It's not really news that understanding your revenue is something of utmost importance these days if you want to consciously grow your business.
But do you know your accrued revenue? Have you gathered all the information you can about it?
This financial concept is of great importance to SaaS companies, where contracts can extend over many accounting periods. So if you're not yet familiar with it, it's time to change that because it's not just another ordinary accounting term.
Therefore, in this article, through real-world examples, we will explain the value of accrued revenue in managing your SaaS business effectively.
What is Accrued Revenue?
At its core, accrued revenue represents the recognition of revenue that has been earned but not yet received. In SaaS, this often occurs when a company provides services to a customer but hasn't received payment for those services.
So, accrued revenue definition is essentially about money that you've earned but haven't physically obtained.
This revenue is a key component of accrual accounting, one of the two primary accounting methods used by businesses.
In accrual accounting, revenue is recognized when it is earned, regardless of when the actual cash is received. This contrasts with cash basis accounting, where revenue is recognized only when cash is received.
💡 Note: Don't confuse this term with deferred revenue and unearned revenue. Later in the article, we will explain the difference between accrued revenue and the other two metrics.
Why Accrued Revenue Matters in the SaaS Industry?
We have several reasons for this:
01 Accurate Financial Reporting
It helps SaaS businesses adhere to the revenue recognition principle, a fundamental accounting principle. Therefore, it ensures that your financial statements accurately reflect the revenue your business has earned, providing a clear picture of your financial health.
02 Cash Flow Management
Managing your accrued revenue allows you to anticipate future cash inflows and outflows, aiding in cash flow management and budgeting. This is particularly vital in the SaaS industry, where subscription-based revenue streams can fluctuate. It enables businesses to maintain stability and allocate resources efficiently, ensuring consistent service delivery and customer satisfaction.
03 Long-Term Success
The SaaS industry's long-term success relies on maintaining customer subscriptions. Therefore, recognition of accrued expenses and revenue helps companies:
- make operational decisions, such as current asset allocation and growth strategies,
- deliver the services they've promised,
- and invest in product development and customer support.
As a result, it can lead to customer retention and growth.
How to Record Accrued Revenue?
If you have no idea about accrued revenue journal entries, this section is for you.
Recording accrued revenue involves a series of accounting entries. The specific steps may vary depending on your business and accounting practices, but we can point out a general overview:
So first, determine the amount of revenue that has been earned but not yet received. This could include services rendered, products delivered, or subscription fees accrued.
- Create an Accounting Entry
In your accounting records, typically using a double-entry bookkeeping system, you'll make an adjusting journal entry. Debit an asset account, such as "Accounts Receivable," to recognize the amount you expect to receive. Credit a revenue account, recognizing the money you've earned.
Periodically, reconcile your accrued income with actual payments received. As payments are received, reduce the amount in the "Accounts Receivable" account and recognize it as revenue.
❗ Tip: It's better if you complete the accounting entries on the fly, then, there's less chance that you'll make a mistake with the entries.
Why Should You Record Accrued Revenue?
Accrued revenue is more than just an accounting obligation, but why should your business prioritize recording the income that is accrued?
Here are the reasons.
👉🏻 Compliance - adhering to the revenue recognition principle is a basis for sound financial reporting. It ensures your business follows generally accepted accounting principles (GAAP) by recognizing revenue when it's earned, not just when cash changes hands.
👉🏻 Accurate financial statements - this metric helps in presenting accurate financial statements, including the income statement and balance sheet, which are crucial for decision-making and financial reporting. Without it, your income statement might show periods of high revenue when, in reality, those earnings are tied to future services or goods delivery.
👉🏻 Transparency - recording this income allows you to provide a clear picture of your company's financial health to stakeholders, including investors, creditors, and shareholders. It demonstrates your commitment to transparent financial reporting and can enhance your credibility in the eyes of potential investors or lenders.
👉🏻 Cash flow planning - also, monitoring it lets you better plan your cash flow and allocate resources effectively.
👉🏻 Legal and tax compliance - properly accounting for accrued revenue ensures your business complies with legal and tax requirements.