What exactly is this guide about? Well, an alternate title for this post could be: The complete guide to understanding the relationship between SaaS sales, bookings, billings, cash, revenue, MRR, and ARR.
At their core, SaaS revenues are simple. You sell 100 subscriptions at $100/mo, you make $10k per month or $120k per year. But as your business grows more complex, your sales team, finance department, and investors will all focus on different aspects of your revenue. In this post we’ll use a simple example to explain what all these different takes on revenue are, how to calculate them, and why they matter.
In our example, we sell a $60,000/yr annual subscription. To keep things simple, we’ll assume we sell one subscription per month and everyone always renews. Let’s also assume our customers pay us in one lump-sum payment, but it takes two months to receive payment from them. Finally, it takes three months of consulting, customization, and configuration before customers can actually start using our service.
How does all of this impact revenue? Well, depending on which way you’re looking at it, in January 2017 you could be talking about:
$120k in bookings
$65k in MRR
$60k in cash
$50k in recognized revenue
Let’s take a look and see why.
We’ve also created a SaaS Revenue Guide model (click to open model) you can use to explore the concepts below using different values that apply to your business.
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Bookings are perhaps the most straightforward way to look at revenue. They are simply a reflection of what you sold. If you sell a $60,000 annual subscription, you have booked $60,000 in revenue. A $5,000 monthly subscription? $5,000 in revenue. Two-year $120,000 subscription? $120,000. Bookings are simply how much customers have agreed to buy from you. Because you’re looking at the full value of your subscription contracts here, this is called Total Contract Value (TCV) Bookings.
One twist is often applied to bookings, especially in sales organizations. To make an apples-to-apples comparison of how your company is growing each month, bookings can be looked at in terms of their first year value, or Annual Contract Value (ACV) Bookings. This is often the number used to determine quotas and commissions. In an ACV Bookings view, a $60,000 annual subscription, $120,000 2-year subscription, and $5,000 monthly subscription are all considered $60,000 worth of bookings – the amount of sales they’ll generate in the first year.
Let’s look at January 2017 from a bookings perspective. 1 new $60,000 subscription was sold, so there’s $60,000 in bookings from that. And one subscription sold the year before renews, for another $60,000 in bookings. Because it’s an annual subscription, the TCV and ACV Bookings numbers are the same.
Jan 2017 Bookings: $120,000
Cash is another pretty straightforward way to look at revenue. When you’re selling monthly subscriptions charged to a credit card immediately when someone subscribes or renews, cash is basically the same as bookings – you receive cash for the subscription price when you sell it. However, as you get into different subscription and contract lengths, and higher priced products, cash and bookings often become very different for two reasons: billing and collections. Let’s take a look at how those two elements impact cash revenues.
Billings: When someone signs a one-year subscription contract for $60,000, you book $60,000 in revenue as described above. And you could bill them for all $60,000 in one lump sum. Or you could agree to bill them $15,000 per quarter. Or $5,000 per month. Obviously, this part of your agreement will have a direct impact on when and how much cash you receive.
Payment terms and collections: For larger deals, it’s common to have terms like “Net 60” which means the customer has 60 days to pay their bill/invoice. And not everyone pays right on time. The delay in actually receiving cash you’ve billed people for due to payment terms and collections delays is very important to take into account when modeling your cashflow.
So now let’s take a look at January 2017 from a cash collections perspective. Because we receive a lump sum payment for the contract 2 months after we bill the customer, we receive $60,000 in cash for the subscription we sold in November. Even though we have bookings from selling both a new subscription and one renewal in January, we won’t see cash from those sales until March.
For comparison, here’s what our cashflow looks like if we switch the agreement from one lump sum payment to four quarterly payments of $15k.
Jan 2017 Cash Collections: $60,000
When your CFO or accountant talks about revenues, they are usually talking about GAAP (Generally Accepted Accounting Principles) revenues, or recognized revenues. Some of the articles linked at the end of this post go into more depth on this, but put simply it’s what financial accounting rules say “counts” as revenue. So what counts as revenue to accountants? It’s when you’ve delivered the product or service that you sold. There are countless nuances to recognizing revenue that differ for each individual business, product, and sale, but for most SaaS sales there are two key factors involved in revenue recognition:
Delivery start date: In a self-service monthly subscription where someone signs up and starts using the service right away, you start recognizing the revenue right away. However, in larger deals there’s often a phase of implementation/customization/configuration/etc before the customer starts using the service. In our example we have a 3-month implementation period before usage starts, so we have to wait 3 months before we start recognizing revenue.
Delivery period: In a monthly subscription where you charge for one month of service and deliver one month worth of service, you recognize revenue for one month. Simple. But with an annual subscription, even though you may bill and receive payment for the whole year up front, you have to recognize that revenue over the period you deliver the service. In our example, that’s twelve months, so we recognize 1/12 ($5,000) of the booked revenue each month.
One more important concept that I’ll mention but not go into here (it’s covered in some of the linked posts below) is deferred revenue. That’s simply the difference between the amount of revenue you’ve booked and the amount of revenue you’ve recognized. So, after the first month of a $60,000 annual contract, you have $5k in recognized revenue and $55k in deferred revenue. That basically means you’ve earned $5k of that business and still owe $55k worth of service to customers. The linked articles discuss in detail what deferred revenue amounts and trends tell you about the state of your business.
In our example we’ve booked $120k in January 2017 revenue and received $60k in cash. How about recognized revenue? Well, we’ve started providing service to the customers who subscribed through October. The November through January sales are still in the setup period. So that’s 10 subscribers we’re recognizing revenue from, at a rate of $5k per month, for a total of $50k in recognized revenue.
Jan 2017 Recognized Revenue: $50,000
Now let’s switch gears from the financial/accounting view of revenue to the SaaS-centric view of revenues. This is all about active subscribers, and how well we’re doing at gaining new subscribers and retaining existing subscribers. From a SaaS perspective, an active $5,000 monthly subscriber and an active $60,000 annual subscriber are both worth the same to us in any given month – $5,000 in monthly revenues. What Monthly Recurring Revenue (MRR) does is standardize all the different subscription terms in your business into a monthly subscription amount so you can compare the growth in your business in terms of subscribers, regardless of what type of subscription they sign up for.
In our example, we are selling one new subscription each month and they all renew, so in January 2017 (our 13th month) we add our 13th active subscriber paying $60k/year, which is equivalent to $5k/month, resulting in 13 x $5k = $65k in MRR.
You’ll often see references to ARR or Annual Recurring Revenue. Getting that is actually as simple as it sounds: just multiply MRR by 12 to get ARR.
Jan 2017 MRR: $65,000
Finally, let’s take a look at all four SaaS revenue charts together:
If you’re interested in reading in more depth on this topic, here are a few good articles discussing the meaning of these different takes on your revenue, why they are important, and how to analyze them to understand the state of your business better:
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