One of the first steps to gaining proper financial insight into a SaaS business is correctly modeling out how revenue flows through the company. With that, you can much more accurately gauge revenue performance through these metrics.
The following is an explanation, at a high level, the different ways to view revenue. In future posts, we will dive into further detail on properly tracking and calculating each as they can get quite complex.
All revenue starts with the booking, specifically when your sales team converts an opportunity to a paying customer. That being said, a contract or multi-month commitment isn’t necessary — having a customer sign up to your service through a month to month recurring billing process still counts.
Bookings is important to track because it most prominently measures the performance of your sales organization, especially over time. Despite not properly adhering to proper accounting practice, many companies retain a view of their bookings over time specifically to be able to measure their sales effectiveness and efficiency.
2. Recognized Revenue (Accrual)
Now that the booking has been made, you’ll need to record it properly in your books. Let’s hypothetically imagine that you book an annual contract paid upfront. GAAP (Generally Accepted Accounting Principles) standards mandate that you don’t get to recognize that revenue until the service/product has actually been delivered to the customer. Therefore, each month that goes by, a portion of that revenue gets recognized by the company until the contract is complete. This is typically tracked in your accounts receivables and forms the basis of proper accrual-based accounting — something that is essential for accurate financial planning and analysis down the line, in addition to being compliant with accounting standards.
When the booking is scheduled out for the period of the contract, what happens to the revenue that hasn’t yet been recognized? This is recorded as deferred revenue and is simply a balance of all revenue that you expect in the future, but have not yet delivered the service/product.
This is a huge topic in itself, that cannot be fit into just this one article.
Finally, at the end of the tunnel is when the cash actually deposits into your bank account. When tracking cashflow, you would record when the actual cash is collected. This may be soon after the contract is signed, or even months on out. Invoices typically come with payment terms and due dates that specify the time given to make the deposit.
Remember though, that even though you may have collected the cash, you still cannot recognize the revenue until the service/product has been delivered. Representing cashflow with revenue is a rookie mistake!
However, that doesn’t mean cashflow is not important. Cash is essentially the lifeblood of the company. Knowing how it comes in and goes out of your organization is extremely important in staying out of trouble. Correctly monitoring revenue recognition and deferred revenue can even help you predict your cashflow into the future.
4. Revenue Performance
As a subscription business, performing revenue recognition is not quite enough to measure actual performance of the company. We’ll have to step outside GAAP and accounting altogether to get an idea of how well your subscriptions are growing. The SaaS community have come up with a metric representing this — MRR or monthly recurring revenue (some prefer to look at this annually or ARR). It is simply calculated as the total revenue expected from customers every month.
The idea of MRR is closer to bookings, except the bookings are amortized out for the duration of the period you are tracking (monthly or annually). MRR can help predict growth, in conjunction with a variety of other important SaaS metrics such as churn, LTV, etc.
As you can see, each revenue view offers a very different but equally important look into your business. Having knowledge of all of them will help getting insights and drive better decision making.
These summaries are only the tip of the iceberg however. Topics such as MRR and revenue recognition can get quite complex and we will be addressing them individually in other articles.