- Hi there, Dan Martell here,
serial entrepreneur, investor, and creator of SaaS Academy.
In this episode I'm gonna share with you
what is accrual accounting, accrual versus cash.
Hey, first off, I'm not an accountant
but I play one on the internet.
I literally have read and looked at
probably 2,000 different balance sheets,
PNLs, cashflow statements, you name it
and I've had to teach dozens of SaaS founders specifically
and that's why you wanna watch this on how to think about
accrual accounting versus cash accounting.
It's not as complicated as the frigging accountants
wanna make it seem but be sure to stay to the end
because I'm also gonna share with you
my Precision Scorecard.
A framework to help you understand
how to measure specifically deferred revenues
and other things we're gonna talk about in this video
so that you get a weekly report to keep your eye on,
to make sure your business is moving in the right direction.
Let's get into it.
(upbeat music)
So here's a funny story.
Back when I was building my company Spheric,
I had done two other companies prior to that point
and they failed, okay, Maritime Vacation and NB Host.
And I finally start with Spheric Technologies
and somewhere in one of the business books
I was reading at the time, they say
you really need to understand your numbers.
You've heard this from so many people,
Tilman Fertitta, crazy restaurateur,
incredibly successful billionaire talks about it,
"You need to know your numbers."
Warren buffet, "You need to know your numbers."
And I was just like, "Man, I know how to make money,
but I don't understand what the accountants do
with all those transactions."
Like I can't tell you how to read an income statement
or a cashflow statement or a balance sheet, et cetera.
They were all things that were like
I had them and I had to sign off at the end of the year
to make sure they were accurate
because if you know I could go to jail
if I didn't pay my taxes, et cetera.
But I didn't understand
so I reached out to this guy named Dave Richie.
He was a local entrepreneur.
He owned a shipping company, a dry cleaning company,
some restaurants, some real estate.
And I remember this and he was probably about
14 years older than me.
And I reached out to him I was just like,
"Hey Dave I was wondering if you could teach me
how to read financial statements?"
And he was kind enough like knowing what I know now
how ridiculous that request was he replied and he's like,
"Hey Dan, I'd love to meet up.
I'll teach you what I know
but the truth is that's what accountants are for."
And I kinda dove into it and realised he was right.
At the end of the day
the accountants should do all the heavy lifting
but what your responsible to do
is to direct them into the right way.
So I'm gonna share this because
accrual accounting for SaaS is a must.
It makes it ridiculously impossible
to understand the business if you don't do it.
So let's dive into the specific aspects
and why it's important for you.
Number one, clear cashflow in better decision.
So what the difference is okay,
is accrual accounting essentially says
the income is collected when the service is delivered.
Okay, so if somebody pays you
for an annual contract upfront,
you didn't deliver the service yet.
You might've delivered that month's value
but you didn't deliver the whole year.
So what ends up happening is that check for 100 grand
or let's use 120,000 so we keep the math easy,
is 10,000 every other month is looked at
as like our accounts receivable.
It's an invoice for a future date
owed on a future date versus cash,
versus saying in my account, which is look,
the truth is small businesses all around the world
they do cash accounting.
I get it, it's simple.
They're like, "Am I doing good?
How much money is in my bank account?"
But that's not a true understanding
of how your business is doing
because the last thing you wanna do
is have all these customers.
You're doing three-year annual contracts
and they give you all the money upfront
and you're sitting on millions of dollars
of what you think is profit.
But the truth is, is you still have to operate.
If you just think about, you got expenses
for three years into the future
that's coming from that pot of money.
And if you don't look at the reporting
from an accrual point of view
you're gonna think that you're rich.
You're gonna go buy yourself a new Lamborghini
and then you're gonna have customers pissed off
because you don't have any developers,
no money for the servers, no money for customer support,
and they're gonna leave
and then ask you for their money back, et cetera, et cetera.
So, I mean, that's the real reason
is you want clear cashflow understanding
so you can make better business decisions
about should you hire that extra engineer?
Are you able to upgrade your systems?
Should you buy or change CRM solutions? et cetera.
Whatever is gonna cost you money
if you don't have an accrual process
to project into the future
to understand what your cashflow is gonna look like,
it's gonna make it harder to make good decisions.
Number two is we wanna track MRR with accuracy.
MRR stands for Monthly Reoccurring Revenue.
And I remember one time I was working
with a coaching client, Adrian,
and I said, "Hey man, what's your MRR?"
He goes, "I don't know I know my ARR."
Well, the good news, if you know
your annual recurring revenue, divide it by 12
and that'll give us our MRR.
But here's the risk of not knowing MRR
is if your goal is to double in revenue,
you're at two million ARR and you wanna go to four million
is the incremental change on a monthly basis
for ARR is so small, you go from 2 to 2.2 to 2.4.
It doesn't feel good.
As a percentage, it might look,
if you're getting 7, 8% a month.
But what I love is the monthly.
I love focusing on the monthly
because what I learned a long time ago
is the more frequently we can measure and change and affect
and the beauty of software
is we can get down to the weekly numbers.
We can look at our pipeline and our revenue
and cash collected.
We can still get the cash portion
but we can start looking at MRR
and are we growing it on a month over month basis?
And it helps us smooth out all those,
maybe we have customers that are not gonna renew
or maybe you have some different changes in your prices.
If you don't look at it on a monthly basis
you won't see those big shifts to give you feedback.
So tracking MRR accurately is the biggest reason
for you to move to an accrual-based accounting process.
Number three is identify business trends.
So I remember one time I was working with another client
Emerick, he had made a big pricing change in their software.
They have a social media marketing software.
And because they weren't looking at things
on a monthly basis, on an MRR level monthly
and it was just kind of like going
that pricing change had a negative effect.
But the first month it had a negative effect.
They just assumed, "Oh, it's that time of year.
September, it's a slower time of year for us."
Then the next month they were like,
"Oh, maybe there's something going on," blah, blah, blah.
It took three months, 90 days for them to realise,
"Holy moly, that change we made back three months ago
is reduced our monetization by 20%, change it back."
We need to really focus on the monthly costs,
the monthly expenses, the monthly income,
so that we can make better identification
of business trends.
Both support tickets costs,
everything in your core business
needs to be done on a monthly basis
in regards to when the service was delivered
and when the expense was occurred
so that we can get ideally reduce the distortion.
That's what it's called is distortion in your numbers, okay?
So make sure that you look at accrual
so that you can make better identifications
of business trends so you can make better decisions.
Number four, financial implementation.
So two things you need to understand to just implement this.
As an entrepreneur it's really simple,
is the income, it's deferred as receivable
so it's paid up front.
So if they pay on a monthly basis,
no worries, no harm no foul, that's easy,
'cause they're just gonna pay their credit card.
But if they pay up front you wanna defer that income
as deferred revenue and it shows up as a receivable
in your books, okay?
So deferred revenue.
So you might have a bunch of cash
but every month you might have a deferred revenue line
which is the amount of money that you expect
because clients pay you every month
and that's gonna show up.
And the second thing is your expense
should occur the day of service.
So maybe somebody invoices you today
but you don't actually get them
to do the work until the future
or they do the work but they don't invoice you
until 30 days later.
From an accrual point of view
you want to record the expense
on the day of service delivered.
That's how this whole thing gets cleaned up.
That's why people are like,
"What if people pay me up front?"
I just answered the question.
You defer it on as a receivable
that they owe you every month.
And if you get a service you need to expense it
on the day they delivered the service.
It has nothing to do with when you paid it
or when the invoice was given to you.
So that is accrual accounting.
You need to do it as a SaaS founder.
It just cleans up everything.
Number one, it clears up your cashflow.
Number two, it helps you track MRR accurately.
Number three, identify your business trends.
Number four, most important is
the financial implementation of it all.
And the good news is you ask your accountant to do it.
You don't need to do it.
Now, I mentioned at the beginning of this episode,
I wanna share with you my Precision Scorecard.
It is a framework and a template that you can implement
in your business to track your revenue, track your expenses,
track your profit on a monthly basis
because here's the deal,
if you have profit and you don't reinvest it
into next month under growth opportunities,
you're giving up seven times potential revenue
or valuation into the future of your business
because that dollar reinvested could have helped you grow
in your monthly recurring revenue.
And the valuation on average for a SaaS company
if they're doing about three million plus
is about between four to seven X their top-line MRR.
So if you've got profit you wanna reinvest.
The Precision Scorecard will help you track that
on a weekly, monthly basis,
help your team get focused on quarterly outcomes,
build the accountability.
Just click the link below to download your copy
of my Precision Scorecard Framework.
And if you like this video
even though it was a super dry topic.
Accounting, literally I find it boring
but without it we don't have the optics
and the visibility to grow our business.
And if you like this video
be sure to smash the Like button.
Leave a comment and let me know
what was your biggest takeaway from this episode.
And as per usual I wanna challenge you
to live a bigger life and a bigger business
and I'll see you next Monday.