Over the past decade, tech companies have realized the advantages of using a subscription service model, known as Software as a Service, has over the traditional software sales model. Rather than selling a single license for a lifetime of access, the SaaS model views the software as an ongoing service—and allows companies to charge a monthly or yearly fee for that service.
But, while this model does have its advantages, providing a service in the form of software also comes with increased operating costs, as businesses focus on providing improved customer experience throughout the customer relationship.
Because of the unique qualities of the SaaS model, a SaaS income statement has become a vital document for evaluating the financial performance of your company. It helps business leaders and investors determine whether a company is heading toward profitability.
But what is a SaaS income statement and what should it look like? How do you factor in revenue recognition, so you can show profits and losses accurately?
In this article, we’ll explain what a SaaS income statement is and what it should include. We’ll also look at how you can prepare one in accordance with the revenue recognition principle.
Here’s what we’ll cover in this article:
- What is a SaaS Income Statement?
- SaaS Income Statement Example
- Accrual or Cash Basis: Which is Right for SaaS?
- How To Structure Your SaaS Income Statement
- Best Practices For SaaS Income Statements
What Is a SaaS Income Statement?
A SaaS income statement is a financial document that shows your company’s revenue and expenses over a given period (monthly, quarterly, or yearly). It’s also known as a profit and loss (P&L) statement.
An income statement paired with a balance sheet and other cash flow statements can give a good estimation of your company’s financial health. Importantly, it shows your company’s ability to earn profits over time — all of which are key to making informed business decisions.
SaaS Income Statement Example
Here’s an example of an income statement from HubSpot from 2009 to 2019.
Above, we can see that HubSpot had a gross margin of 43% — not terrible, but not that great either. However, the company greatly improved their profit margin over the years. By the end of 2019, their gross profit margin rose to 82%, which was significantly higher than the industry average of 59% for software.
Before we look at how you can create a SaaS income statement, there are two accounting methods that you’ll need to know about: accrual and cash basis accounting.
Accrual or Cash Basis: Which Is Right for SaaS?
The key difference between accrual basis and cash basis accounting is when your revenue and expenses are recorded. Here’s an overview of both accounting methods. We’ll also look at which one you should choose for your SaaS company.
Accrual basis accounting is when a business records revenue when it’s earned, and records expenses when they’re incurred.
For example, if you sent an invoice to a customer for $100, you’d still record the revenue in the current month, even if you don’t expect to receive payment until the following month. The same applies to expenses. If you purchase office equipment on credit, you’ll still record the expense even if you pay the full balance later.
The accrual method includes receivables and payables, which provides a more accurate view of a company’s financial health. However, accrual accounting is more complex. It requires double-entry bookkeeping where each transaction is recorded in two accounts.
Cash basis accounting is when a business recognizes revenue and expenses only when money changes hands.
For example, if a customer signs an annual contract and pays up $1,000 front in January, you’ll record all of the revenue in that same month. Expenses work the same way. If you have a monthly contract with a vendor, you’ll only record those expenses when you pay.
Cash basis accounting is common for small businesses. However, it doesn’t consider liabilities and receivables, which makes it difficult to assess a company’s financial health.
So, which accounting method should you use for your SaaS business?
It’s best to use accrual basis accounting for SaaS companies because it gives a more accurate picture of a company’s financial performance. It reflects earned revenue and incurred expenses at any given time.
Accrual basis accounting also follows the Generally Accepted Accounting Principle (GAAP) — a set of accounting rules and procedures issued by the Financial Accounting Standards Board (FASB).
With that said, let’s look at how you can structure your SaaS income statement.
How To Structure Your SaaS Income Statement
Here’s a list of the different components in a SaaS income statement. We’ll explain what they are, why they’re important, and how you can calculate them.
Bookings are when customers commit to buying your products or services (or a subscription in this case). Tracking this metric helps you forecast future revenue growth. If a customer signs up for a paid plan, it’s considered a booking.
As you enter bookings in your income statement, you’ll estimate the Total Contract Value (TCV). Here’s the formula:
- TCV = Monthly Recurring Revenue (MRR) x Contract Length + One-Time Fees
For example, let’s say a customer signs up for a 2-year plan that costs $150 a month. However, they also pay data migration fees which are $5,000. The TCV for this booking is $8,600.
Note that you can divide bookings into three categories:
- New bookings: Bookings from new customers.
- Renewal bookings: Bookings from existing customers.
- Upgraded bookings: Bookings from existing customers who upgraded their account.
Segmenting and analyzing your bookings can help you understand how effective your sales team is at converting new customers.
If a customer pays their balance upfront, the revenue you collect becomes deferred revenue, in which case it’s listed as a liability on your balance sheet.
Based on the accrual basis accounting method, you’ll record revenue when it’s earned — even when cash hasn’t changed hands yet. Per GAAP rules, a business can only recognize revenue when it delivers services to its customers. This is known as accrued revenue.
For example, if a customer signs up for a 1-year contract valued at $5,000 and agrees to pay monthly, you can’t recognize the full amount because you haven’t delivered a year of service. Instead, you’d recognize $416 of revenue (5,000 / 12) for each month you provide a service. This follows the five-step process for recognizing revenue using ASC 606.
Check out our white paper on ASC 606 revenue recognition and implementation for details.
3. Cost of Goods Sold (COGS)
Cost of goods sold (COGS) is the cost that your company incurs to deliver and maintain your software product.
For a SaaS company, COGS typically includes:
- Hosting and server costs like Amazon Web Services (AWS)
- Licenses for third-party apps that support your product
- Software subscriptions to develop your product
- Salaries for customer success and DevOps teams
- Customer onboarding and training costs
In general, you’d include an expense in your COGS if you need it to maintain and deliver your software to your customers. That means you won’t include overhead costs, sales and marketing expenses, or other administrative costs.
4. Gross Profit
Gross profit tells you how much your company made after accounting for direct costs. It appears under revenue and COGS in an income statement.
Here’s the formula to calculate gross profit:
- Gross Profit = Revenue – COGS
Companies can also calculate their gross margin, which measures gross profits as a percentage of revenue. This metric helps you measure how efficient your company is at earning profits.
Here’s the formula to calculate gross margin:
- Gross Margin = ( Revenue – COGS / Revenue ) x 100
A high gross margin means you have more profits left over to grow the business.
5. Operating Expenses
Operating expenses are the costs that a company incurs to keep the business running. Some examples include:
- Salaries and wages
- Supplies and equipment
- Marketing and advertising
- Maintenance and repairs
You’ll record operating expenses in your income statement as they’re incurred. Let’s say your company orders supplies for $5,000 in August and the vendor offers net 30 terms. You’d record $5,000 as an operating expense in August even if you paid the invoice in September.
6. Non-Operating Expenses
Non-operating expenses are expenses that aren’t related to your day-to-day activities. Some examples include:
- Interest payments on loans
- Obsolete inventory charges
- Lawsuit settlements
- Losses from investments
- Restructuring costs
These types of expenses tend to be one-off payments. They also typically appear below operating expenses on an income statement as separate lines.
Here’s an example of non-operating expenses highlighted in red:
While these costs are unrelated to your normal operations, separating them from operating expenses gives you a better idea of how well your company is performing.
7. Non-Cash Expenses
Non-cash expenses don’t involve an actual cash transaction, but they’re still recorded in an income statement per GAAP standards.
One common example is depreciation, in which you spread the cost of a tangible asset over its useful life. For example, let’s say you purchase a computer for $5,000 and estimate that it has a useful life of five years. You’d add a depreciation expense of $1,000 for the next five years.
Other examples of non-cash expenses include:
- Unrealized gains and losses
- Stock-based compensation
- Deferred income taxes
- Provisions for future losses
By recording your non-cash expenses, you can reduce your taxable income. However, keep in mind that these types of expenses are based on estimates. Incorrect estimates can skew your financial statements.
8. Earnings Before Interest and Taxes (EBIT)
Earnings before interest and taxes (EBIT) is an indicator of a company’s profitability. It’s also referred to as “operating profit” or “operating earnings” on an income statement.
Here’s the formula to calculate EBIT:
- EBIT = Revenue – COGS – Operating Expenses
EBIT is a useful metric because it measures your company’s operating efficiency by ignoring variables like taxes and capital structure. However, EBIT excludes depreciation and amortization of fixed assets.
9. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
Earnings before interest, taxes, depreciation, and amortization (EBITDA) is another indicator of your company’s profitability. By excluding variables like interest payments, taxes, and non-cash expenses, you can assess your company’s operational performance.
Here’s the formula to calculate EBITDA:
- EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
Let’s say a company has the following lines on its income statement:
- Net income: $10,000,000
- Interest: $500,000
- Taxes: $3,000,000
- Depreciation + Amortization: $2,000,000
The company’s EBITDA is $15,500,000. By excluding depreciation and amortization, you can get a more accurate view of your operating profits. This is important, especially if your company has a lot of fixed assets.
10. Net Income
Net income is often the last item on an income statement — this is where the term “bottom line” comes from. It represents your company’s profits (or losses) over a given period.
Here’s the formula to calculate net income:
- Net Income = Total Revenue – Total Expenses
Total revenue is the net total of income earned. Total expenses include the operating and non-operating expenses that your company incurred.
Once you’ve calculated your numbers, you can put your income statement together. Use our SaaS financial model template instead of creating one from scratch.
Here’s a snapshot of what the SaaS income statement template looks like:
Edit and customize the template to fit your needs. You can also calculate and track other key SaaS metrics like churn, annual recurring revenue (ARR), and more.
Best Practices For SaaS Income Statements
Follow these best practices as you prepare your income statement:
- Choose a reporting period: Businesses typically report their income statement on a monthly, quarterly, or annual basis. Monthly statements can help you spot trends in your financial data over time.
- Categorize your revenue into two subcategories: Separate recurring revenue from existing subscriptions and non-recurring revenue from one-off payments like setup fees. This will enable you to accurately track metrics like monthly recurring revenue (MRR).
- Subtract bad debts from your revenue: You recognize revenue when you raise an invoice, but what if a customer can’t pay? This can inflate your revenue. Deduct the “bad debt” from your recognized revenue for a more accurate view of your financial health.
- Deduct discounts from gross revenue: Offering discounts is a great way to attract new customers. But make sure to deduct the discount from your gross revenue to avoid skewing your numbers.
- Follow disclosure requirements: Disclosures provide stakeholders with information about your company’s financial health. Every company has different requirements, so seek legal counsel when preparing your income statement.
Following these steps will help you create a SaaS income statement in a few easy steps.