Tl;dr: We are going to cover key SaaS terms like booking, billings, and revenue so you don’t have to pretend to understand them. As usual, I’ve also built an excel model to have a play with.
You probably understand some SaaS terms, but I bet you don’t really understand them all, let alone how to calculate them.
Don’t be bashful. You know it’s true. I wrote about the importance of asking dumb questions and one investor (who isn’t dumb) asked me to help explain key SaaS terms. Here is his question:
Run Rate, Recurring revenue, bookings, ACV etc. put everything in a shaker, drop everything in a deck and you confuse everyone 😉 You could post something to clear up the confusion given your experience?
So now we are going to go through key ‘top line’ revenue related SaaS terms and clear them up so you really get them.
Here is what we are going to cover:
- Accounting revenue
- Deferred revenue
- GMV (This is not SaaS but you need to get clear)
- P&L review
- Gross vs net revenue
- Gross profit
What we are not going to cover (everything else SaaS):
- CAC, LTV, payback time and churn. They are key points in SaaS and need their own articles
- More accounting terms like the difference between EBITDA and FCF and what breakeven means
I’m going to start this off with a simple, one-company example, then I’m going to illustrate this with extracts from a model I have made for you which has 9 companies with all sorts of different terms in their contract (You can download it the normal way in the download box on the page). Hopefully, if you can get the basics you can then understand when it gets a little more tricky. To be clear, the model I made is relatively complex actually, but I have stopped short of building a full-on model. If you want a full-on SaaS model, get the normal SaaS model or the crazy enterprise SaaS version.
Download the model for this SaaS blog
Just give me the big picture, dude
I get it… before you get into the weeds, you want to know what is happening. This is how I think too. So let’s do it.
To start with, I’m going to make the simplest example, whilst still accounting for some complexity. You sign Google for a 3-year contract, they pay $1200 a year and you bill them monthly. To make this a little more complicated, we are going to charge $1000 in professional services up front. So how do we turn these into the metrics we are going to learn about? Let’s find out now:
- Bookings: We are booking all the revenue from the sales contract. The sales guy is happy as his comp is based on that. 3 years at $1200 = $3600, that’s the main revenue. BUT, we also offer professional services, right? So we need to add $1000. $3600+$1000 = $4600. That’s also the Total Contract Value.
- TCV: See above. That’s the whole value of the contract, right. The TOTAL contract value. $4600. The TCV is different from the ACV in that it includes the ‘other stuff’. If you don’t have professional services, the calculations are a bit more simple.
- ACV: The annual contract value is the annual equivalent. So it’s basically just $1200, or the $3600 divided by three. ACV doesn’t include the professional services
- Billings: Billings is money in the bank. Bookings is money you are going to have, it’s like cash flow. So we are going to bill multiple times over the contract. We bill monthly so $1200 over 12 months is $100 per month in billings. We include professional services in the first month, so it is $100 + $1000 = $1100
- MRR: MRR is the recurring revenue we are getting monthly. So turn annual to monthly. We get $1200 a year and there are 12 months. So $1200/12 = $100 a month. That’s the MRR we get. MRR is just recurring revenue so it excludes professional services.
- ARR: ARR is sort of the same concept as MRR. It’s just the total amount of money we get per year from our MRR. That’s 12 x monthly revenue. We can calculate that by 12x MRR or just take the first year revenue. In both cases, it’s $1200.
- Revenue: ‘Revenue’ is the only top line item you have to report in accounting land. All our other terms just live in SaaS land. Whilst we like the metrics, the government doesn’t care. In most cases, it’s pretty much just your MRR. The key thing you need to think about is what money is going in the bank. Here, our first-month revenue is our MRR and our professional services, that’s $100 + $1000, or $1100. In the second month, it’s $100 = our normal MRR.
- Deferred revenue: I hate accounting, but it’s all about zen-like number balance. If you take money from Google and you need to keep delivering services you haven’t provided them, you ‘owe’ them services which have a $ value. That’s deferred revenue. Ignore the professional services as it’s paid upfront and we assume we deliver the value in the first month. The example I have shown doesn’t have deferred revenue, so there is zero deferred revenue. Let’s assume Google are paying annual upfront with the $1200 and NO professional services (to make the math simpler). The deferred revenue after month one is our billings ($1200) less our first-month revenue ($100). That’S $1200 less $100, so $1100. After month two, we are one-sixth through our billings, so it’s $1200 – $100 – $100 = $1000. If we divide $1000 by $100 we know we still have 10 months of value to deliver. That’s what this deferred revenue stuff is about. Frankly, no one cares about it other than bean counters ;). VCs don’t care and neither should you. Oh, make sure your accountant does, though…
Let’s see these SaaS metrics in a chart
First off here are all the assumptions and the answers.
Next, you can see the values charted against each other.
Ok cowboy. That wasn’t too hard was it?
Let me be honest so you don’t feel silly. I actually didn’t really ‘get’ these terms before I made the SaaS fundraising model. I knew of the terms, but I couldn’t explain them to you. It’s only when I actually did the basic math that I ‘got it’. Do the same.
Let’s dig into the terms now.
You know what revenue is, it’s like money, right? For most businesses like ecommerce where you just sell a shirt, revenue is revenue. Things are a bit more complicated in SaaS revenue as people may keep handing over those dolla bills, yo.
Well, revenue is an accounting term. Revenue is ‘recognized’ when service is provided to customers over time. Don’t want to throw nerd shit at you but revenue is recognized ‘ratably’ over the life of a subscription if you want to know the right word to use.
So say we’re offering annual subscriptions, each month we recognize just a portion of this money as revenue; 1/12 in case of our yearly plans. We get $1200 a year and there are 12 months. So $1200/12 = $100 a month
We’re not considering any kind of churn nor contraction here, but if clients churn out or switch to a lower priced package, your revenue will decrease.
You will account for revenue under either GAAP or IFRS. Here you can see Twilio show revenue growth under GAAP in the public software sector
Life is about to get boring…
Remember above we figure out that we are recognising $100 of revenue of that $1200 contract? What do you think happens to the other $1100?
The $1100 is deferred revenue. Deferred revenue gets smaller over time. It’s recognised as a current liability as deferred revenue on your balance sheet (Or it could be a long term liability if it’s over a year. Again, this is boring shit, get your accountant to deal).
Deferred revenue is the difference between your billings and what you have ratably provided. Basically, you have money in your bank account and you can spend it, but in accounting land, you haven’t earned the right to show it all.
Startups with a lot of yearly billing deals have high deferred revenue. People who just bill monthly don’t.
MRR stands for Monthly Recurring Revenue. You hear this term so much as it’s the reason SaaS is great. The whole recurring thing. MRR is a measure of your predictable revenue stream. You don’t include unpredictable revenue in it like one-off professional services.
If you charge annually, you convert the annual stuff into monthly.. because we are talking about monthly recurring revenue. Trust me, this is super easy to understand.
Annual Recurring Revenue.
Whenever people say their MRR to me, the first thing I do is times it by 12 to get what their annual revenue is. “So, Alex, we are doing $100k MRR“… Ok so they are doing $1.2m ARR. So they are about series-A stage, have a reasonable size team, have some PMF and prob looking to scale up around now.
You just multiply MRR by 12 to get ARR.
ARR is really simple. There’s just not much to it, if you calculated MRR right, anyway.
Oh, since I’m teaching you the basics… If you want to convert ARR to MRR… you just divide ARR by 12 😉
If you close a big contract you ‘book’ that all. Every dime they say they commit to paying you are booked. Boom. You recognise that booking typically when a contract is signed. When you recognise a booking matters- often a salespersons’ commission will be based on it.
Bookings are just a contract though. It’s the biggest figure. But it’s just a contract, there is still hope involved. You haven’t been paid yet (billings) and you haven’t delivered a service to the customer (deferred revenue).
Your bookings in any given month, is the sum of all the closed deals, regardless of different prices and length (bookings is the full duration of the contract). You don’t include any funky adjustments, credits, nor one-time charges.
What makes up a Bookings number?
- New Contract – this is new business, when you get a first-time customer
- Renewal – your client who was a new contract signs a new contract to renew their subscription. The implication being they haven’t churned
- Expansion – when an existing client starts paying more than they were in the old contract. Reasons for this are increasing prices, adding additional products they upsell to, buying more seats etc. Anything when clients hand over more $
- Contraction – when client doesn’t really use your product, but still uses it. They pay you less money by switching to the basic version, less features etc
- Churn – this is when your client is pissed and dump you for a new model. This is bad (no shit sherlock…)
In our Google example, we are booking $4600 for the 3 year contract.
Gross vs net bookings
Bookings can be gross and net. If you say gross bookings it’s an indication of how your sales and marketing teams are doing, but it’s pretty misleading as to how the business is actually doing. Gross bookings are like saying we filled this bucket up with water (sales) but neglecting to say there is a hole in the bucket.
Gross bookings are all the bookings you made in a month. Net bookings are a little more complicated as there are 4 main components.
- New client bookings – You get new customers who pay you (New customers not renewals). Note if you are dealing with big companies you may have multiple contracts with the same firm. New contract from an existing client is not new business
- Expansion bookings – existing customers pay more than they were before. Why do they pay more? An increase in the number of seats sold, buying new product features, or you jacking up the price before they renew their contract
- Contraction bookings – the opposite. They spend less by cutting seats, downgrading to the basic package etc
- Churn – bye bye customer. They have bolted with the money you were banking on to feed your cookie addiction
You want to track each element of the bookings.
Bookings vs. Revenue
A mistake some people make is to use bookings and revenue interchangeably. Yeah, no. Not the same thing, mate. But you should know that by now.
I’m going to make sure it’s clear anyway.
- Bookings is just a contract. It a contractual obligation to pay you. But that means jack till you are paid… so it’s not revenue. What exactly are you going to do if Google stops paying you your $100? Fuck all
- Revenue you get to show as accounting revenue as you ratably provide the service over the life of the contract. How and when revenue is recognized is governed by your bean counter under IFRS or GAAP, depending what country you are in
Oh, in case you are wondering… letters of intent (LoI) and verbal/handshake agreements are neither revenue nor bookings, they’re bullshit some dodgy geezers might use to inflate numbers to investors. Don’t be that dude.
When you get a bill you pay it, right? Billings is when you actually collect your customers’ money and it will be hitting your bank ASAP. In SaaS land people pay a month or if more, typically a year upfront. Yeah, if you are more enterprise, you can have say 3 year contracts though.
- If you only do monthly contracts, then your bookings and billings are exactly the same.
- If you have an annual contract, then if they pay you a year up front your bookings and billings are also the same.
- If you have an annual contract and they are billed monthly then you will book a year, but your billings will only be the first month because you are only getting paid that $100 now, right?
In our example, Google is billed $100 for the first month plus $1000 in professional services so $1100.
Do you get how bookings and billings are different now? Bookings is what we think we will get from a contract over time, and billings are what actually gets wired.
Now we are going to get into contracts. The two key terms are TCV and ACV.
When looking at contracts, you always want to put them in context to understand them.
- How large are they? Are you getting a few hundred dollars per month from your customers, or are you able to close large deals? Of course, this depends on the market you are targeting (SMB vs. mid-market vs. enterprise).
- Are they growing? If it’s growing, it means customers are paying you more on average for your product over time. That implies either your product is fundamentally doing more (adding features and capabilities) to warrant that increase, or is delivering so much value customers (improved functionality over alternatives) that they are willing to pay more for it.
Total Contract Value (TCV)
TCV is the same thing as ‘bookings’. It’s the total value of the contract. If you talk about the TCV you booked, you will have contracts of different length aggregated into that one number for the time period of say a month or a year.
Here is something really key to remember here. Make sure TCV includes the value from all forms of one-time charges, professional service fees, and recurring charges. It is the big number you are ‘sure’ on.
The only thing you do not include in TCV is usage charges. Huh? If you are Zapier, you have no idea how many zaps people are actually going to use right if you are charging on a variable basis. You can’t put a TCV on something which is a moving target, right?
Take a look at Twilio here. They spell out their variable revenue:
- Large customer accounts with no commitments
- May have significant usage fluctuations
How companies manage this in forecasting, I have no idea. Sure they just stick a finger in the air with heuristics from empirical data, but it’s ignored in accounting land.
I find TCV a funny term since it is the same as bookings. I think it’s just more specific. You emphasise that the number you are talking about is the total of everything you booked, like it makes sure everyone knows what we are talking about here. Also, I’m being prescriptive with definitions here. People actually have all sorts of definitions of terms. There is no authority who said this is what the SaaS terms mean. So what I am explaining is what I personally think are the right definitions. So just be aware of this when talking to people, if it matters, to ensure you both are using the same definition. Assumptions are the mother of all fuck ups.
In the Google example the TCV for the client is $3600+$1000 = $4600.
Annual Contract Value (ACV)
ACV is the value of the contract over a 12-month period. We are back to ARR to MRR land again in a way, but it’s for a year not for a month. And in the same strain, ACV doesn’t include all the one-off stuff. It is plain vanilla revenue.
In the Google example, the ACV is the annual equivalent. So it’s basically just $1200, or the $3600 divided by three. ACV doesn’t include the professional services.
What do ACV numbers look like?
I found this post on Quora from 2014 (which is a while ago) but anyway. Thought it would be interesting to see.
- HubSpot — ACV $6K-$10K: This is a guess based on public pricing. It’s closer to the lower end of that, I believe, given the target audience.
- Marketo — ACV $15-$30K. I am a customer. I’d expect downward price pressure, since they’ve launched an SMB product.
- Zendesk — ACV $400-$900: Guessing most customers are still 2-3 users.
- Bazaarvoice — ACV $135K: From S1- $135k revenue/client in 2011  (disclaimer: I work here).
- Salesforce — ACV $15K: in 2004, had 11k customers, run-rate $162m in revenues.  (disclaimer: I used to work there).
- Box — ACV $300-$500: probably 1-2 user average.
Gross Merchandise Value (GMV)
GMV is not a SaaS term. You use it in marketplaces (frequently used interchangeably which is annoying and I think some founders do it on purpose to mislead you) and in ecommerce. Just want to make sure you understand that GMV does not equal revenue!
- GMV is the top of the top line revenue related number. It is the total sales dollar volume of whatever you are selling. Put it this way, if you buy some shoes on eBay for $100, eBay does not make revenue of $100. They just take a rake on it. It is useful in marfketplaces to understand the volume of transactions that are happening, implying it is liquid. You can also put a run rate on GMV.
- Revenue is the rake (share) of GMV that the marketplace actually charges the seller. If eBay has a 10% rake, they get $10. Revenue is a sum of the total fees that eBay charges as services, including transaction fees (based on GMV), listing fees, ad revenue, premium placement etc. Revenue is NEVER larger than GMV.
Whilst we are at it, I thought to cover a couple more terms and explain a few differences. See this P&L (Profit and Loss) extract from my SaaS fundraising model. Go line by line and you can see where all the key line items are.
Gross and net revenue
Gross and net revenue are quite often the same in SaaS. There is a larger difference in ecommerce where you are more likely to see discounts and vouchers.
In my P&L above you can see there is a line item to deduct for the discounts and vouchers. This is only useful to see how much you are making before you are discounting. Yes, typically most SaaS companies offer a discount on an annual package (often 1 to 2 months) but it’s not really the same thing. Listing vouchers on some coupon site is more what I am talking about.
Now, the other line item you will have to get to net revenue is if you have partners which take a clip on your revenue (e.g. you have a partner in China). If you do affiliates, I put those costs in the marketing expense as it is actually a marketing channel. I’m not an accountant so if you are and have a view, let me know in the comments so I can clarify this for everyone. Cheers.
Ok, what’s with the cancellations line item? Again, cancellations are something you see more often in ecommerce. It’s when people make an order and then cancel it, so you deduct it out of the revenue. In SaaS, this could be if a customer gets angry and you refund them. I have the line item in case there is a specificity in your business model where you need it (to make the model flexible for everyone). It’s not a very common line item.
We got down to net revenue after cancelations. Now we have something important. COGS. Your gross profit margin matters. The difference between your net revenue and gross profit is your COGS. These include servers, customer success etc. I’m not doing a blog on COGS (which it needs to do it right as most people don’t understand it). Here is Twilio showing their main COGS costs.
Profit is not the same thing as revenue. You have pesky costs. Whilst investors care about the top line revenue related figures we have been digging into, ultimately they want to understand how profitable you can be. First stop on the profit train is your gross profit. If your gross margins are low then you have a crappy SaaS business. Your COGS are fairly likely to scale with your revenue so you want it small. The great thing about SaaS is that as you scale your margins ‘should’ get larger. You only need so many developers etc, so many of your costs should remain fairly fixed. You just need to hope to hell your marketing CAC doesn’t balloon as you scale (hard).
And to be clear, marketing gets MORE expensive not cheaper… A lot of people think their CAC will decline.
Here is Twilio showing that acquiring customers efficiently matters:
Why does marketing have it’s own line item?
OK, marketing can be scaled up and down. You spend more, you grow more. You spend less and hopefully you have control over profitability. By explicitly showing your marketing cost you show you know this fact.
How do you get to EBITDA?
In short, you have G&A, R&D, and S&M. Those are bunched into OPEX. Frankly, no one gives a toss about anything after EBITDA. You can see Twilio map out their OPEX here:
Average Revenue Per User (ARPU)
ARPU is your end of month MRR divided by the number of users you have in a specific time period (month, quarter, or year). ARPU matters as it demonstrates the value of users regardless of what they buy.
Note, some people call it Average Revenue per Account (ARPA).
It is best practice to split ARPU/ARPA down more. You could have your aggregate ARPU and your new customer ARPU. So you end up with more metric terms such as: Average Revenue per Existing Account and Average Revenue per New Account.
Breaking out your ARPU/ARPA metrics helps you see how things are evolving in your new customer behave viz a vis the existing ones. You may be able to dig int and see whether customers are more willing to accept cross-selling or being up-sold to high packages. The way of calculating ARPU is basically the same, you just need apples for apples, so only new customer revenue over new customers.
Let’s get more complicated
I told you I made a model for you to play with. I kept the above restricted to one simple Google example as I want you to get the basics before you start dealing with how complicated this can all get.
The assumptions in the model are:
- I have made up 9 clients
- You get one new one every month
- They have random payment frequencies (Think billings)
- They have different contract lengths from one month to 36 months
- Some have professional services
- There are three pricing points- basic, premium and pro
Things to note:
- This is not a full SaaS model. The math is way more complex
- No churn at all so everything renews
- There is no upsell – so no contraction/expansion on pricing
Yes, the model is dynamic. You can change the assumptions. This actually wasn’t easy to build at all, btw. I haven’t spent time making sure everything is absolutely perfect, but it looks like things work right. I’m actually going to show you some scenarios so you can see how things change.
So below you can see the assumptions (download the model… and play).
Now we can see a summary of all the key metrics.
Then we have the MRR and the ARR. You can see that you are adding new MRR and ARR each month like a waterfall.
You will notice that in the annual columns that MRR is the same in every year. That is because we get all that MRR in 9 months, we have no new clients after, there is no churn and no upsell. It will stay the same. The same is for ARR since ARR is just MRR times by 12.
Bookings and billings
I have added three clients who have professional services. They are all one off and happen in the first year. The implication of that is what? Come on, have a think. Yeah, bookings will be higher in the first year. We have $600k of professional services.
Now let’s look at bookings. The big number comes from Blue Apron. They are booked for $1740 as they have a 3-year contract. If you look at billings we make the same in the bank each year, other than the first year due to PS.
The next one is Zuora who have a two-year contract but also have professional services. The first year of bookings is for $680. There is nothing in the second year booked and in the third year we get them for $480.
Next, for illustrative purposes look at Facebook. They have one-month billing and a one-month rolling contract. Bookings and billings are exactly the same.
Finally, if you’re wondering why Microsoft and Ola have lower bookings and billings, it’s because they come later in the year and you haven’t milked them for much money yet due to the contract structure.
The last section we are checking out is the revenue and deferred revenue. We are back in accounting land now.
Ok, you will notice that revenue is larger than MRR in the annual boxes. I’ve just shown the run rate MRR and in the revenue, it is the sum.
The deferred revenue changes every month, but in the annual calcs it shows as the same number as I’ve calculated the year end number.
To calculate deferred revenue I take the billings and then deduct the rolling sum or revenue and professional services.
Let’s see how things change in charts
I’ve chucked in a bunch of variables here by making a variable (or all) basic, meaning monthly contracts and payments terms. You can see the differences mainly by seeing where spikes happen.
This chart is the basic assumption in the model. We have random terms.
So what does this look like:
- MRR adds up quickly over 9 months so ARR flats out once MRR stops growing and flat lines. This will happen in all scenarios
- Bookings have a big spike because of Blue Aprons’s 3 year contract
- Revenue slowly increases and then flatlines
- Billings and bookings spike depending when you have multi-year contracts
Contract length set to 1 year
In this scenario, all clients have a monthly contract, but the payment terms are as before.
You will see that all the big bumps have gone from bookings. You don’t get big booking bumps if you don’t have longer contract durations. Everything else is the same.
Payment length set to 1 year
If payment length is just one month, then you still have the bookings bumps, but everything else flattens out pretty sharpish. You don’t have any deferred revenue when you are booking and billing the same amount each month.
Payments and contracts to 1 month and professional services
In this case pretty much everything is smooth. The only bumps we have are in billings becuase there are professional services. Revenue is not deferrred so it’s flat lines to zero the whole time. MRR and revenue are the same thing.
Payments and contracts to 1 month and no professional services
In this example there are no bumps anywhere. Most of the line items are the same. Revenue, bookings and billings are all the same. Deferred revenue is zero. ARR is what it always is.
TBH, I kind of blew my wad explaining how all the terms work in the basic version. Explaining the complicated version with the model seems a bit like duplicating myself and ain’t nobody got time for that. Hopefully looking at the ‘bumps’ in the charts you can see the differences in various scenarios of payment frequency and contract length
So if you read the above, what you should do is download the model and then have a play with it. Put in different assumptions and see how shizzle changes. It’s not that complicated but you need to really ‘get’ it to understand this all. As I admitted, I didn’t ‘get’ all this till I forced myself to break it down for you.
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