Accounting for SaaS

The advent of sofware-as-a-service means providers must reconsider how they structure their finances, says Niki Dixon

The economy may be emerging from recession but end user companies will still focus on the cost of IT. Large capital outlays and payments for unused licences are no longer accepted as businesses design their technology strategy for the next decade.

As a result, we are seeing the emergence of myriad software-as-a-service (SaaS) subscription-based models. Software is accessed when the user wants to use it, and is typically paid for as a rental per active user, reducing the maintenance and support burden as well as acquisition costs.

Are you ready to respond?

Few providers will be able to ignore this trend. But trying to cram a perpetual licence model into SaaS without transforming both the product and sales cycles to match will not work. You must plan around all aspects of the business.

Key points to consider

● Security and reliability remain key concerns for the end user, so how are you going to adapt to providing your software other than through the customer’s own platforms? How do you decide which companies will provide the necessary infrastructure you wish to deliver to your customers?

● What changes do you need to make to your sales processes? How will you adapt your existing sales function to the new approach?

● Are you equipped to advise your customers on the adjustments they will need to make to their organisation to deal with these changes?
Previously, their failure to make best use of your product could have been seen as simply their problem. On a usage model that risk comes back to you as the provider.

● How will these changes affect cashflows? What do you need to charge to take account of the changes in the level of service provision and how do you take account of the transfer of risk from the end user to your business?

● How will your funding needs change as a result of the proposals – do you have a credible solution to those needs?
● What will the change do to your annual accounts? Will it affect existing banking agreements based on key financial performance measures? If so, how will your customers and suppliers view these changes?

Significant change

Previously, licence fee payments for the software were typically supplemented with fees for maintenance, support and upgrades. In many cases, licence fees involved a substantial single, upfront payment to the provider.
Once a customer has been secured, the income for the period of the contract can be calculated. Where a perpetual licence is granted with no further obligations, all the income is recognised upfront.
Many software companies show substantial sums of deferred income on their balance sheets where upfront payments are received, spread over the contract period. These patterns of cashflow and income recognition are well understood by investors and banks alike.

Subscription model

In contrast, the subscription model is based on short-term cashflows and invoicing patterns. Income is recognised as it is invoiced; payments are in arrears, based on actual usage, shifting the pressures on cashflow from the end user to the provider. In the short term these changes may adversely affect turnover as the old models unwind and new customers come on board.

For software providers, economic uncertainty has come on top of unprecedented industry transformation. A clear strategy, new relationships, new funding arrangements and resolute action will be required to ensure survival and prosperity in the face of these changes.

Niki Dixon is head of technology at accountancy firm Grant Thornton