Subscription-based business models are becoming increasingly popular in the ecommerce industry. And it’s easy to see why. These models can mean predictable revenue, data for insights, as well as the potential for scalability. Moreover, they can help with retention through recurring engagement, while lowering customer acquisition costs.
Despite this, subscription billing can pose a number of accounting challenges. These include billing discrepancies, navigating multiple payment methods, and issues with revenue recognition and reconciliations.
Thankfully, with years of experience in ecommerce accounting, we’ll guide you through the best practices for subscription billing to help you navigate these challenges.
The Specifics of Subscription-Based Ecommerce
Subscription-based models receive recurring revenue from payments made at regular intervals, in exchange for access to products or services. This can make for a predictable income generation, and accurate forecasting, as you’re not only relying on one-time sales.
And if you offer a variety of subscription models, you have the added advantage of flexibility and customization. This is a great way to upsell and boost your income, and means you can tailor your offerings to your customer needs.
But with these benefits come potential pitfalls. Notably, reconciling subscription payments can be complicated, especially with tiered offerings. After all, you need to ensure that your business meets accounting standards like ASC 606 for revenue recognition, which necessitates accurate record-keeping and reporting.
Without adequate billing systems and processes, if a client up- or downgrades their subscription, or their payment fails, it can wreak havoc with your books.
Reconciliation Challenges
The downside of having subscription-based income means that your company may have varying billing cycles, as customers can subscribe at any time. Managing and reconciling payments across different intervals can be tedious, particularly if your subscribers change their plans mid-cycle. In fact, changed subscriptions may lead to credits or refunds, or prorated billing, which need to be billed correctly and recognized appropriately.
Another factor to consider is how your subscribers pay. Using different payment channels requires data integration and synchronization from multiple sources. Similarly, if a customer’s payment fails because of an expired bank card, insufficient funds, or a technical glitch, your records need to reflect this.
And then there’s churn management. Reconciling the rate at which your subscribers cancel their subscriptions, involves accurately tracking customer data and implementing mitigation strategies to prevent declining revenue and profitability.
Streamlining Subscription Payments
With an effective strategy in place to streamline your accounts receivable, subscription-based payment reconciliation is much easier. But how do you do that?
Consolidate invoicing
Rather than sending separate invoices for each billing cycle, consolidate them for subscribers who have multiple subscriptions. That way, you reduce your administrative overhead.
Communicate effectively
Clearly communicate your billing cycle information to subscribers in advance. This includes payment reminders and notifications of any changes to your billing cycles.
Provide flexible billing options
Where possible, be flexible with your billing cycles. For instance, you could give subscribers the choice between monthly, quarterly, or annual billing.
Use technology
With accounting software like QuickBooks or NetSuite, you can automate a variety of accounting processes, from payment alert reminders, to reconciling your accounts and billing schedules. This can help with matching payments to invoices, flagging discrepancies, and generating reports for further analysis.
There are several benefits to automation, including eliminating errors and delays, quicker approval processes, increased accuracy, and reduced costs.
Embrace payment gateways
Payment gateways can make or break billing practices for subscription-based models. Your chosen method gateway must support recurring billing, and include features like automatic card updating and retry logic.
Of paramount importance is that any third-party payment platform must be able to integrate with your existing accounting software. This will allow you to automate financial reconciliation and reporting, and ensure that your data is accurately recorded and synced across systems.
Revenue Recognition Best Practices
Accurate revenue recognition is crucial to a subscription-based model. It involves recognizing income earned over the subscription period, rather than at the point of transaction. This can help with financial analysis, and improves investor confidence and valuation.
However, determining when and how to recognize revenue can be tricky. After all, it differs depending on whether you’re using the cash or accrual accounting method.
With the cash accounting method, revenue is recognized when cash is received from subscribers, regardless of when you provide the goods or services. The accrual accounting method recognizes revenue when it is earned, no matter when the money is received.
Despite this, the IRS requires any company making over $25 million in sales for three consecutive years to use the accrual-based method.
As mentioned above, it’s also vital that your revenue recognition complies with accounting standards for transparency and consistency in your financial reporting. It’s therefore important to establish clear policies and guidelines for recognizing revenue that factor in your billing cycles, contract terms, and subscriber use.
Handling deferred revenue
With a subscription-based model, you’ll have to deal with deferred revenue. This is essentially an advance payment for products or services that will be delivered later. It can make accounting challenging, and requires careful tracking and reconciliation to ensure accuracy.
There are several ways to handle deferred revenue. These include:
- The straight-line method, where income is recognized evenly over the subscription period.
- The usage-based method recognizes revenue as the service is consumed, rather than evenly over time.
- A tiered pricing method accounts for subscribers who pay different fees based on the features or tiers they choose. Here, revenue is recognized based on the subscription plan chosen by the customer.
No matter the method you choose, with the right accounting software, handling deferred revenue can be simplified through automation.
Alternatively, you can alleviate the headache of revenue recognition by outsourcing your accounting. That way, a specialist can handle the complex transactions and ensure regulatory compliance, while you focus on the bigger picture.
Customer Churn Analysis
Analyzing customer churn, or the rate at which subscribers cancel their subscriptions, gives you valuable insights into customer satisfaction, product performance, and overall business health. Although a subscription-based model has a steady and predictable income, it can come with high churn from cancellations.
This will have a direct impact on your revenue. High churn rates can mean declining revenue, making it difficult for your business to sustain growth and profitability. And because it’s often more expensive to acquire new customers than to retain existing customers, analyzing your churn can help to identify opportunities to improve subscriber satisfaction and enhance product offerings. If you need assistance with this, a business mentor or coach can help you make sense of your data to maximize customer retention.
The impact of churn patterns
Tracking and analyzing churn are essential for understanding customer behavior. This can be done in a number of ways:
- Segmentation analysis separates your subscribers based on demographics, user behavior, or subscription plan. That way, you can identify patterns within different groups, and compare them for insights into which segments are most at risk.
- Survival analysis techniques can help you analyze churn behavior over time, to understand the probability of churning at different points in a subscription lifecycle and identify risk factors.
- Sentiment analysis involves analyzing customer feedback, reviews, and support interactions for insights into the reasons for churn. This allows you to address underlying issues and improve customer satisfaction.
- Cohort analysis requires tracking groups of subscribers during the same time period and analyzing their behavior. This can give you insights into the impact of changes to your products, pricing, or marketing strategies.
However, without accurate data, it’s impossible to do a thorough churn analysis.
Data Validation and Quality Control
Data isn’t just important for your financial reports and effective decision-making. It can also be used to reflect customer trust and satisfaction. After all, your subscribers expect accurate billing and timely resolution of any issues.
But in order to do this, you need quality data.
Identifying and rectifying data discrepancies
With the right strategies in place, you can easily ensure that all your data is valid and accurate.
For example, you can run automated data validation checks to highlight any discrepancies. This includes verifying customer information against databases, validating payment transactions, and flagging issues.
Another way to ensure quality data is to conduct internal audits. Regularly review your customer records and billing information, by comparing it across different systems, reconciling transaction logs, and verifying the accuracy of your statements.
Data cleansing is also vital. This means standardizing data to ensure consistency and accuracy. For instance, you can remove duplicate records, correct formatting issues, or update outdated information.
However, this requires internal controls and standard operating procedures (SOPs) that outline exactly how data should be formatted, stored, and shared.
Communication and collaboration
Because data comes from a number of sources, and possibly different departments, cross-functional collaboration is essential. This includes aligning goals across departments, and creating a feedback loop. That way, you can troubleshoot and optimize data practices across departments.
Compliance and Data Security
In addition to the regulations surrounding revenue recognition, subscription-based e-commerce businesses must comply with a number of other regulations.
These include the Payment Card Industry Data Security Standard (PCI DSS), which outlines how to securely process, store, and transmit cardholder data. Also, if you operate in California, be aware of the California Consumer Privacy Act (CCPA), which requires providing subscribers with rights to access, delete, and opt-out of the sale of their data.
As such, data security measures are crucial. This includes encryption of sensitive data, implementing access controls, and regular internal audits. Failing to secure your data can have legal repercussions, and also negatively impact your customer trust, and your reputation.
With this in mind, it’s best to constantly review your reconciliation processes, to ensure that they are compliant and streamlined.
For help managing the accounting of your subscription billing, or to speak to an expert about best practices, schedule a Discovery Call with one of our CPAs.
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