template
The following is the SaaS P&L Template that a SaaS business can use to calculate its Gross Margin and to determine profitability.
|Subscription and support||xx||xx|
|Professional services and other||xx||xx|
|Cost of revenues:||xx||xx|
|Subscription and support||xx||xx|
|Professional services and other||xx||xx|
|The total cost of revenues||xx||xx|
|Research and development||xx||xx|
|Marketing and sales||xx||xx|
|General and administrative||xx||xx|
|Loss on settlement of Salesforce.org reseller agreement||xx||xx|
|Total operating expenses||xx||xx|
|Income from operations||xx||xx|
|Gains on strategic investments,||xx||xx|
|Income before benefit from (provision for)income taxes||xx||xx|
|Benefit from (provision for) income taxes||xx||xx|
SaaS P&L Benchmarks
KPMG, in its SaaS report, has laid out key revenue and cost SaaS P&L Benchmarks to evaluate revenue growth and profitability of a SaaS business. The following section lays out the key benchmarks that SaaS businesses can use to assess their performance.
|Revenue SaaS Benchmark||Definition||Formula|
|Total Contract Value||The total value of the customer contract including one-time and recurring revenue for the period specified in the contract.||(Upfront and recurring payments over life of subscription)|
|Backlog||Backlog is the unrecognized revenue over the term of a SaaS or subscription agreement. It represents bookings that have not yet been billed and are determined from Total Contract Value (TCV).||Bookings Not Yet Included n Deferred Revenue/Revenue at the beginning of the Period|
|Annual Contract Value||The annual value of the customer contract including one-time and recurring revenue over the first year of the agreement.||(Upfront and recurring payments over the the first year)|
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