For businesses operating in the software landscape (specifically those with a software-as-a-service delivery model), there are a plethora of relevant metrics to differentiate between and monitor. The challenges of monitoring these metrics are not unique to any one company - I (and probably many of you readers) have witnessed both large, public companies, as well as smaller, private entities, deal with reporting struggles. This is due to the fact that all companies must always ensure financial reporting for both internal and external purposes is understandable, consistent and positions them to receive the most value from investors.
One particular challenge that software companies face is the proper disclosure of bookings, billings and revenue. As we will expand upon in this article, it is important to truly understand the differences between the three metrics. By doing so, companies can properly position these key datapoints to internal and external stakeholders without creating a laundry list of follow-up questions and/or concerns.
Back to the Basics: A Comparison of Bookings, Billings and Revenue
Before digging into some best practices and common challenges in reporting these metrics, it is helpful first to understand the fundamental differences between bookings, billings and revenue. Bookings are the lifeblood of growth and expansion for companies, as they represent the total economic value of all new (or expansion / upsell / renewal) contracts that are signed. These bookings are generated by sales personnel who convert pipeline opportunities into customers. As was detailed in Part 2 of the KPI Series, bookings can be stated on a total contract value (TCV) basis or an annual contract value (ACV) basis, depending on the length of contract signed. Bookings themselves do not directly affect a company’s balance sheet or income statement – they are a sales performance metric that results in eventual billings and revenue recognition (which, as we will discuss, both do have an impact on financial statements). Let’s begin with a quick illustration of bookings (and let’s assume that the booking occurs in day one of month 1):
Billings typically represent the total billed / invoiced value to a specific customer based on the contract length / term and booked value. Billings are important to monitor and report, given they represent the cash to be collected by the company for providing the product / service to a customer over time. Depending on a company’s business model, billing cycle and cash collection policy, billings can be stated on either a monthly, quarterly or annual basis. Unlike bookings, billings affect both the balance sheet (primarily through a company’s deferred revenue, accounts receivable and cash balances) and the income statement (through the recognition of revenue over time). The below is a continuation of the prior example to illustrate billings:
Lastly, revenue represents the allowable portion (allowable based on both GAAP and whether or not the company has provided the product / service to a customer) of a customer’s booking / contract value that can be recognized as revenue in a single period. With FASB’s recent issuance of ASC 606, there are a number of modified rules that must be met in order for a company to recognize a booking value as revenue in one period (we will touch upon the details of ASC 606 in a later article). In the simplest of instances, billings will equal revenue if company employs monthly billing; otherwise there can be a variance between billing and revenue streams (again, ASC 606 adds nuances to this point that we can go over later). To avoid delving into the complexities of ASC 606 here, the example we will provide below will assume the simplest of terms – a single contract with a defined, static price (no discounts) for a product that is to be delivered monthly to a customer. Let’s look at how revenue stacks up against bookings and billings for Company ABC in the example below:
The Challenges of Bookings, Billings and Revenue in a Complex Business Environment
As mentioned at the outset of this article, reporting on the three metrics tends to incite heartburn for companies, both from an internal and external perspective. For public companies, the only metric that is required to be disclosed of the three is revenue, with bookings and billings being optional. This optionality can create complexities, as the disclosure of bookings and billings metrics is often dependent on a company’s desire to position themselves for long-term value creation (which also sometimes results in hard-to-follow calculations for the metrics).
Additionally, challenges arise for public companies in reporting these supplemental metrics, as management must be cognizant of maintaining a consistent, long-term view on reporting methodologies to investors. For instance, if a public company decides to report bookings and billings one way when it goes public, it will be the expectation of sell-side analysts and investors to continually receive the same metrics calculated in the same manner in the future. If the metrics are all of a sudden removed from this public company’s reporting, and management provides no tangible reason to justify the removal, external stakeholders may end up being alarmed and/or begin to question the validity of the financials and management’s ability to deliver consistent shareholder value creation. For private companies, reporting on these metrics is a bit simpler, as they can report on all three for internal purposes with less required expectations from external investors (although private-equity and venture-capital firms do indeed have their own reporting standards that are implemented). Nevertheless, private companies still deal with many of the same challenges public companies face with respect to bookings, billings and revenue. This is due to the fact that both public and private companies operate in a highly evolving, complex business environment that is not as simple as the illustrative example I provided in the prior section. Let’s explore an example of the type of challenges a company faces that may over time lead to a loss of simplicity, consistency and transparency in financial reporting:
As seen in the cases above, reality often differs dramatically from expectations, especially when dealing with the demands of serving the needs of customers as sufficiently as possible. Over multi-year period comparisons, these complexities tend to pile up, creating burdens on company management teams to explain why current and projected reporting materially differs from past results and/or expectations. Therefore, as I stated in Part 1 of the KPI Series, it is always good to revert to these three basic rules of thumb, as they can help with decision-making and hopefully reduce the complexities and difficulties of reporting on a consistent basis (and also dramatically reduce the length of footnote disclosures in financial packages and board presentations…):
1) Keep it simple
2) Keep it consistent
3) Keep it transparent
Concluding Thoughts: Less Can Be More with Bookings, Billings and Revenue
As we bid adieu to this article, I wanted to include a headline that summarizes a few key takeaway points:
1) When deciding to report additional financial metrics (e.g. bookings and billings) to provide external parties with more details on a company’s performance and trends, it is a good idea to apply a long-term assessment to determine if the additional detail is worth the disclosure (particularly important for public companies). Therefore, within the allowable parameters of investor demands and disclosure rules / regulations, less reporting can be more beneficial;
2) When deciding to adjust reporting of key metrics, it is important to adequately and correctly disclose the changes to ensure proper comparability and understandability of the financials between periods (e.g. ensure the disclosure of billings declining in one comparable period vs. prior comparable period is due to a change of billing frequency vs. churned customers). Therefore, in this case, less disclosure transparency can be more confusing; and
When reporting to external parties and investors, business owners should always be as concise and as clear as possible. It is good to treat every interaction with external stakeholders like it is the first of its kind, ensuring that key internal metrics are always explained plainly, are easily understandable and never lead to concerns on the quality of the financial data that is provided. By doing so, companies can ensure that less investor inquiries on reporting validity can be more valuable to the business in the long-run.