SaaS revenue is a complex topic that warrants your attention regardless of where you are in your startup’s lifecycle.
Whether funded or trying to bootstrap, you need customer revenue flowing into the business. Otherwise, how would you finance day-to-day operations or invest in talent, new features, and process improvements? Or, perhaps most importantly, prove that people are willing to pay for your product?
Some of the many SaaS metrics and variables are under your control, and some are mere indicators requiring strong steering from the management team. Proper management of cash and revenue requires an understanding of what’s going on in terms of customer contracts (bookings), revenue (recognized in financial statements), and billings (invoicing and cash).
These similar but different terms all link to customer contracts and the money coming into the business. They’re essential for piloting the financial health of your business and managing cash.
Bookings is an important non-financial metric. It doesn’t directly impact your startup’s cash flow or bottom line but reflects customer commitments to you and is normally shown as the value of the contract for the current year (Annual Contract Value — ACV for short) or total contract value (TCV). Either is fine, but your reporting must be consistent for the KPI to be meaningful.
In the month that a customer signs a new contract, you report the bookings. For example, in May, after signing a two-year contract for $24,000 TCV, paid every three months in $3,000 installments, you’d report bookings of $24,000 (or $12,000 if you’re reporting ACV).
Tracking bookings over time can help you assess your startup’s growth trajectory. Stable revenue coupled with a downtrend in bookings might indicate future cash flow issues. This downtrend might be coming from attracting fewer customers, shorter contract lengths, or decreasing prices.
Billings is the SaaS term for the money you’re owed in the short term, as it’s typically been invoiced already. Understanding the differences in bookings vs. billings will help you better manage your revenue streams. This KPI is essential for planning the cash you’ll be collecting each period.
Continuing the previous example, since the contract was signed in May, we will invoice $3,000 in May, August, and November.
The billings accounting would look like this:
High bookings but low billings mean you’re pushing cash collection out to future periods. While your customers may appreciate this, it points to future cash flow issues and is unsustainable over the long term. Robust cash collection practices are critical to ensure liquidity and enable long-term growth.
Revenue is a financial metric reflecting money exchanged for a service provided. A business can have high profitability on paper (or in your financial reporting) and still run out of money for operations. However, don’t confuse revenue with cash on hand or cash received.
Revenue mainly affects your business’s profitability, as shown in your financial statements. Because companies typically pay taxes on profits, revenue and its profitability impact also affect your taxes. Improper reporting might cause your taxes to be too high or too low, leading to overpayment or penalties for underpayment.
But getting revenue recognition right can be tricky, especially for SaaS businesses using accrual-based accounting (which you probably should be doing, but that’s a conversation to have with your accountant).
Learning the concepts behind balance sheet accounts, deferred revenue, and revenue vs. billings will help you better understand your SaaS’s profitability and why upfront payments don’t equate to massive profits.
Bookings and billings are essential metrics to follow, but you can’t rely on them as sole business performance indicators. Because of the frontloading that occurs when you’re paid in advance, it will look like you’re doing better than you are.
Let’s return to the example above and the $24k contract you signed in May. Imagine that because of your great service and attractive discount, you convinced the customer to pay annually in advance. That means in May you:
A novice might think: “Hey! We collected $12k in cash, so revenue must be $12k.”
Not so fast, though!
Doing that would make the single month look very profitable, but what about the next 11 months? There will be salaries, rent, and web hosting services to pay and reflect in your monthly financial statements. And those months will look pretty dreary without revenue to cover those costs.
Here’s where that balance sheet account plays an essential role.
Deferred revenue is money you’ve invoiced but haven’t earned yet.
Accounting principles (GAAP and IFRS) state that revenue is only recognized once you’ve delivered or met your contractual obligations (i.e., granting access to your service). Until you’ve done those things, the revenue is at risk. Even with a long-term contract, the customer can cancel, and you’ll need to refund the money.
The deferred revenue concept is fundamental to SaaS and other service contract businesses but often not intuitive at first glance.
In the example above, the correct revenue recognition for May would be $1,000. The remaining $11,000 will stay in the deferred revenue account on the balance sheet. Each month, $1,000 will be booked from the balance sheet to the revenue account and recognized in the P&L each month.
Recognizing more revenue than you should inflates your revenue (and profit) figures, making it look like you have more money than you do.
Although revenue is a calculated metric in accrual accounting, improper recognition could mean that you’re providing your service for free later on. Or at least it would look that way from a financial standpoint because there’s no revenue left to cover your costs.
Your accountant can help you set up systems and tools to prevent this.
In a digital world, cash is still king. To constantly improve your service and grow your business, you need it to come into your business early and often. Understanding billings is the first step to improving cash flow through pre-payments or automated monthly payments.
Because even if you start with outside funding, any startup’s goal is to become self-sustaining. To do that, you need to generate your own cash and work towards profitability.
Assuming you have solid bookings and excellent products, how can you increase billings and improve cash flow?
Encouraging customers to pay upfront for a whole year ensures you have the cash necessary to meet their needs. You can often drive them in this direction with discounted prices, “free” extras, or upgrades.
The extra cash in the bank is worth more than the future reduction of monthly revenue or gross margin impact.
Getting paid in advance is especially critical when you’re first ramping up or if you experience a sudden increase in bookings. Depending on your SaaS business, you might require a lot of resources for customer onboarding and support, driving higher costs. But not billing right away increases the risk of a cash flow crunch or overworking your staff because you can’t afford to build out the team.
Convert your existing monthly contracts to annual contracts.
Monthly contracts can be attractive to customers and a nightmare for companies for the same reason — the freedom to cancel anytime.
Push monthly customers to an annual plan through small discounts or other incentives, i.e., locking in prices before an increase. Once they’re satisfied with your product, this should be easy. They may even be happy to switch!
Every single day counts when closing a big deal. Invoicing as soon as possible means the money ends up in your bank account sooner.
Cash in the bank is essential for continuing to provide excellent services.
Also, SaaS invoicing can be a headache, so use tools to track billings and invoicing. Failed payments and expired credit cards cost you money, and inaction means the money, and maybe the customer, is gone. Baremetrics has Recover, an automated solution to help manage failed payments.
Tracking and forecasting billings manually is a challenge, but Forecast+ gives you the tools to do it better.
Here’s how you can bring billings into Forecast+:
This worksheet helps you manage your bookings and billings and accurately forecast your revenue.
Are you satisfied with your SaaS company’s cash flow? Regularly forecasting your revenue metrics like billings and bookings can help you better plan your cash flow.
Try Forecast+ by Baremetrics for free to experience how better revenue tracking can benefit your SaaS.