Accounting and Sales departments are often seen as being on opposite ends of the spectrum from one another. The differences in the nature of the work done in the “front of the house” is fundamentally different than the nature done in the “back of the house.” This tends to attract different personality types to the two different departments, both instrumental to an organization’s success in their own way. The same fundamental differences are also evident in the Key Performance Indicators (KPIs) that each department favors. While all well-designed KPIs should be indicative of company performance, some KPIs are better aligned with certain aspects of the business. Today we’ll take a look at three common KPIs for subscription-based software companies (specifically SaaS) and how they are useful to different parts of the organization.
Revenue, as defined within the Generally Accepted Accounting Principles (GAAP), is the financial metric which public companies report on their Income Statements, a report that public companies file with the SEC. It is the most traditional of the three metrics and has a very specific set of guidelines around the way it is calculated. Revenue is calculated, or recognized, after the good or service has been provided and is often only recognized in part. For example, a customer who pays for a one-year subscription up front would have 1/12th of the revenue recognized each month, assuming their contract began on the first day of the month.
CMRR stands for either Contracted Monthly Recurring Revenue or Committed Monthly Recurring Revenue, depending on who you ask. This is a relatively new KPI that has become very popular with the rise of the subscription economy. It is not a GAAP financial measure and is therefore not reported to the SEC, however it is commonly discussed by management teams and is a key metric that private equity and venture capital investors look to. The CMRR number represents the monthly recurring amount a company can expect to receive from their customers who have purchased ongoing subscriptions. Typically the CMRR amount for a specific customer or contract is determined at the time of contract execution, e.g. the beginning, though it might be altered over the life of the contract if there are add-ons, downgrades, price increases, etc.
Bookings is a metric designed to measure the total spend that a customer has committed to spending with your organization. Similar to CMRR, Bookings is not a GAAP measure meaning the exact calculation may vary and it isn’t reported to the SEC. The most common approach is to use the Total Contract Value (TCV) as the Bookings amount. Unlike Revenue, Bookings shows the entire committed amount in the month the deal is won. Unlike CMRR, Bookings includes non-recurring amounts such as services or hardware. Bookings is commonly used as the basis for calculating sales commission and is therefore often very important to the sales organization. Unlike CMRR, a Booking number doesn’t get updated if there are contract changes down the line, but instead a new, separate Booking is created for the add-on.
Why Don’t They Tie? The Devil’s in the Details
It is a bit unfortunate that the “R” in CMRR stands for Revenue because it only kind of represents revenue in reality. It is not uncommon to find someone from accounting and another from sales looking at Revenue and CMRR trying to make them tie out. As it turns out, the trick to getting them to tie is simple. Don’t! They’re fundamentally different, and while they should show similar trends, they will likely never tie to the penny. Here are just a few reasons why:
If a customer starts their subscription on the 8th day of the month, revenue will show only n – 7 days worth of revenue where n = number of days in a month. CMRR however is intended to show the value of a full month and will therefore always be 100%. Bookings on the other hand, will actually show the entire value of the contract as of the date the deal is signed as opposed to spreading any of it out.
Discrepancies in calculation based on # of days
Let’s say you sign up a new customer with a one-year subscription term for $1200. Calculating CMRR should be fairly simple, right? You book $100 in CMRR. Assuming that this customer started their subscription on the first day of the month, you would think that Revenue would also follow the same calculation, however that isn’t always the case. In some instances the monthly revenue is derived by first calculating a daily rate and then multiplying by the number of days in the month. In our example, the daily rate would be about $3.2877, meaning in February we would show $92.06 in revenue while in May we would show $101.92. While this method is less common than evenly distributing across months, the calculation of partial periods based on exact days isn’t uncommon, essentially compounding the differences which result from partial period revenue.
Improperly coding of other revenue
Obviously, simple human error can obviously skew the accuracy of any KPI, however this particular case is relatively common and worth mentioning. Many companies segregate recurring revenue from other types of revenue on their financial statements making it easy to identify. Given the increasing complexity of today’s financial management systems, size of accounting teams, and geographical separation it has become increasingly difficult to get every transaction right every time. Often an end-user doesn’t choose the revenue account on a Sales Invoice or similar, but instead chooses a product or item, which if mapped incorrectly may cause dollars from services, hardware, or other types of non-recurring revenue to end up in the recurring revenue bucket. This highlights one of the reasons it’s critical to ensure proper design of your Financial Management solution.
Different sources of truth
Managing different parts of your business in different systems is often a messy undertaking. Unfortunately, for years it was simply the status quo as on-premise solutions were often developed within silos, particularly in the systems designed for small to medium sized businesses. Errors in manually duplicating data entry are fairly common and often a major pain point. Integrations between systems have helped to reduce this issue but depending on the technical details of the integration, sometimes changes only sync one way or simple integration errors occur throwing two systems out of sync from one another.
Finally, certain aspects of the business are likely to have fundamentally different processes and accompanying features in the systems that house them. For example, in the accounting world there is a formal process to “close the books” which permanently locks down the data from future changes. This typically doesn’t happen in the same way within the sales department and those of us who have experienced this reconciliation nightmare before know that often something gets changed in one place after but hasn’t changed in the other. This serves as another reason that it’s critical to have a single source of truth when reporting on the metrics that really matter to your business.
Which Metric is Right?
As we love to say in consulting, it depends. Each metric tells a story about how the business is performing and provides valuable insight. Often at the executive level all three are examined with similar levels of scrutiny. The key differences to keep in mind are:
- GAAP Revenue has clearly defined rules about how it is calculated, while the calculations of CMRR and Bookings may vary some from company to company
- GAAP Revenue tells the story of what has already happened, while CMRR and Bookings are more forward-looking
- GAAP Revenue for public companies is reported publicly as part of the Income Statement, while CMRR and Bookings may or may not be published
One thing that we know for sure is all three are powerful indicators of performance for a subscription-based company and those organizations who are not currently calculating, evaluating, and discussing them may already be a step behind. As the subscription economy continues to grow, I expect we will continue to see increased focus on subscription-specific KPIs. This is likely to bring both more rigidity in the exact calculation of some metrics as well as new KPIs altogether.