Introduction
Technology is increasingly becoming a big part of our lives. In fact, many living in the developed world probably already realise we can no longer live without technology alongside us now.
This entrenchment of technology, software and data in every aspect of our lives also means stock investments in technology companies may generate long term positive returns for us.
One increasingly popular type of technology company monetizes revenue based on the “Software as a Service (SaaS)” model. However, there are many terms involved in the SaaS model that are confusing, and deter retail investors from understanding their business models.
In this article, we will share these 9 must-know terms if you are already a SaaS investor, or have plans to be one!
1
Revenue
2
Bookings
3
Billings
4
ARR
5
DBNER
6
DBGRR
7
DBNRR
8
Deferred Revenue
9
RPO
Revenue
If you have some accountancy background, you will already know this very important detail regarding revenue:
“Revenue can only be recognized after a service is performed”
Here’s an example of how revenue is typically for a SaaS company, assuming their subscription is an annualised model.
Let’s assume a customer paid at the beginning of the year, $12k annual subscription value which is revenue for the SaaS company. Please take note not all of it goes into sales/revenue.
For a normal SaaS business, revenue is typically recognized accrued. So the company is only allowed to recognise quarterly revenue as $3k (12/12 * 3).
Bookings
Following from the above, the use of the “Bookings” term is useful to capture the $12k sales.
Bookings are typically the same thing as “Total Contract Value (TCV)”.
So let’s say using the previous example, assuming the customer commits to an annual $12k contract at the beginning of the year. Boom, that’s $12k in bookings.
Billings
The difference between billings & bookings is in how payment terms are structured.
Using the same example, if the customer cannot pay all $12k upfront, and your sales agent allows them to pay half upfront, and the other half 6 months later, then:
January billings: $6k
July billings: $6k
Hence the primary difference between revenue, bookings and billings is payment frequency.
If the customer pays one month at a time ($1k), billings & revenue would actually be the same.
Also, if the customer paid all $24k upfront, bookings and billings in January would be the same.
Annual Recurring Revenue (ARR)
Isn’t revenue, just revenue? Is there really a need to introduce unnecessary terms?
Well apparent there is!
In a nutshell, revenue can be different from ARR.
That’s because the ARR equation is based upon Monthly Recurring Revenue (MRR), and to get ARR, it just has to be multiplied by 12.
A situation where ARR can differ from revenue is when a customer upgrades. This brings us to the main reason why the term ARR was introduced – it allows SaaS companies to evaluate if with time, their product stickiness levels have increased and therefore resulted in higher ARRs!
Here’s an example to drive the point home:
Jan 1: $1k revenue = MRR
June 2: customer upgrades to $2k monthly plan
June MRR = $2k
December ARR = $24k
Yearly Revenue = $12k + $6k = $18k
So one can clearly appreciate that when a customer upgrades ARR > revenue!
Dollar-based net expansion rate (DBNER)
This measures how much a cohort of customers increases their spend year-over-year.
How this is derived is achieved via this 3 steps process:
- Identify all customers contributing revenue the latest 1 year
- Determine their total revenue in the last 1 year
- Determine their total revenue 2 years ago
- Divide 2 by 3.
What’s the general idea here? It’s another way to assess if the same group of customers have been spending more over time.
Dollar-Based Gross Retention Rate (DBGRR)
Typically, this is derived by taking the percentage of ARR (or revenue) that has not been lost to churn (customers that have unsubscribed). It also doesn’t include upgrades (expansions).
The highest this can be is 100%.
Dollar-Based Net Retention Rate (DBNRR)
This is similar to DBGRR but includes expansions. You can also think of it as the DBNER but inclusive of churn.
This is perhaps the most important of the three since it includes everything that measures whether the company’s product(s) and marketing have resulted in more sales with time.
DBNER and DBNRR can be well over 100%.
Deferred Revenue
Deferred revenue is actually a liability because the company still has to perform a service on money that’s been collected. Hence it doesn’t make its way into the profit and loss statement.
Here’s an illustration of deferred revenue.
If a customer pays $24k for an annual contract upfront:
Billings: $24k
Q1 revenue: $6k
Deferred revenue: $18k ($24k-$6k)
We can now see that billings can actually be calculated as revenue + changes in deferred revenue.
Remaining Performance Obligations (RPO)
This term is perhaps the most confusing, which is why we have left it to the last!
Officially RPO means it is all the contracted revenue that has yet to be recognised.
Deferred revenue is just one source of unrecognised revenue. Backlog is another whereby customers have committed interest and have committed contractually but have yet to pay.
In simple terms RPO = deferred revenue + backlog!
Conclusion
If you have persisted to read to this point, congratulations because these accounting definitions can be extremely confusing!
However, if you currently own SaaS stocks, or are planning to, you must know what you own. Otherwise, how would you know if the SaaS company is meeting your expectations, exceeding it, or is performing poorly?
Knowing these terms will better allow you to evaluate SaaS companies’ earnings reporting every time earnings come out!
One final point is that it is important to read the footnote of such financial reports because one SaaS company can report things slightly differently from another!
