Cash vs Accrual Accounting
Which one is best?
Sorry to bring up such a nerdy subject. But it’s kind of important. As a non-accountant, if we start from the perspective that the purpose of accounting is to give the people running a company a clear picture of performance, allowing them to make the right decisions, then is it better to focus on cash or accrual when it comes to SaaS?
Firstly some definitions (again, for non-accountants like me!):
Cash Accounting
Small businesses often run a cash accounting process. When revenue comes in and expenses are paid, you record it all. It’s simple to get your head round: how much money did we earn and how much money did we spend?
Accrual Accounting
With accrual accounting, you look at when revenue and expenses are earned or incurred, regardless of when cash is received or paid. If you are paid an annual subscription in January, you actually ‘earn’ that money in 12 monthly instalments rather than all at once in Month 1. Similarly, if you are paying an annual subscription or hosting costs in advance, then those expenses are ‘deferred’ evenly over the period rather than in the month you physically paid the bill.
Why does it matter?
Who cares about how an accountant reports your earnings, the only thing that really counts is cash in the bank, right? Yes and No. Firstly, of course cash is very important! You can’t pay your staff in deferred revenue. So you need to have a clear view of your cash position and some sort of cashflow forecast.
BUT… looking at only cash in and cash out for a SaaS is confusing. It’s like trying to listen to a podcast at a heavy metal concert. The words are there, but it’s going to be an effort to make them out.
Let’s look at why:
What’s your MRR?
Here’s a cash accounting math question for you:
You’ve got 100 customers.
Your monthly subscription price is $500 or people can get two months for free and pay $5,000 up front for an annual subscription.
Last month, your revenue was $50k.
What is your MRR?
Go!
Errr…. who knows? It depends on how many are paying monthly and how many are paying annually. And what about if someone is later renewing but they haven’t actually stopped using the service?
Remember that most of your annual customers won’t have paid you anything last month. If you acquire customers on a regular cadence, only 1 in 12 of your annual customers hand over money in any given month.
So, maybe in this case you had 50 monthly customers (50 x $500 = $25k) and 50 annual customers, but only 5 of them paid any money (5x $5000 = $25k).
On that basis. although your Monthly Revenue was $50k, your Monthly Recurring Revenue (MRR) would be $45,833 (25k +(50 x 5k / 12)).
But there is no way of getting to that figure just by using number of customers and monthly revenue.
What about new business?
Same goes for new business, Let’s say you won five new clients last month. Two of them pay $500 monthly and three of them pay $5,000 annually. Your total income last month was $16,000. What’s your new Monthly Recurring Revenue (MRR)?
In this case it’s $2,250. But just being given a figure of $16k, there is no single formula you can apply each month.
If you can’t accurately understand what your MRR is then you can’t get a sense of your growth trends. If you don’t understand your growth trends you will find forecasting impossible and you’ll have no way of knowing whether you’re really improving things. More cash might just mean more people paying you annually.
How’s your retention doing?
Similarly, some existing customers have paid you some money, what is the gross expansion rate? What about churn? One annual customer churning may look worse than five monthly customers churning if you are simply comparing cash revenues between individual months.
And what if a customer is late paying their invoice?
Peaks and Troughs
In an agency, a peak is good: it means that you had a good month or so, where you won a load of work. A trough often follows where your new business is catching up. It’s useful to be able to keep track of them so you know either that you need to double down on your effort to win new business, or maybe you have had enough years to learn that things are always a bit quieter in December so there’s no need to panic.
But for a SaaS business, peaks and troughs in terms of cash, don’t really help that much. Maybe you won a huge customer a year ago and they’ve just renewed. Maybe you just added annual billing as an option and saw a spike in revenue. Maybe you just got hit with a massive AWS bill that makes your expenses this month much higher than usual.
The reality with SaaS businesses, assuming they have more than a handful of customers, is that they don’t tend to have huge peaks and troughs in their revenues because of the repeatable nature of the revenue model.
A cash accounting approach will show the peaks and troughs almost in real time. Accrual will give a more honest assessment of your growth over time.
CAC
Customer Acquisition Costs (CAC) are another thing that might get lost in the noise. Although CAC is something that you probably want to take a longer term view on and relates to the number of new customers rather than their revenue, CAC is generally used in conjunction with Lifetime Value. Your LTV:CAC ratio shows the profitability or otherwise of your acquisition strategies.
If you can’t easily work out this number, then how do you know whether your CAC is too high or too low? Answer: you don’t.
Investors
Maybe you never want investors. But one day you might consider it. If your accounting is cash based and you’ve had to manually work out your MRR, they are going to be more cynical. As a SaaS founder, especially one that is venture-backed, you should know your MRR and the elements that underpin it at any given time. It shouldn’t be a question that you’ll ‘have to get back to them’ on.
So when should you start using accrual accounting?
You can see that relying on anything other than accrued revenue and costs will exaggerate some aspects and obscure others. It would be like driving to a new city with no map or road signs.
Which means, IMHO, the time to start is now. Start from the start. Even if you are only charging on a monthly basis right now, your expenses maybe annual. And at some point in the future you may want to switch to annual subscriptions. (In fact, I would say you certainly should switch as, ironically, it will have a really nice impact on your free cash flow).
And what about where you have both types of revenue?
If you’re an agency or a consultancy and you get significant amounts of revenue from both project work and subscription, then what?
Project-based revenue is inherently lumpy—large invoices come in when milestones are hit, followed by quieter periods with lower cash flow. SaaS revenue, on the other hand, is (or should be) relatively stable and predictable. If you only track cash accounting, these two revenue types can blend together, making it hard to assess the health of your SaaS business independently.
The best approach may be to segment your financials. That means:
Separate P&Ls: Keep distinct reporting for your services and SaaS operations. This helps you understand the true contribution of each to overall profitability.
Accrual for SaaS, Cash (or Hybrid) for Services: Accrual accounting is a must for SaaS to track MRR, churn, and growth trends. For services, cash accounting might still make sense for simplicity, but a hybrid approach (e.g., recognising revenue over the duration of a project) can give better insights.
Cash Flow Planning: Since services revenue is often more immediate while SaaS revenue builds gradually, you need a solid cash flow model to ensure that your SaaS investment is funded properly—especially if you’re transitioning from services to product.
If your long-term goal is to move toward SaaS, getting your financial reporting right early is just something you should do. It will help you track the transition, prove the viability of your SaaS business, and make informed decisions about growth, pricing, and investment.
