Why is Revenue Recognition so hard for Subscription Businesses?
The rise of the subscription economy has presented a lot of new challenges for financial professionals and controllers. Primarily, subscription-based businesses are unique in that the line between front office and back office operations is blurred. In a traditional transactional sales model, the process probably looks something like this:
- Sell a service or good
- Fulfill the product
- Invoice the customer for the good or service rendered
- Collect payment from the customer
- Sell more to the customer and repeat the cycle
This process is very linear and allow clear separation between front office and back office operations. Front office (Sales) can use SFA (e.g. Salesforce) to track progress of the sales, and the back office (Finance, Accounting, Ops) can use ERP to track fulfillment, billing, and collections.
In a subscription-based business (e.g. SaaS), this sales process is no longer linear.
When a good or a service is being sold as a subscription, the subscription becomes a living object that evolves over time.
For example, your customer may first sign up on the most basic plan to test out the service, but as your customer becomes more dependent to your solution, the customer may want to add more users or upgrade to a higher-tier plan. And all of this could happen during the middle of a subscription term.
This upsell process is typically driven by Sales or Customer Success, but has massive implications for your finance & accounting teams which neither SFA or ERP systems can really properly handle. Not to mention, each subscription sale could bundle different services: implementation, service, support, and more. Below are just a few of the challenges that could arise:
- How do you properly recognize upgrades & downgrades mid-cycle?
- How do you properly amortize upfront payments over the period when the service is being provided? What if you have different payment plans (e.g. annually, quarterly, semi-annually)?
- Do you recognize implementation and other one-time fees right away or over period when service is rendered?
Head of Finance is really one of the most under appreciated roles within a subscription-based organization. Without proper revenue recognition, you cannot properly plan for the future. So make sure you do it right.