In the age of a-solution-for-everything, it’s no surprise that companies spend roughly $13k per employee annually on SaaS tools, with almost $4k wasted per employee. Further, the average company changes 43% of its subscription stack a year. Considering these expenses are financially impactful and have the tendency to change often, it’s crucially important for companies to accurately track these subscriptions to eliminate wasted funds and avoid unwanted renewals.
Surprisingly enough, most companies use an average historical figure or some multiple to forecast their technology spend. The clear issue is, most technology spend is pre-committed contractual agreements that should not warrant surprises to the accounting and finance team. Because of this predetermined expense schedule, subscription expenses should be forecasted to a larger degree of accuracy than other spend categories such as travel & entertainment.
After experiencing the pain-points of forecasting and monitoring renewal terms of our own software subscriptions at Trace, we set out to create a comprehensive model that tackles both cash flow forecasting and monitoring upcoming renewals. Below we’ll dive into the nuances of tracking and monitoring these subscription agreements.
Typical Financial Components of Subscription Agreements:
It’s important to first understand the financial implications of entering into a subscription agreement.
Start-up Fee: It’s quite common for companies to charge new customers a start-up fee. This often includes costs associated with onboarding customers onto the platform and getting them up-to-speed on navigating the space.
Recurring Fee (Monthly/Quarterly/Annually): This fee is generally guaranteed and represents the agreed-upon service fee that your company will pay in exchange for access to the service/platform. The frequency of this fee will depend on the vendor, but is likely to occur on a monthly, quarterly or annual basis. The amount of this fee will be dependent on the fee structure:
- Flat Rate: A predetermined, constant fee that does not change as usage or users increase.
- Pay-Per-Use: A fee structure based on usage (a good example of this is AWS). The more a service is used, the higher the invoiced amount will be.
- Pay-Per-User: A fee structure based on the number of users (or often called “seats”) that have access to a vendors platform.
- Tiered: This fee structure is common among SMB SaaS tools where there’s a free, professional and enterprise package. More features become available as the package is upgraded.
Annual Fee: Although less common, a vendor may include an annual fee in your company’s service agreement. Be sure to read the fine print!
Renewal Fee: Some vendors will charge customers a fee once their expiring contract is renewed (either automatically or manually). It’s extremely important to ask your sales representative if the contract renews automatically, at what date, at what price and all the incremental costs associated with the renewal.
The Issues of SaaS Spending in Corporations
What exactly are the issues that exist for subscription spend in organizations? Ironically, the issue itself is not necessarily allocating dollars to potentially productive tools and resources for the organization. The right tools can likely help improve productivity and further refine your company’s operations. Instead, the issues typically fall into the following categories:
- Missed Renewals: Monitoring subscription agreements for upcoming renewals is crucial for several reasons. The first being that many agreements contain auto-renewal elements that stipulate if the contract is not terminated before a certain date, it auto-renews for another agreement period (typically a year). With this renewal often comes renewal fees. While this may not be worrisome for a SaaS tool that is regularly used, oftentimes the auto-renewal occurs for unused tools and therefore results in another year of waste capital. On the other hand, some agreements may not contain auto-renewal elements and therefore require the company to manually renew the subscription agreement to lock in the current rate and/or fee structure for another period. Once an agreement is terminated due to a lack of renewal, it requires the company to originate a new agreement that may include an increased rate, fee structure as well as one-time startup fees.
- Lack of Ownership/Accountability: There tends to be a lack of visibility and accountability into a subscription agreement throughout its lifecycle. As expected, projected users of SaaS tools are likely involved in it’s acquisition. However, as the subscription lifecycle progresses, it’s common for the responsibility of the subscription agreement to be handed to the IT department. The disconnection between those using the tools and those managing/accounting for the tools results in a mounting amount of wasted capital that is identified after the fact by the finance and accounting team. If a team shifts from using one SaaS tool to another, who takes the lead on ensuring the previous tool will be manually canceled at the end of the current agreement to avoid auto-renewal (a very common element in SaaS subscription agreements). This illuminates the issues presented when users of SaaS tools are not held responsible for managing the agreement, and instead rely on the IT department to pick up the slack.
- Expense Forecast Accuracy: Depending on the fee structure, a subscription agreement may contain a variable portion (for example, cost per seat/user) along with a fixed platform fee. Forecasting this expense then becomes more difficult as it’s value is dependent on external factors such as headcount. Assuming headcount and/or usage fluctuates, using a historical average will therefore result in an erroneous forecast that will produce unwanted surprises during the Budget v. Actual analysis.
- Cash Outflow Forecast: A common mistake when forecasting is assuming the invoice and cash flow date are the same. A subscription agreement may invoice your company July 1st, but the actual cash payment may not occur until August 1st due to the payment terms. Additionally, identifying exactly when an annual or renewal fee will occur is crucial for accurate cash flow forecasting.
- Expense Amortization: Adhering to GAAP principles requires accurate expense amortization. From an accounting perspective, the focus is not cash flow but instead amortizing the total cost of a subscription agreement over the contract term. Although the first invoice of an agreement will be received (and paid) on July 1st, the actual services began on May 1st, requiring an expense accrual.
It’s clear there are material complications that arise with the introduction of subscription agreements within your organization. To help our community better overcome the obstacles created by these agreements, we’ve created a free financial model that has helped us gain a better grasp on managing various subscription agreements, preserving cash by cancelling unused tools in time, holding budget owners accountable regarding their tool stack and more accurately forecasting our cash flows.
In summary, our free comprehensive model will allow you to:
- Accurately forecast monthly, quarterly and annual cash-flows.
- Display spend by department, vendor and type.
- View upcoming renewals and associated costs by vendor, department and budget owner.
- Filter the dashboard view by cost-center location.
The model allows us to more granularly forecast our subscription spend and avoid using multiples or a historical average. It also preserves corporate resources as we are less likely to waste dollars on unused or underused subscriptions simply by revisiting agreements as their corresponding renewals approach - it prompts budget owners to investigate the utility of a tool/resource and determine if the value it creates is greater than its cost.
But wait, there's more.
Alright, we’ve figured out how to track the general terms and financial costs of your organizations various subscription agreements using our free template. But, how does your accounting team know how to amortize these expenses? Or how does Legal give their stamp-of-approval for the contract terms? What about budget-owners giving their employees approval to engage in another subscription service and eat away at budget? Who’s going to monitor the subscription agreement for renewal and make the decision when it’s time? What about company-wide subscriptions that are used across all departments - how does your company allocate this expense across departments?
There are all fundamentally important questions that any well-run organization must be able to answer. Thankfully, all of the above (and much, much more) can be solved by the Trace Platform. Request a demo!