Musings about Bookings vs Billings vs Revenue

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Hi everyone,
NTNX had a fair amount of discussion about about billings and revenue ratios. I started to look into it which lead me down the rabbit hole. My understanding of bookings, billings and revenue are below.

Non-Saas Company Bookings, Billing, Revenue.
Bookings – The money customers have committed to paying. For example, a customer comes to you at the beginning of the year and says we want 20 widgets at 1 dollar a widget over the next year. They would have booked 20 dollars with your company . In january you would have booked 20 dollars, 0 dollars in billing and 0 dollars in revenue.

Billings – The money you’re currently owed. Your company has already made 5 of the widgets and delivers to the customer 5 of the widgets in february. Now You have 5 dollars of billings in february, and 0 dollars in bookings, 0 in revenue.

Revenue – The money exchanged for the service provided in that time period. In march your company is still making the additional 15 widgets, has delivered 5, and receives a payment for 5 dollars from the customer for the widgets delivered in February. So in March your company has 0 dollars in bookings because you haven’t booked any more business, 0 dollars in billings because you haven’t sent company A another bill yet because you are stilling making the additional 15 widgets and 5 dollars in revenue because company A took their sweet time to send you a check.

In this example the company is extending the customer leverage (per my non academic definition of leverage) In the next example the customer is extending the company leverage.

SaaS company Booking, Billings, Revenue
Now here is the interesting thing about SaaS companies. They flip that whole thing on the head. Typically a SaaS company is collecting the money for a service up front or in advance of the service. In the widget company above you notice that the company was Booking the business, then billing for the service, and then finally receiving the revenue 3 months later. A SaaS company is a different animal, the following is just one example. Customer A comes to the SaaS company and signs up for a year of service. The service costs 15 dollars a month or the customer can sign up for a year at 120 dollars for a discount. They pay that 120 dollars up front but the company can’t recognize that revenue until they provide the service. Enter in the concept of deferred revenue. So in this example, the company has collected 120 dollars in january, but they can only recognize 10 dollars of Revenue. They have to list a liability of 110 dollars because that 110 dollars represents the service the company still owes the customer. Each month the company will get to recognize another 10 dollars and their deferred revenue will go down 10 dollars. In many SaaS companies booking and billings are functionally the same thing. So in the above example the company booked 120 dollars in january, billed 120 dollars, showed 10 dollars in revenue and 110 dollars in deferred revenue.

You can see why there is an advantage to being a SaaS company, you get lots of cash up front. You have that cash to use as you see fit. I think that is also a disadvantage through. As a SaaS company you need to be sure that the contracts you enter into with your customers is going to give you enough money over the lifetime of the customer for you to make a profit on the customer. You are essentially forecasting that the money they give you now is enough for the service you will provide them in the future. Earslookin has posted about how it is difficult as a shareholder to be sure that a SaaS company is using its cash appropriately. GAAP account doesn’t give us great tools to measure how a SaaS company is doing. This is why I like to focus on a company being operating cash flow positive or even better free cash flow positive. In my mind that is a huge hurdle to pass that shows 1) the companies business model can at least pay for itself 2) The company isn’t going to need to raise money. A little caveat on that, we have had a couple of companies raise money recently. They were companies that didn’t”need” to raise the money for operations. There is a big difference betweening needing to raise money to continue operating the company and wanting to raise money for business opportunities.

Well, as you can see I got totally distracted from my original question about NTNX billings vs revenue. I’ll save that for another time. Please feel free to correct/add anything that isn’t clear or wrong.

Best,
E

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I think your contrast of SaaS vs traditional is a bit skewed by focusing on a widget company. One gets a somewhat different view if one looks at something like selling an ERP software package which can be delivered both ways.

In traditional sales one makes the sale, lets say for $100,000 of which 10% is due on signing, 80% on delivery, and 10% 90 days after delivery (there are lots of patterns, but this is a common one). In this structure, the billing and the revenue tend to be simultaneous; there is no A/R delay. The same company may later sell a custom report or some other service. That will often be nothing up front, billing on delivery, and 30 days to payment. But, let’s keep focused on the big software sale. The sale might include some custom work, planning, obtaining a new computer, etc. that will delay the installation. Let’s randomly say that takes 3 months. So, cash flow is $10,000 on signing, $80,000 after three months, and $10,000 after 6 months … and nothing after that although lets say that there is a 15% annual maintenance fee so that one gets $15,000 each year going forward. So, after 5 years one has taken in 5 * $15,000 + $100,000 or $175,000, but the big chunk of $115,000 is all in the first year.

By comparison, the SaaS company might offer an equivalent software package for say $42,000 per year ($3500/month). There might be the need for the same delay of the start of service, but let’s say that one starts in 3 months and that the sale is made in March so the package is in service for 6 months in the first year. Payment may be in bulk up front or it may be monthly, but the revenue recognition will be monthly. If bills are sent for each month, they will generally be due before the start of the month they cover. So, there will be only $21,000 in revenue the first year and $42,000 each subsequent year. This means that over 5 full years of service, the company will have received $210,000.

So, there is your contrast.


Traditional $115,000 first year, $175,000 over 5 years
SaaS         $21,000 first year, $210,000 over 5 years

SaaS smooths out the revenue stream and generally leads to higher billings in the long term, whereas traditional is heavily front loaded.

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Hi Tamhas,
I picked simple examples on the two extremes mostly to illustrate the concepts. Your example is really great. I like how it shows how a standard software company will do its billing and revenue recognition compared to a SaaS company. The standard software company is going to have very little deferred revenue (depending on how they structure their contract). One other note, a SaaS company can also have very little deferred revenue if it is billing monthly and the customer pays monthly. Although the reality for these companies is some of their customers will be paying yearly, some monthly. For example, nutanix which started all this. They have some revenue that is billed annually, some monthly, some stuff that is billed just once, some that is billed like a standard software company, some stuff that is billed one time and then they put all those numbers together in one big lump sum of revenue, deferred revenue. This is why they were talking about billing to revenue ratios, billings and # of customers.

Thanks for your post, I agree, your software company is a better comparison than the widget company.

best
-e

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Wow, Ethan, you really did go down a rabbit hole!

You asked for corrections. I have a few, but to keep it simple let’s start with the Non-Saas
company that makes widgets.

You said: Billings – The money you’re currently owed. Your company has already made 5 of the
widgets and delivers to the customer 5 of the widgets in february. Now You have 5 dollars of billings
in february, and 0 dollars in bookings, 0 in revenue.

Correction: Billings – The amount you’ve invoiced to the customer. Your company has already made
5 of the widgets and delivers to the customer 5 of the widgets in February. Now you have 5 dollars
of billings in February, and 0 dollars in bookings in February, and 5 dollars in revenue in
February.

If the company delivers the widgets in the current period, and invoices the customer for those
widgets in that period, then the revenue for those widgets is recognized in that period.

Incidentally, this also sets up an accounts receivable which is the amount the company is owed
for the 5 widgets.

Thanks,
Ears

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I picked simple examples on the two extremes mostly to illustrate the concepts.

Yes, but I think that the examples have to be comparable businesses on both sides or the difference is likely to have as much or more to do with the nature of the business than the difference between traditional and SaaS. One can’t sell widgets by subscription and, frankly, phased delivery isn’t even that typical.

Many SaaS companies will have an annual agreement, regardless of how the billing is done. If so, booking the deferred revenue is reasonable since there is a commitment to continue to use the service.

Note too that there are companies who provide a highly standardized product only and the customer just uses what is there, like Mongo, and companies which provide a product that gets a lot of customer-specific customization. In the traditional model, a fair number of companies were “over the transom” deliveries, i.e., the customization was up to the customer, not the vendor. That doesn’t work so well with a cloud-delivered SaaS model. When I was developing and selling an ERP package, I had some unusually productive proprietary development tools which allowed me to provide customizations at an exceptionally competitive price, so my customers were not motivated to do their own customizations. Whenever possible, I would try to identify underlying business issues in a customization request so that I could provide a solution which could be integrated into core product as a feature which was available to all customers, present and future. But, some customizations, like forms, are inherently customer-specific. This allowed me to reap substantial additional on-going revenue even though the sales were on a traditional basis … in some cases several times the price of the original sale.

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Revenue – The money exchanged for the service provided in that time period

Just to repeat what ears mentioned, when you bill you recognized the revenue and if the customer doesn’t pay then it goes into doubtful claims, write-off, etc and charged against revenue.

Now coming to SaaS company, not all companies require you up-front payment and if you look at the payment terms, up-front yearly payment has discounts, and companies offer monthly payment terms too. If you work the numbers you will see the monthly payments often come with 10% interest rate, i.e., if you add the 12 monthly payments and compared that with annual up-front payments, the annual payment typically comes with a discount that would equal to 10% interest rate.

So while companies may collect up-front payment they are accompanied by discounts. In addition, the SaaS companies invoices has two components, a fixed monthly charge and some variable charges. These variable charges are billed often quarterly or monthly (if the amount is significant).

Often in a company that is growing rapidly, this cash pretty much goes towards paying for building capacity, R&D, etc.

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Thanks for all the replies. I appreciate the help learning all this.

@ears and kingran - "you bill you recognized the revenue and if the customer doesn’t pay then it goes into doubtful claims, write-off, etc and charged against revenue

I get where I went wrong and ears correction about the revenue, but I’m having trouble with the what kingran said above. My understanding is you can only recognize the revenue once the service has been performed. So you can bill but if you haven’t performed the service then you can’t recognize the revenue. Is that correct?

best,
e

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For short term things, one can bill for a service in advance or after the service is performed and the revenue is recognized at the time of billing. For long term things, if one bills in advance, then the portion of the revenue attributable to future periods is booked as deferred revenue and recognized at each future period is reached.

9

My understanding is you can only recognize the revenue once the service has been performed.

In general yes. I don’t want to over complicate this. You get annual subscription of $1200, you recognize each month $100.

10

For short term things, one can bill for a service in advance or after the service is performed and the revenue is recognized at the time of billing. For long term things, if one bills in advance, then the portion of the revenue attributable to future periods is booked as deferred revenue and recognized at each future period is reached.

That may work in practice for small $ amounts, but under US GAAP accounting standards, the technically correct answer is to recognize the revenue in the period the service is performed, regardless of whether it is billed before, during or after the service period - and regardless of how long or short the period of service may be.

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So you can bill but if you haven’t performed the service then you can’t recognize the revenue.
Is that correct?

Yes.

Moving on to recurring revenue / subscription model / deferred revenue…

There’s nothing magic about the SaaS model. The recurring revenue / subscription / deferred
revenue model has been around longer than me, which is saying something. Substitute the word
“magazine” for widget and you have goods sold through a subscription model. I can go to the newstand
to buy Better Homes and Zombies magazine for $6 a copy, or I can subscribe for a year at $4 per
copy. If I subscribe for a year, the publisher bills me $48 which creates a receivable (I owe them
$48), the publisher records a liability of $48 deferred revenue, and each month the publisher
recognizes $4 of revenue when they send me that month’s issue and reduces deferred revenue by $4.

We are almost ready to talk about how Nutanix calculates Billings, which is another story.

Thanks,
Ears

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We are almost ready to talk about how Nutanix calculates Billings, which is another story.

Lol - excellent, can’t wait!

Ant

13

Ears,

There’s nothing magic about the SaaS model. The recurring revenue / subscription / deferred
revenue model has been around longer than me, which is saying something.

Are you taking into account the new rules under ASC 606 since it is directly related on how you recognize Revenue?

I am trying to understand how ASC 606 affects recognition of Revenue.

Andy

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ASC 606 tends to (try to) normalize some revenue recognition differences in practice where one company records certain payments as expenses while another records them as “contra” (negative) revenue. It can also shift revenue between periods by either accelerating or deferring revenue across periods. There are too many possibilities to try to list and I am not an expert in SaaS company accounting, but here is a relevant link that may help. In the end, and over multiple periods, aggregate net income would be unchanged.
https://daily.financialexecutives.org/practical-applications…

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Andy said: Are you taking into account the new rules under ASC 606…?

Talk about rabbit holes. I think this is going to take some time to work out as companies interpret
the guidelines and get push back. There are now five criteria, two of them being identifying
performance obligations and recognizing revenue when the entity satisfies the performance obligation.
That may change the timing of some transactions, but the basic idea of recognizing revenue when a
good or service has been delivered and in the customer’s control remains roughly the same. I’m by no
means an expert on this stuff, so…

I sent Ethan this example offline to help explain Nutanix Billings calculation, and he suggested
some of you might also be interested, so I’m posting it below…

Nutanix calculates Billings (a non-GAAP measure) much the same as other SaaS companies:

Billings = Revenue + Change in Deferred Revenue.

To use my magazine publisher example…

  1. Suppose you subscribed to Forbes magazine near the end of December 2017 for a 1 year subscription
    of 12 issues for $48. The newstand price is $6 per issue, but Forbes is charging you only $4 per
    issue because you are subscribing for a year. If you had subscribed for two years they would have
    given you an even better deal and charged you only $3 per issue.

Forbes bills you for $48 in December and will report $48 in Billings and $48 in Deferred Revenue for
Q4_FY2017 since nothing has been delivered to you yet so no Revenue is yet recognized.

At the end of Q1_FY2018, Forbes will have sent you three issues, and will therefore recognize 3 * $4
= $12 in Revenue. It will also deduct $12 from Deferred Revenue because this amount is no longer
deferred and has been recognized. So, Revenue for Q1_FY2018 = $12 and Deferred Revenue balance =
$36. The CHANGE in Deferred Revenue = -$12 <<< $36 (end of this period) - $48 (end of last period) =
-$12>>>. If there was no other activity, then Billings = $12 + (-$12) = $0.

Summary for this first example

Q4_FY2017 Deferred Revenue = $48, Change in Deferred Revenue = 0, Revenue = $0, Billings = $48
Q1_FY2018 Deferred Revenue = $36, Change in Deferred Revenue = -$12, Revenue = $12, Billings = $0

  1. Now let’s complicate things a bit. Suppose near the end of March 2018 your brother subscribes to
    Forbes for two years at the $3 per issue rate. Forbes bills him 24 * $3 = $72. This $72 is goes to
    Deferred Revenue because Forbes hasn’t sent him any issues yet. So Q1_FY2018 Deferred Revenue is now
    $36 (from you) + $72 (from him) = $108. To calculate the CHANGE in Deferred Revenue, it is $108 -
    $48 = $60. Revenue stays the same = $12. So Billings now = $12 + $60 = $72.

Summary for this second example

Q4_FY2017 Deferred Revenue = $48, Change in Deferred Revenue = 0, Revenue = $0, Billings = $48
Q1_FY2018 Deferred Revenue = $108, Change in Deferred Revenue = $60, Revenue = $12, Billings = $72

You can see this will get even more complicated when there are more customers, all with different
subscription terms and start dates. But the calculation itself is fairly simple: Billings = Revenue

  • Change in Deferred Revenue.

The ratio between Billings and Revenue is important because Revenue may be understating the growth
of the business. To plan for future expenses and to anticipate cash flows, you really need to look
at Billings as well as Revenues. The Billings/Revenue ratio may also give you an indication of the
mix of business for the different subscription terms. Also keep in mind that Price to Sales ratios
are also subject to misinterpretation if the ratio of Billings to Revenue is high.

Anyway, kind of a long-winded reply. I hope you find it of some help. Please feel free to question
anything. Plus I may have made mistakes in my examples so be sure to ask if something doesn’t make
sense.

Thanks,
Ears

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Ears,

Super explanation… THANKS

17

ears,

Now, if the magazine allows you to cancel and get the subscription money back, how does it impact the booking or deferred revenue, assuming the customer is not paying upfront, rather enters an contract to subscribe?

18

I sent Ethan this example offline to help explain Nutanix Billings calculation, and he suggested some of you might also be interested, so I’m posting it below…

Ears, Ethan, thank you for this explanation. Makes complex accounting (for me) understandable.

John

19

Now, if the magazine allows you to cancel and get the subscription money back, how does it impact
the booking or deferred revenue…?

As you probably already know, revenue recognition for a subscription business can get very
complicated. I have no special expertise here. You can do a search and find many resources
to help you with the many possible scenarios. Here is just one source…

https://www.chargebee.com/resources/guides/saas-accounting-1…

Thanks,
Ears

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I believe any business that offers any kind of money back guarantee on past services (which they would have already recognized as revenue) estimates that cancellation rate and books a “reserve”, which is established in lieu of revenue as a type of ‘liability’. In theory, that liability gets converted to revenue as the guarantee period passes, though in practice, if they perpetually have these types of guarantees outstanding, just gets adjusted up/down as cancellation rates vary over time (or as management wants more/less revenue recognized in the quarterly earnings :slight_smile: ).

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