What is Subscription Revenue? Accounting, Calculation, and Pricing Models

How do you calculate subscription revenue?

The way you calculate subscription revenue depends on the pricing model you use in your SaaS business. A subscription pricing model defines how you charge your customers. There are four subscription pricing models prevalent in SaaS business plans:

• Flat-rate pricing 
• Tiered pricing 
• Usage-based pricing 
• Hybrid pricing

Here are some examples of calculating subscription revenue based on your pricing model.

Calculating subscription revenue with a flat-rate per account pricing model

In the flat-rate model, a company charges all its customers the same price and bills them at the same frequencies. Here’s the formula to calculate subscription revenue in a flat-rate per account model:

Calculating subscription revenue with a tiered pricing model

In this model, companies bill customers depending on their size or volumes. For instance, a payment service provider might charge different prices depending on the number of product features its customers use.

The formula for calculating subscription revenue in a tiered model is similar to that in a flat-rate per account model. However, you’ll have to add the individual revenues from each tier (also referred to as plans).

Let’s assume the following:

• Tier 1 - 1,000 accounts paying $500 per month
• Tier 2 - 5,000 accounts paying $250 per month
• Tier 3 - 10,000 accounts paying $100 per month

We can calculate subscription revenue as:

Calculating subscription revenue with a usage-based pricing model

Usage-based pricing is a pay-as-you-go model in which customers only pay for what they consume. While this type of pricing introduces more variability into  subscription revenue, it’s becoming a very popular pricing model for SaaS companies with products and services that are both scalable and lend themselves to usage tracking. Examples include the amount of compute your customers use, the gigabytes of data they’re transferring or storing, the number of API calls, or specific uses such as the number of contacts in a CRM system.

Usage-based pricing commonly starts with a base price + additional costs for overages (e.g. number of API calls, number of contacts, etc.). Let’s look at an example of a SaaS for which the price paid by the customer is based on the number of API calls made: 

Customer A uses 25,000 API calls with a base fee of $500 for the first 5,000 API calls + $250 for each additional 5,000.

We can calculate subscription revenue from Customer A as:

• First 5,000 API calls = $500
• (20,000 additional API calls / 5,000 API calls per usage tier) * $250 = $1,000

Calculating subscription revenue with a hybrid pricing model

A hybrid pricing model combines two or more of the pricing components discussed above (flat-rate, tiered, and/or usage-based pricing). Hybrid pricing can be thought of as “a la carte” pricing, which makes calculating subscription revenues the most complex of the four different pricing models.  

The following example illustrates the complexity inherent in a hybrid model. Let’s say our SaaS company has three customers (Companies A, B, and C) and uses a hybrid pricing model that includes two components:

• Flat-rate price per user – $100 per user per month
• Usage-based Fees – $1,000 for the first 10,000 searches + $1,000 for each additional 5,000 searches.

To calculate subscription revenue, we must add revenues from each of the three pricing components above from each of their customers. 

Company A with 200 users and makes 510,000 searches

Company B with 1,200 users and makes 2 million searches

Company C with 5,000 users and makes 10 million searches

Revenue from Company A: 

User-based revenue = 200 x $100 = $20,000

Usage-based revenue = $1,000 + (500,000 / 5,000 x $1,000) = $101,000 

‍Total Revenue = $20,000 + $101,000 = $121,000

Revenue from Company B: ‍

User-based revenue = 1,200 x $100 = $120,000

Usage-based revenue = $1,000 + (1,990,000 / 5,000 x $1,000) = $399,000

Total Revenue = $120,000 + $399,000 = $519,000

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Revenue from Company C: ‍

User-based revenue = 5,000 x $100 = $500,000

Usage-based revenue = $1,000 + (9,990,000 / 5,000 x $1,000) = $1,999,000

Total Revenue = $500,000 + $1,999,000 = $2,499,000

With hybrid pricing, your revenue will vary from customer to customer as you would expect with any pricing model. However, you will also have additional variability from month to month due to the usage-based component of your pricing model.   

Because every customer’s monthly spend will be different and will vary from month to month, you cannot simply multiply the monthly revenue by 12 to calculate your annual subscription revenue. Rather, you’ll add up the total revenues across all your customers each month to get a total monthly revenue and then sum the total monthly revenues for a given 12-month period.

Is subscription revenue the same as ARR?

Yes, ARR and subscription revenue are the same when referring to annual subscription revenue. Monthly subscription revenue and MRR are the same. 

Like ARR and MRR, subscription revenues are not generally accepted accounting principles (GAAP) items and thus do not appear separately on a company's financial statements. 

How do you grow subscription revenue?

Every SaaS company aims to grow its subscription revenues because this type of revenue attracts a higher valuation multiple as compared to non-subscription revenue, making the business more attractive to investors. Here are a few tips to help you grow your subscription revenues:

• Leverage freemiums - In the freemium model, a SaaS offers its users a free trial before upgrading them to paid plans. This model gives users a taste of the product before paying. You can also offer add-on services over time using the freemium option, boosting your SaaS continuous planning efforts.
• Price transparently - Modern consumers are highly sensitive to hidden fees and surprise charges. List all fees upfront and eliminate any non-critical one-time fees during onboarding.
• Use customer success data - Customer success teams are vital to enhancing your product and gathering feedback. Use this feedback to inform your product roadmap and any feature development in the future.
• Pay attention to usage analytics - Monitor how your users behave on your platform and which features they use the most. Which features generate the most complaints? Analyzing these datasets will help you build your product along the right lines.

How should you recognize SaaS subscription revenues?

SaaS revenue recognition is a complex subject. Before diving into the specifics of revenue recognition, you must understand a few key terms.

Important subscription accounting terms to know

• Bookings – A booking occurs when a customer signs a contract and commits to purchasing the SaaS company's product or service. Bookings are not a GAAP or International Financial Reporting Standards (IFRS) measure and are not subscription revenue.
• Billings – This is the revenue you collect from your customers through invoices.
• Deferred revenue – This is revenue you have received for services you have not delivered yet. For instance, if a customer pays you up front for an annual subscription, this amount is initially treated as deferred revenue since you have not delivered any product or service yet. Then, as you deliver your services, you can move the corresponding share of that deferred revenue into billings. 

How does SaaS revenue recognition work?

Revenue recognition is the process of recording revenues when a product or service (or revenue-generating activity) has been delivered. Note that you can recognize revenue before receiving cash.

SaaS companies face unique revenue recognition conditions since the payment's term changes how they recognize revenues. Typically, SaaS companies split the cash they receive into recognized and deferred revenues. Note that SaaS companies record revenues on their books on an accrual basis.

Here's an example. Let's say a customer pays you $360,000 upfront for an annual subscription. You receive $360,000 in cash but cannot fully recognize this sum as revenue just yet because you have not delivered services for a whole year.

You will first record $360,000 as deferred revenue and move (360,000 /12) $30,000 every month from deferred revenues to recognized revenues. You can do this because as each month passes, you can confirm you've met performance obligations by delivering the services. 

Any revenue earned from obligations such as installation services or customer support must be amortized throughout the contract. SaaS revenue recognition is governed by the Financial Accounting Standards Board (FASB) standard ASC 606.

ASC 606 follows a five-step process and defines all the criteria you must fulfill before recognizing revenue from a contract, determining transaction prices, and determining when you have met the performance obligations under that contract.

Accounting for SaaS subscription revenue

Here's how you can account for SaaS subscription revenue:

• The cash you receive upfront is classified as unearned recurring revenue and is a liability on your balance sheet. You can recognize this revenue once you deliver services during the subscription period.
• The cash you have in deferred revenue is a liability and you must record it as a credit.
• As each period in the subscription contract passes (either a month or a quarter, etc) you enter a credit equal to the amount of recognized revenue and debit the deferred revenue liability.

How Drivetrain simplifies subscription revenue analysis?

• Drivetrain offers a purpose-built revenue forecast software designed for FP&A's unique needs with a familiar spreadsheet-like interface that can help you easily build multidimensional models across different segments (countries, products, etc.) and identify your revenue drivers.
• Monitor budget versus actuals, quota attainment ratios, and conduct variance analysis at the click of a button.
• Pull data from all your revenue sources automatically, eliminating  time spent cleaning and preparing data.

Subscription revenue is a central SaaS metric and forms the basis for further scenario planning. Accounting for subscription revenue is perhaps its most challenging aspect. By following  the tips we’ve presented here, you can make sure you’re accounting for your revenues properly.

Want to see how Drivetrain can help you simplify subscription revenue tracking and modeling for your SaaS business? Get in touch with us today to book your demo.