It’s tax season and you are readying for your quarterly Board meeting. You are going to report your numbers: income, expenses, balance sheet, maybe bank balance and plans to bring on more customers. You might be discussing the cost of acquiring customers, pricing changes or pivoting your business model to deliver services more efficiently. Whatever your model, if you are delivering any type of software or platform services, you need to understand and educate your Board on how the recent accounting changes may impact how you report.
Starting January 2018, public companies will report their financials using ASC 606. What is usually a dull and yawn inducing subject may become a main interest to you, your board and your investors. ASC 606 may impact two overridingly important financial measures, revenue and profitability.
Currently if you are providing SaaS subscriptions and services, you report revenue pro rata. A 12 month $120K contract is recorded as $10k per month. This type of reporting of “hosted revenue” does not change under ASC 606.
You may be running software services on your customers servers or providing “on-premises” services. In that case, the entire value of the 12 month, $120K contract can be recognized immediately versus ratably over the life of the contract. The whole $120k can be recorded as income in one month. That can be a large impact to your revenue and profitability.
I can think of some of the consequences that you might face. By reporting an entire contract value in one quarter, it may cause your overall revenues to drop the following quarter. Revenue may look bumpier instead of maintaining a smooth growth trend.
Another change for software companies under ASC 606 is profitability. Currently, sales and marketing costs are accounted for during the period in which they are spent. When ASC 606 took effect on January 1, 2018, sales and marketing expenses will now be reported and pro-rated over the life of the contract. This change alone can make your net income increase immediately (with the associated decrease in sales and marketing that period and the spread of that expense over more time), and your sales efficiency which can no longer be assessed in your P&L statement.
When analyzing the impact of ASC 606, you must recognize the impact on setting targets and goals for the following period, there are questions you must face. Can we continue to operate at a higher margin level? Or is this a one-time occurrence? Do we need to invest more in sales and marketing?
Its complicated. Whereas public companies must adopt this new accounting standard in January 2018, private companies are required to move in 2019. It is surely a topic for your next board meeting. Bringing these accounting changes to the attention of your Board and projecting their impact is a good strategy to take with your Board. Refer to your accountant and get this one on your priorities for 2018.