Is this Metric the Most Important Leading Indicator of a Company’s Growth and Health?
There are many variables that go into a company’s path to sustained growth and health. Whether it is the vertical end market that is being sold into or the size of customer (e.g. SMB, mid-market, enterprise) served, companies must make thoughtful, data-driven decisions across a wide array of factors over the long-term to remain in business. Although the graph below is not representative of all businesses and cases (which is why universal is marked in quotation marks), it highlights many of the key phases that all types of companies face and must work through over their growth lifecycle:
Through this often-unpredictable business cycle, business owners and investors have a wealth of data and metrics at their disposal to assess a company’s financial performance, growth and health. Rather than solely focus on backward looking, historical heuristics to evaluate future performance, it is critical to find key metrics that can be used as leading indicators of a company’s potential outlook. One KPI that does a fantastic job of serving as a leading indicator of future performance is booked revenue. Let’s explore how and why this metric is essential to thoroughly monitor across every business and investment.
What is Booked Revenue and Why is it so Important?
Booked revenue represents the total economic value that a company has under contract or “booked” at any given time. It differs from what a company reports as recognized revenue (aka GAAP revenue), as booked revenue includes the full value of secured customer contracts that have not yet (partially or at all) been converted into revenue. It is essential to understand the distinction between booked revenue and GAAP / recognized revenue when assessing how to use each in the construct of assessing a company’s potential outlook. Recognized / GAAP revenue conveys the amount of allowable economic value a company can recognize as revenue in a given period. Without projections available, recognized revenue is a primarily backwards looking, historically-focused metric. On the other hand, booked revenue includes both the value of recognized revenue in a given period, as well as the full value of contracts that have been booked, but have yet to be recognized as revenue. The below juxtaposes recognized revenue and booked revenue on a monthly basis for an illustrative company:
As can be seen above, the monthly recognized revenue balance is lower in each period when compared to the booked revenue figures due to the timing of revenue recognition for new bookings. This delay is the result of the allowable revenue recognition in a period based on accounting rules. As a result, booked revenue is an important metric to monitor, as it can provide internal and external stakeholders with details on a company’s momentum (or conversely, lack of momentum) in booking new business, and therefore, generating sustainable growth. Although booked revenue is not a “GAAP” metric or something that can be used on a company’s income statement, it is a leading indicator on forward performance, expanding one’s analysis of a business.
Two Simple and Common Ways to Present Booked Revenue
When deciding how to present a company’s booked revenue, there a number of methods to utilize to arrive at the figure. The two that will be presented here are very common across subscription revenue clients I worked with, as well as other companies analyzed over the years. The first is a booked or contracted annual revenue metric, which annualizes all of the components that impact a company’s recurring revenue stream (e.g. new business, upsells / downsells and churn) in one period. This metric conveys the total value of business that a company has under contract at any given point of time, irrespective of what revenue has been recognized / deducted to-date. As a continuation from the prior example’s booked revenue, here is a presentation of booked annual revenue for Company ABC:
By annualizing each item in Company ABC’s booked revenue waterfall in one period, booked annual revenue serves as a proxy for expected performance over the next 12 months if the business were to do nothing different or be unaffected by any factors. For instance, the ending booked revenue amount in month 1 ($10,278.6) represents an approximation of Company ABC’s annual revenue as of the end of month 1, assuming the business operated in a steady-state environment with no variability in new, upsell, downsell and churned revenue over the next 12 months (even though we know that in the real world, this will never be the case, given that actual revenue recognition is impacted by a variety of variables)
The second method of presenting a booked revenue figure is by applying a run-rate calculation on the company’s in-period amount of recognized revenue. This methodology is similar to the booked revenue method highlighted above, in that it annualizes the value of a company’s in-period value to arrive at a revenue proxy over the next 12 months. However, one key distinction is that run-rate revenue calculations are annualized off of recognized, GAAP revenue, therefore including the impact of revenue recognition (e.g. delays based on accounting principles or the company’s delivery model). This example displays Company ABC’s recognized GAAP monthly revenue and run-rate revenue:
Run-rate revenue provides another way to estimate a company’s revenue over the next 12 months. Each respective period in the example above only includes the partial, ratable portion of revenue from new business, upsell / downsell and churn. The Company’s GAAP revenue at the end of these 12 months would only include the full 12 period impact of month 1’s figures, while partially including the impacts of months 2 through 12 (i.e. 11, 10, 9, 8, 7, 6, 5, 4, 3, 2 and 1 periods impact from months 2 to 12, respectively). With the inclusion of run-rate revenue as a KPI, business owners and investors can effectively portray and understand the full economic value of a company’s existing book of business over an annual period.
Concluding Thoughts: Be Sure to Include Booked Revenue in a Company’s KPIs
Over the lifecycle of a company, there are many KPIs that are important to consistently monitor. Depending on a company’s maturity, some KPIs become more or less critical to track towards. Booked revenue is one metric that is important throughout the entire “universal” business cycle, as it can represent a company’s forward financial performance. By continually tracking booked revenue, business owners and investors can keep a pulse on a company’s prospective growth and health profile, ensuring the right strategic and operational decisions are being made to create the most value for all stakeholders.