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Accounting Rules Create Headaches For Saas Vendors And Big Risks For Customers

 

Financial analysts have long known that the published accounts of software companies can be a real minefield. With the advent of Software-as-a-Service, the accounting challenges multiply, creating real headaches not just for analysts but also for customers who are concerned about the financial health of vendors who adopt the SaaS model.

The rules that vendors choose to apply for revenue recognition from software products are arcane and can seem arbitrary. More than one high-flying software vendor has fallen back to earth following overambitious revenue projections that failed to materialise. In some cases, they have been obliged to adopt more conservative revenue policies and even restate results.

SaaS vendors face their own unique accounting challenges when it comes to revenue recognition. For example, at what point can vendors record revenue from customer contracts that are delivered over time? How should they allocate consideration among different elements within a customer contract?

One UK SaaS vendor, Access Intelligence, recently warned investors that sales and profits would be below market expectations and blamed the shortfall on the revenue recognition basis adopted for its SaaS business model.

Smaller vendors that are heavily-loss making and reliant on a single source of finance such as bank loans or overdrafts to continue trading, can quickly find themselves in deep financial trouble if revenues fall short of expectations. Once covenants are breached, the situation can deteriorate rapidly if the lender moves to seize assets to pay back the loan.

Few customers are in a position to continuously monitor the financial health of their software vendors and, indeed, they are often the last to know when a bank calls in an overdraft or a lender refuses to renew a loan agreement.

That’s why it is so important that businesses using SaaS services have in place a SaaS escrow agreement that include the monitoring of the creditworthiness of  the SaaS supplier.

If a supplier might be running into financial troubles, the escrow agent makes sure the business knows about the risk in good time. It can then seek guarantees from supplier or take other appropriate action to ensure the business is not at risk if the supplier were to stop trading.

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