Bookings vs Revenues vs Collections
A reader suggested this topic for MBA Mondays. It is a good one.
When a customer commits to spend money with your company, that is a “booking”. A booking is often tied to some form of contract between your company and the customer. The contract can be simple or very complicated. And some bookings do happen without a contract. Examples of these contracts with customers include an insertion order in advertising, a license agreement in enterprise software, and a subscription agreement in “software as a service” businesses.
Revenue happens when the service is actually provided. In the case of advertising, the revenue is recognized as the ads are run. In the case of licensed software, the revenue is recognized when the software is delivered and accepted by the customer. In the case of a subscription agreement, the revenue is most often recognized ratably over the life of the subscription.
The customer’s cash shows up in your company’s bank account when it is collected. That can happen at the time of booking the business (as is typical in subscription businesses), or it can happen at the time of revenue recognition (as it typical in ecommerce), or it can happen a long time after revenue recognition (as it typical in advertising).
It is important to track all three of these metrics very closely. You want to know how much revenue your company has booked, you want to know what your monthly revenues are, and you want to know how much revenue you have collected, and most importantly, how much you have not yet collected (that is called Accounts Receivable).
It is also possible to collect cash at the time of booking in advance of when the revenues will be realized. That is called deferred revenue and it is a liability because delivery of the revenue is an obligation of the company. Many companies have four revenue oriented items they track; bookings, deferred revenues, revenues, and collections.
An interesting metric that many analysts and financial managers track is the book to bill ratio. You get that by dividing monthly (or weekly or quarterly) bookings by the revenues in the same period. If bookings are lower than revenues, that can be a negative sign. If bookings are a lot higher than revenues, that can be a positive sign. But it can also mean that your company is having a hard time getting revenue realized.
In some industries, not all bookings turn into revenues. In the advertising business, for example, it is often the case that not all the booked business can be delivered (and thus recognized as revenue). This is a big issue in highly targeted advertising businesses. If you have such a business, it is important to track your yield which is the percentage of booked revenue that you actually deliver in a given period.
I like to think of the bookings to billings to collections as the way revenues “flow” through the business. And since revenues are the life blood of any business, it is important to understand your company’s specific flow and measure it along the way.
Great topic Fred. For anyone that offers an annual, pre-paid subscription (or similar), this can cause a lot of confusion – especially if there is a variable component on top. A simple $120 a year subscription turns into $10/month bookings, with actual revenue being realized on a month to month basis with ADDITIONAL premium services booked and revenue earned on a month to month basis as they are “bought” by the subscribers. I’ve seen organizations move towards pricing strucutures that are easy for the company to plan and track – and the flip side – companies pricing based solely on making the product “easy to buy” – which might end up being hard to plan and track. Looking forward to some good comments on this topic.
If the subscription is paid up front entirely then usually the $120 is booked, with $110 in deferred and $10 recognized each month.If the subscription is set up to be monthly with easy exit clauses, then you are booking $10/month, no deferred, and $10 rec rev each month.
thanks Chris – you are right. Was typing/writing too fast and didn’t proof read.
Fred, what approach to calculating bookings have you seen when revenue from a customer contract is variable based on usage and not able to be predicted upon signing? For example, a cell phone company doesn’t know how many minutes their customer will talk, or a card processor doesn’t know how many transactions will be swiped. We have this type of variable transaction model in our business and have been estimating bookings based on historical averages, but there are problems with this approach, including the fact that if the historical rates are increasing over time, you are always understating your bookings. Seen any better alternatives out there?
Charlie – I ran business with this model – and we did not count anything as a booking, unless it was guaranteed – this is why so many subscription models with variable rate pricing try and set up an attractive “up-to” pricing level – like cell phone providers. I pay $80/month for up to X minutes with blah blah features. My bookings for the cell phone company are just $80/month. Anything above that is just booking as incurred – i.e. bookings and revenue happening at the same time. It can be very frustrating to sign a big customer that will “pay as you go” and not be able to assign a bookings number to it without a pre-pay, but that is the whole point. If there is a risk they might not spend, you should not count it in bookings – their actual will just show up in bookings as you go along > which just means you need another forecast line for “contracted/estimated”
either do what dan suggests in his reply or estimatei’ve seen both approachesif you estimate, you have to constantly be re-evaluating your assumptions
Great post. This stuff is intimidating and complex to a lot of entrepreneurs, and yet it’s “basic stuff” to good accountants, etc.In other words, when you’re at “Series A” level and revenues are getting near $1m….it’s a pretty good idea to include “CFO” in your pitch and anticipated spend.
Very important topic. As an acquirer of start-ups (I run M&A for a public tech company) this is one of the things I look at most closely during due diligence. Does the company understand and track the difference between their bookings and revenues, or are they playing “fast and loose” with the numbers to show me an artificially smooth growth curve? Eventually we will reconstruct it all, so it’s important to us that we have a team that is (a) honest and (b) sophisticated in how they present this.Collections and deferred revenue are more important for more mature businesses, to determine (as you point out) the quality of revenue. For small, high-growth start-ups, though, it’s really important to set strong policies about revenue recognition and stick by them.Here’s a topic idea for you, Fred: compensating salesteams for bookings vs. revenue vs. collections. (Though I know your ideal investment doesn’t need a traditional sales team!)
I like the comment “eventually we will reconstruct it all” can you elaborate on “sophisticated in how they present this”I’ve come to believe when somebody has a complicated model that has elaborate spreadsheets that take hours to figure out they are either trying to bullshit me or they don’t want to concentrate on the real business instead they want to mentally masturbate with numbers instead of concentrating on delivering value to customers.Maybe that’s just me.
By “sophisticated” I definitely did not mean “complex” in terms of tracking revenue and bookings. I mean are they precise and consistent in how they present the information to me. It’s very, very common for companies to tell me they had $x million in revenues, then it turns out it’s really bookings, then it turns out they actually don’t have a consistent policy for recognizing revenues, etc. It’s a big red flag, because it shows they don’t really know how to run a mature business.
Thanks Andrew….I always worry when people misunderstand complexity and sophistication.Simple elegance is the ultimate in sophistication, but many people when they view simple elegance think…that’s so simple…its stupid. Its only stupid because you couldn’t think of it so simply.I’m big on analogies. Both of my brothers are much smarter than me, but one of mine not only was denied tenure, but was fired as an engineering professor because his work was “too simple”…after the out roar they granted him tenure in less than a week.His big problem….DARPA wanted to figure out for many reasons (think in-flight refueling) how to catch a baseball hit by a bat. He solved the problem by realizing that a baseball player can’t possibly see the spin on the ball, see precisely where it was hit, calculate the swirling wind in a stadium and calculate the trajectory….they keep the ball in a constant angle to the horizon and run to it in a parabola (that’s why catching balls hit straight at you are so hard). That work was considered stupid simple, although it landed him on the front page of the NYTimes Sports Section.He also hold the patent for how you test Gore-Tex shoes…..they spent countless man years and he was fresh out of school, but he figured out you put water in the shoe and see how it comes out with a centrifuge versus trying to figure out how it got in (sloshing over the side, wicking up the laces, etc) R&D thought that was a “hillbilly” design but its in every shoe plant because you want to find if a press is causing a hole in the shoe ASAP.
andrew – i am so pleased you joined in and left this comment. it totallyenriches this discussion with real world tangible information. thanks forsharing it.
Easiest is to compensate a sales team with bonuses on top line bookings against/over plan, and commissions trailing invoicing. When growing, sales can’t get paid too far in advance of collections, but also must feel the benefit of the “big win”.
At my previous job we built a sales team from the ground up as part of a (relatively) mature business. The sales comp question was a tough one to crack. As you said, it’s important to see cash for a big win, but you don’t want to pay out too much on a $50k booking from an F500 company only to wait 90 days for the cash to come in.Eventually, we settled on a hybrid where you got paid commission up front (within the month) for ALL bookings, and if your collections ended up past due in future months that was docked against your commission for the current month. Yes you run the risk of people booking a huge deal and walking out the door with no eventual collection, but our un-collected/cancellation rate was <1% so it wasn’t a huge problem. But we went through a bunch of iterations before we settled on this model.The key takeaway was that is was really really important to have the salesperson have some skin in the collections game. Wouldn’t necessarily work at a bigger company, but at the beginning stages you want salespeople focused on closing AND collecting (which is often a proxy of the quality of the deal they are bringing in in the first place).
That is exactly the way you do it and it works for the big upfront sale model.On a subscription business you pay both on new sales and on the “book of business”I would never pay for the future value of sales…..which is the biggest problem with the upfront sales model which is why I have left that model back in the last century.A collection problem always goes back to the salesperson (after several iterations with accounting) because one of two things happened…..the sale was bs…..or the customer is playing a game saying the salesperson said this….when they did not…..either way like in all conflicts you never want to be the third person in…..settle it out among the two parties involved.
Quite a few SaaS vendors require full up-front payments on yearly contracts. Walks like a duck…
I’m with you there. Although unless its a really small amount you must be losing some sales because that just makes it harder to buy. I’ve always had the Cortez theory (burn your ships to motivate the troops) I let anybody cancel with 90days notice. If you’re really selling SaaS you have to get to the mindset of making sure people use it and you might as well find that out fast.
So they would collect all commissions in the month it was booked, then you would dock them if the payment was delayed…only to re-instate the commission once paid?
Yep…a lot of our collection problems cleared up after that :-).
I’d replace my sales people if I had that problem! You mentioned semi-“mature” business – perhaps there were culture issues.My comments on sales comp is generally in relation to a startup/small biz…where the founders are generally involved in most good-sized deals (where terms/etc are issues to be watched).
Any discussion about compensating sales teams that has the word “easiest” in it makes me lift my eyebrow in skepticism! There is no easy in salesforce comp, I don’t think.
I might say the same thing about generalizations..;)Sales comp can get very complex, very quickly. And most sales people love to look for holes – and will spend far too much time figuring out how to optimize.Of course, this is all in the context of startups/small biz, so commission gates and all that fun stuff that happens in 500M+ companies doesn’t need to exist.Of course in small biz, sales people must be directly involved in collections…but it doesn’t have to mean that their comp needs to be tied to it. Depends how good you are at hiring and how you manage/motivate. Process around defining what is an order and proof that terms were discussed helps too.
Pay it quick. Pay directly and clearly related to gross sales. Make it easy to understand. Don’t mess with it. Once you start fooling around with any of those four, you are headed for at least one variable to be sub optimal.
Yes, it always gets complicated, but that doesn’t mean that you should not try. Whenever you have to chose, go for the easier pick. That way the system will be just complicated, not incredibly complicated.I’ve been in sales most of my time and I’ve seen that if the sales person involved can’t calculate the commission mentally while going to the meeting the system won’t work.
Great post. My company sells a mix of SaaS and shrink-wrapped software, both of which generally have multi-month services engagements associated with them and I’ve quickly learned to take my time when, and be precise about which number I’m discussing.I’d second the suggestion for discussing of the implications of pegging sales compensation to each number. If not from Fred, then maybe an experienced commenter can take up the task?
tee’d up for next week via a guest post
Andrew compensating sales people around, bookings, revenue etc is a great topic. I wrote about it in Nov. of last year, some good thoughts in the comments as well.Post is here:Bookings vs Revenue: http://asalesguy.com/2009/1…
“If bookings are lower than revenues, that can be a negative sign.”Could you please flesh this out a bit?
Morgan look at bookings as a leading indicator. Imagine I get 10 customers to “book” business with me totaling 10m bucks. Call it a promise to buy. A month in 3 of those customers come through for a million each. I now have 3m in revenue and 7m in bookings. A good sign, higher bookings than revenue.Now imagine another month has passed and the sales team only books 2 more deals, and the remaining 7 have come in. Now I have 7M in revenue and only 2m in bookings. Looking forward there is now only 2m in “backlog” against a current revenue number of 7M. This suggests the business is sliding backwards if sales can’t get more bookings in. Bookings lower than revenue suggests a declining business. Revenues higher than bookings suggest a growing business. Hope this helps.
Got it, thx. He said earlier there could be be bookings without a contract and I switched the two in my head. I looked at it like you might have a a growing base of one offs – revenue coming in without a “contract,” and was wondering why that would set off red flags. Instead it kind of means you want to see the pipeline growing as well.
I have 2-doubts here …1) Is it booking/revenue or booking – revenue?2) It is really hard to digest revenue being higher than booking…revenue will always be less than booking (you get revenues from what you booked)… if the realization time is greater than the evaluation time… then it sounds like trending the business over short period of time…than waiting for year-end trending.
This is also a VERY interest set of metrics when it comes to managing your sales team and creating commission plans.Do you pay on bookings, because the sale has been completed and now it’s up to operations to deliver. Do you pay on revenue, because sales shouldn’t get paid if the company doesn’t realize the revenue orDo you pay on collections, because the deal isn’t done until the cash is in the bank.Bookings vs revenue plays a substantial role in managing a sales team. The wrong decision can have a huge impact on their growth.
“Bookings vs revenue plays a substantial role in managing a sales team. The wrong decision can have a huge impact on their growth”….and their motivation.Which in sales is everything.
Woohoo, thanks for the quick answer Fred!
thanks for the suggestion!
Great post.This is complex stuff but critical to gage growth and figure out comp plans for sales teams.As a sales and marketing guy, my partner was always the CFO.
“As a sales and marketing guy, my partner was always the CFO.”Love this! (Am always inspired by seeing this type of brilliant partnership especially because it so often seems to be missed.)
Donna, so true. I have seen CEO’s treat CFO’s like the enemy. This is usually a foreshadowing of something bad.
CMO and CFO are tied at the hip. With sales for comp and collections, with marketing for cash outlays and affiliate deals, add financial chops to mix is a necessary ingredient.
Revenue recognition is one of the areas that auditors will generally look really closely at. They are always interested in looking at receipts and invoices on either side of the year end to check if there is any manipulation going on.
Good one. Maybe another topic for MBAM is profitability vs EBITDA vs OIBDA vs cash flow positive. Private co CEOs have a tendency to use “profitable” fast and loose, see Demand Media http://bit.ly/cgnsd8
i will do that one eventuallygreat suggestion
For subscription based businesses, I think another metric that’s worth looking at is expected revenue and expected lifetime value. If my company books $1000 of monthly revenue of say, an online advertiser, and that revenue has historically had a 2% monthly churn rate (assume that’s constant for simplicity), I will have theoretically booked 1000/0.02 = $50,000 of expected revenue over the life of this customer. Subtract out expected costs, which are often frontloaded due to sales commissions or other client onboarding costs, and you get your expected lifetime value. Some finance nerds will insist on discounting future cash flows. I say forget that.Once you start to look at new business in terms of lifetime value, you can start to understand what an allowable cost per acquisition is for you clients, which categories of your clients are more valuable to your business in the long-run, and how much “value” is brought into your business by sales in a given time period, even if you won’t actually see that cash (more specifically, the probabilistic expectation of that cash) for some time.
“Some finance nerds will insist on discounting future cash flows. I say forget that.”Don’t “forget that”, take 5 minutes, do it once and decide if it matters in your case. if it matters, figure out the rule of thumb you can use going forward.
It can be useful to do it once, but you have to be very very careful.The main problem is that churn rate is not constant. And in most businesses it not easily predictable either. In subscription businesses you always have a big risk of someone launching something that disrupts the market and send your churn rate from 2% to 20% in a month. If there’s no commitment they can always go, so you should try to set up some exit barriers.
Agreed. My point regarding trying to factor discount rate into LTV was that retention or churn estimates require huge assumptions for time periods that are well beyond the time range of data you have. Those assumptions, along with retention rates changing over time, will vary your LTV outcome way, way more than will taking into account cost of capital. DCFs are very often useful, but in this case, discounting cash flows implies a degree of precision that is just not true. It’s like taking your five year revenue projection to three decimal places.
totally important to be honest with yourself and admit up front that “we aren’t that good” when it comes to finance. at the same time, it’s important to be able to say “yea, i get the concept (money later < money now), i took a look at it isn’t a significant factor in our case” — which is where it sounds like you are.i think the most compelling thing a businessperson can do is to go through your model and put together a couple different sensitivity tables and figure out the what they key drivers of your business are. then you show people either how bulletproof you are or alternatively, and much more commonly, that you know what the biggest threats are and are working plans to mitigate the risk.
Good post Fred – amazing how many people (businesses) don’t acknowledge the distinction between these three things. It’s essentially the difference between a thriving business on paper/failure and true success. It’s all about balance – figuratively and literally (financially)!
another non-obvious case is gift cards. selling a gift card is not revenue. the interesting stuff happens in the case of the 10-20% of gift cards that don’t get redeemed (gotta think this % would be a lot lower for online businesses). when do you get to take that to profit? btw, no definitive answer here yet. in the mean time, businesses doing a lot of gift cards end up with some nice benefits along the way even if they don’t get to call it revenue. (not super relevant to the type of businesses Fred is typically looking at but still good to be aware when talking revenue recognition in general)
In my business we do gift cards but our redemption rate is higher (around 95%). To avoid claims we always print everywhere that they can be used up to a certain date. We then wait for an extra month to attend anyone who comes with a just expired certificate (it’s amazing how pleased they are when we tell them they can still use it… something so simple can get you some great and happy customers). After that we take all the remaining certificates directly to profit.
I think it is also worthwhile to track “backlog” – essentially “un-invoiced” business. Often happens when there are payment terms that spawn multiple invoices (% on order, % on milestone 1, etc).
i should have mentioned backlog in this postthat was a miss
Doesn’t judgment around the book:bill ratio depend on how long an average customer stays with you, or more specifically, the lifetime value of the account?Regardless of committed revenue up front, in order to hit a comparable growth rate, companies that have a 50% customer attrition rate need a very different book:bill ration than companies that have a 10% customer attrition rate and typically grow revenue from an account 10% year-over-year.
yes, very true matt
Can you use bookings to project expected economic growth of a sector? Or is that too wacky?
Much easier to understand than the university accounting course I took a few summers ago -probably has to do with the fact you included SaaS and subscriptions into the details. Thanks much 🙂
In my world a booking is a contract, nothing less. There is always documentation. All contracts have “outs” but most are rarely used. If I find a client or sales person that has excessive bookings that don’t materialize or cancel early, I have a problem that needs to be resolved. People who manipulate these things are very rare.Commissions, whatever the system, are always paid on revenues as recognized, not collected. A sales person is not your bank. If there is bad debt, which should be less than 1% of top line, commissions are charged back.If you have excessive bad debt, the company did not do sufficient credit analysis on the client. Sales people are not your credit department. No one should want them to be.CFOs are not my partner, nor should they be. They are a part of the neccessary financial controls though I have seen many who prefer not to assume that responsibility.
I agree. Sales reps are not your bank or your credit analysis department, but some people do manipulate this things and some controls are needed to prevent problems. However, you should also avoid pissing off all the sales force to control the rotten one. Difficult equilibrium here!
On days like today, I really feel like I’m getting my MBA. Thanks, Fred and all the commenters. Gotta go work out a strawman book to bill analysis. One thing before I go, though: this post would be all the stonger with a good info-viz sketch showing the relationships of book-bill-revenue-collection and how they vary (using, say, color, shape, and proximity) between different industries. Is there an illustrator in the house?
you don’t want me drawingtrust me on that
Deferred revenue can be a problem for everyone involved if the company fails to deliver. Does anyone know what does Groupon do when a business they promote fails? I guess it’s not common, but they say that you get all the money from the promotion in a few days, so theoretically you could run with the money (with all the legal implications that would have) and leave them in a very uncomfortable situation.
So in an early start-up company, if running a valuation (NPV analysis) on your company, is it safe to say that you should only include cash collected if accounting on a cash basis? Thanks for breaking this down on such a simplified level, Fred.
Very well explained. I agree- revenue is the lifeblood of any businesses. Thus, it’s very important to keep track the records as well.