Financial analysts speak a lot about “billings” in a public SaaS companies, but in private VC-backed SaaS companies, you rarely hear discussion of this metric. In this post, we’ll use a model of a private SaaS company (where we know all the internal metrics), to show how financial analysts use rules of thumb to estimate and/or impute internal SaaS metrics using external ones – and to see what can go wrong in that process.
For reference, here’s an example of sell-side financial analyst research on a public SaaS company that talks about billings .
Let’s start with a quick model that builds up a SaaS company from scratch . To simplify the model we assume all deals (both new and renewal) are for one year only and are booked on the last day of the quarter (so zero revenue is ever recognized in-quarter from a deal). This also means next-quarter’s revenue is this-quarter’s ending annual recurring revenue (ARR) divided by 4.
Available to renew (ATR) is total subscription bookings (new and renewal) from four quarters prior. Renewal bookings are ATR * (1 – churn rate). The trickiest part of this model is the deferred revenue (DR) waterfall where we need to remember that the total deferred revenue balance is the sum of DR leftover from the current and the prior three quarters.
If you’re not convinced the model is working and/or want to play with it, you can download it, then see how things work by setting some drivers to boundary conditions (e.g., churn to 0%, QoQ sales growth to 0, or setting starting ARR to some fixed number ).
The Fun Part: Imputing Internal Metrics from External Ones
Now that we know what’s going on the inside, let’s look in from the outside :
- All public SaaS companies release subscription revenues 
- All public SaaS companies release deferred revenues (i.e., on the balance sheet)
- Few SaaS companies directly release ARR
- Few SaaS companies release ATR churn rates, favoring cohort retention rates where upsell both masks and typically exceeds churn 
It wasn’t that long ago when a key reason for moving towards the SaaS business model was that SaaS smoothed revenues relative to the all-up-front, lumpy on-premises model. If we could smooth out some of that volatility then we could present better software companies to Wall Street. So the industry did , and the result? Wall Street immediately sought a way to look through the smoothing and see what’s really going on in the inherently lumpy, backloaded world of enterprise software sales.
Enter billings, the best answer they could find to do this. Billings is defined as revenue plus change in deferred revenue for a period. Conceptually, when a SaaS order with a one-year prepayment term is signed, 100% of it goes to deferred revenue and is burned down 1/12th every month after that. To make it simple, imagine a SaaS company sells nothing in a quarter: revenue will burn down by 1/4th of starting deferred revenue  and the change in deferred revenue will equal revenue – thus revenue plus change in deferred revenue equals zero. Now imagine the company took an order for $50K on the last day of the quarter. Revenue from that order will be $0, change in deferred will be +$50K, implying new sales of $50K .
Eureka! We can see inside the SaaS machine. But we can’t.
Limitations of Billings as a SaaS Metric
If you want to know what investors really care about when it comes to SaaS metrics, ask the VC and PE folks who get to see everything and don’t have to impute outside-in. They care about
- New ARR growth
- Subscription growth margin
- Churn rates
- CAC and LTV/CAC (or increasingly, CAC Payback Period)
Of those, public company investors only get a clear look at subscription gross margins and the customer acquisition cost (CAC) ratio. So, looking outside-in, you can figure out how efficiency a company runs its SaaS service and how efficiently it acquires customers .
But you typically can’t get a handle on churn, so you can’t calculate LTV/CAC or CAC Payback Period. Published cohort growth, however, can give you comfort around potential churn issues.
But you can’t get a precise handle on sales growth – and that’s a huge issue as sales growth is the number one driver of SaaS company valuation . That’s where billings comes into play. Billings isn’t perfect because it shows what I call “total subscription bookings” (new ARR bookings plus renewal bookings) , so we can’t tell the difference between a good sales and weak renewals quarter and a bad sales and a good renewals quarter.
Moreover, billings has two other key weaknesses as a metric:
- Billings is dependent on prepaid contract duration
- Companies can defer processing orders (e.g., during crunch time at quarter’s end, particularly if they are already at plan) thus making them invisible even from a billings perspective 
Let’s examine how billings depends on contract duration. Imagine it’s the last day of new SaaS company’s first quarter. The customer offers to pay the company:
- 100 units for a prepaid one-year subscription
- 200 units for a prepaid two-year subscription
- 300 units for a prepaid three-year subscription
From an ARR perspective, each of the three possible structures represents 100 units of ARR . However, from a deferred revenue perspective, they look like 100, 200, 300 units, respectively. Worse yet, looking solely at deferred revenue at the end of the quarter, you can’t know if 300 units represents three 100-unit one-year prepay customers or a single 100-unit ARR customer who’s done a three-year prepay.
In fact, when I was at Salesforce we had the opposite thing happen. Small and medium businesses were having a tough time in 2012 and many customers who’d historically renewed on one-year payment cycles started asking for bi-annual payments. Lacking enough controls around a rarely-used payment option, a small wave of customers asked for and got these terms. They were happy customers. They were renewing their contracts, but from a deferred revenue perspective, suddenly someone who looked like 100 units of deferred revenue for an end-of-quarter renewal suddenly looked 50. When Wall St. saw the resultant less-than-expected deferred revenue (and ergo less-than-expected billings), they assumed it meant slower new sales. In fact, it meant easier payment terms on renewals – a misread on the business situation made possible by the limitations of the metric.
This issue only gets more complex when a company is enabling some varying mix of one through five year deals combined with partial up-front payments (e.g., a five-year contract with years 1-3 paid up front, but years 4 and 5 paid annually). This starts to make it really hard to know what’s in deferred revenue and to try and use billings as a metric.
Let’s close with an excerpt from the Zuora S-1 on billings that echoes many of the points I’ve made above.
 Source: William Blair, Inc., Zendesk Strong Start to 2018 by Bhavan Suri.
 Even though it’s not labelled as a driver and will break the renewals calculations, implicitly assuming all of it renews one year later (and is not spread over quarters in anyway).
 I’m not a financial analyst so I’m not the best person to declare which metrics are most typically released by public companies, so my data is somewhat anecdotal. Since I do try to read interesting S-1s as they go by, I’m probably biased towards companies that have recently filed to go public.
 As distinct from services revenues.
 Sometimes, however, those rates are survivor biased.
 And it worked to the extent that from a valuation perspective, a dollar of SaaS revenue is equivalent to $2 to $4 of on-premises revenue. Because it’s less volatile, SaaS revenue is more valuable than on-premises revenue.
 Provided no customers expire before the last day of the quarter
 Now imagine that order happens on some day other than the last day of the quarter. Some piece, X, will be taken as revenue during the quarter and 50 – X will show up in deferred revenue. So revenue plus change in deferred revenue = it’s baseline + X + 50 – X = baseline + 50.
 Though not with the same clarity VCs can see it — VCs can see composition of new ARR (upsell vs. new business) and sales customers (new customer acquisition vs. customer success) and thus can create more precise metrics. For example, a company that has a solid overall CAC ratio may be revealed to have expensive new business acquisition costs offset by high, low-cost upsell.
 You can see subscription revenue growth, but that is smoothed/damped, and we want a faster way to get the equivalent of New ARR growth – what has sales done for us lately?
 It is useful from a cash forecasting perspective because all those subscription billings should be collectible within 30-60 days.
 Moving the deferred revenue impact of one or more orders from Q(n) to Q(n+1) in what we might have called “backlogging” back in the day. While revenue is unaffected in the SaaS case, the DR picture looks different as a backlogged order won’t appear in DR until the end of Q(n+1) and then at 75, not 100, units.
 Normally, in real life, they would ask a small discount in return for the prepay, e.g., offer 190 for two years or 270 for three years. I’ll ignore that for now to keep it simple.
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The introduction of a SaaS system can be difficult. But following a method can be very helpful. Much has been written about this on https://www.itpedia.nl/en/tag/saas/ . The SISp method helps you step by step. (The live Google translation maybe strange sometimes but the articles don’t lie.)
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In your model, why are you booking the entire new arr balance as DR the quarter it hits? For ex., in Q1, 2015, wouldnt you only book 1.5 in DR (2/4), given that you would recognize 1/4 at the end of Q1 15?
I think the answer is the simplifying assumption that all orders are received on the last day of the quarter, ergo 100% of any new, one-year subscription goes to deferred revenue to be taken over the coming year and 0% is taken in the current quarter.
If billings is conceptually the amount the customer is paying in cash at any given time for the service, why is revenue relevant to the calculation and not just change in deferred revenue? Revenue is just recognized $s for service provided which is separate from cash intake or what $ amount a company invoices their customer. Thanks.
It’s been a while since I wrote that post but … people want to know bookings as a measure of sales performance but you can’t get it in public companies since it’s not disclosed. Ergo to approximate it they use billings = revenue plus change in deferred revenue on the theory that new sales (e.g., reductio ad absurdum, say they all happen on the last day of the quarter) will show up in deferred revenue. I guess the reason you use revenue is that they don’t all happen on the last day of the quarter — say 1/2 happen at day 45 and 1/2 at day 90 — the first group you will see half in revenue and half in deferred, the second group will be all in deferred. I guess it’s a way of measuring new sales regardless of when they happen in the quarter because they will all go into some combo of revenue and deferred revenue. Now revenue also includes existing sales/customers, but you can compensate for that by looking at growth. Hope that helps.
Why aren’t you calculating revenue as a function of the deferred revenue burn, instead of just dividing ARR by 4?
Victor, thanks for reading and it’s been a long time since I wrote the post. If memory serves I make simplifying assumptions like all deals happen on the last day of the quarter, ergo no current-quarter revenue from this-quarter deals, ergo revenue next period is always ending ARR this period divided by 4. Stuff like that. You can certainly make a better model. I’m always striving to be as simple as possible but no simpler. BTW, if I were to get revenue off deferred revenue burn (a fine way to do it) then I’d have a different problem? How do I get deferred revenue burn?
I realize the post was a bit stale, so thanks for the response! I thought your assumption was that deferred revenue contributions reflect 1 year prepayments and get burned down 1/4th each quarter? I was only asking because it seems that the renewal bookings don’t get reflected in revenue at all, since revenue is ending ARR/4, and ending ARR doesn’t include renewal bookings, only new and churn ARR lost? Unless I’m missing something conceptually?
NM, I see it….the renewal bookings are part of the starting ARR, so it assumes the piece up for renewal just gets carried over, minus the churn piece.