Revenue: It’s Simple, Until It Isn’t

The TL;DR

• We are experimenting with a new series that dives into financial metrics and their importance
• Revenue is deceptively complicated and has numerous permutations that can give you insight into your business
• Recurring revenue is the best type of revenue and everyone wants it

Why bother to do this? 

We are continuing our experiment that we are colloquially calling “Finance, but useful.” The first post was on cash conversion cycle.

Most financial knowledge resources online are written for those with long attention spans (not us) or for students looking to pass their Finance 101 class (also not us.) Very little financial writing exists for non-finance leaders. Our goal is to help you understand what the key metrics are and why they matter for your business. 

People not grasping financial statements is a plague in today’s business environment. From WeWork’s infamous “community adjusted EBITDA” to Robinhood traders propping up Nikola’s stock price over that of Ford despite having 0 dollars in revenue, we are perhaps overdue for a re-education. 

The series (if you folks like it enough!) will walk through various key financial metrics and contextualize them so you can operate, invest, or evaluate opportunities with a higher degree of skill.

Today we will discuss the thing we all love to either completely ignore or completely over-index on - revenue.

My Mind On My Money, And My Money On My Mind

Revenue is the money that your business creates in the normal course of conducting itself. 

In its simplest form, it is the number of units multiplied by the sale price of those units. If I sell 20 units of Every t-shirt and each of them is sold for 5 dollars, I have a revenue of 100 bucks. That’s really all there is to the definition! Supposedly, nice and simple. 

However, the role of revenue gets a lot murkier as the business world increasingly moves towards subscription models. This opacity generally manifests itself in the confusion between bookings, billings, collections, MRR, and revenue. Let’s walk through some definitions and numbers:

Bookings: The amount a customer has agreed to spend

Billings: The amount a customer has been invoiced (billed) for

Collections: When you actually get that cash from a customer. In SaaS, this is generally before a service is provided, in retail when it is provided, and in service industries after the service is provided.

Revenue: The recognition of goods/services provided in the time period. 

MRR: The portion of revenue that is recurring on a monthly basis. 

Are your eyes glazed over yet? I promise there is a pay off here! Let’s use a super simple example of a 12-month contract for a SaaS business. The customer has agreed to 50k in subscriptions with a 2k services fee.

Think of the bookings -> billings -> collections flow as the revenue pathway. The speed at which a business is able to move down this path allows for increased operational flexibility. Aka it is always better to have cash on hand, even if you can’t recognize the revenue yet. If you want to read more about how to handle cash conversion cycling, read Adam’s great post about the topic here.

There is also a difference between receiving cash for a good/service you provide versus being able to say it is revenue. Let’s take the example of a content subscription provider, perhaps an email newsletter bundle that is a great value at only 20 bucks a month :)

If a customer purchases an annual plan, they will hand over the 200 dollars in exchange for a guaranteed 12 months of service. However, as the content provider, we can only recognize the cash as revenue once we have already handed over the proverbial goods. That means even if you pay us all upfront in month 1, we still can’t recognize that payment as revenue until the completion of our agreements with you.

But, we really want you to do that! That initial influx of cash allows us to do fun experiments like this newsletter. A bundle of cash today is so valuable that we will take it over a slightly larger total amount of cash that is periodically received over the year. And none of this nuance is captured in the simple revenue line. The rules governing revenue recognition and cash are complex (the guide for software revenue is an eye-bleeding, 721 pages of drudgery) and you should lean on your accountant if you are trying to be 100% compliant. 

We All Live In A Yellow Subscription Machine

Salesforce’s IPO in 2004 was the dawning of a new age in business - subscriptions. While there has long been a recurring revenue component in business, Salesforce has demonstrated over the last 17 years just how vastly superior this business model is. By adding a digital subscription revenue line you gain the advantage of predictable, forecastable revenue. It allows for more attributable marketing costs, churn calculations, and CAC/LTV ratios.

We have swung so far into the direction of digital subscriptions that every business is looking to add more of it to their revenue mix. Legacy software and media players like Adobe and the New York Times have already fully committed and transitioned to a digital subscription first business. Even for those businesses who are predicated upon atomized good distribution, digital subscriptions are a major component of their strategy. Peloton has been the highest flyer here,  their pairing of one-time bike purchases and content subscriptions spinning them to a stunning ~$43B market cap. But this isn’t restricted to flashy New York-based fitness tech - industrials like Caterpillar, John Deere, and Honeywell have also added subscription software components on top of their hardware lines to have a more predictable revenue forecast.

This subscription addiction has progressed to the point that businesses with a heavy services component are seen as a cause for concern. VC’s will often demonstrate an extreme level of hesitancy when a SaaS business even has a service arm. If you do have this in your business, don’t despair - one of the greatest software companies of all time started the exact same way.

When Workday ($WDAY) initially IPO’d much of the chatter was on their high services component. Before their IPO they were at a ~50% subscription mix! Despite this, their IPO had a 72% pop over their debut price. Ignoring for today the question of whether the bankers mispriced the allocation (Bill Gurley where you at?) the business has consistently decreased the role of services in their business.

Simultaneously their SaaS revenue has skyrocketed:

It is almost certain that if Workday had entirely eschewed services they would not exist today. Their original innovation was taking HR to the cloud. When they first started out the cloud was a novel concept and customers were extremely hesitant to store sensitive employee data “somewhere they couldn’t see it.” Without the Workday team’s ability to do this data migration for them, and without the hand-holding services revenue paid for, this opportunity would’ve been captured by another company. 

The lesson here is that while revenue increasingly goes towards subscriptions don’t be afraid to build a services component if it acts as a beachhead. When you are taking customers on a new and dangerous journey, you’ll have to be by their side most of the way. Why not get paid for it? 

Wrapping It Up

Learning to know what a revenue line means is a little bit of reading the tea leaves. If properly understood, it can help forecast the future of a business. You squint your eyes funny or misconstrue a few variables and you’ll end up looking at a dystopian future. In the product-driven world of Silicon Valley, finance is often a backroom function that is left behind in the heralded pursuit of product-market fit. Here at Every, we take the controversial stance that the revenue you make does matter and that paying attention to your income state may be wise.

If you enjoyed today’s publication, let us know in the survey below. Have a specific topic you want to see covered? Drop a comment or reply. Please challenge us with something really esoteric and see what we can do with it! Thanks for being here.

P.S. Some easily made foibles around revenue language

• ARR: People are cognizant that subscriptions are valuable so they will all try to frame their business as “ARR”. This should mean Annual Recurring Revenue, for when your contracts are 1+ years in length. However, ethically dubious CFOs will say ARR but actually mean Annualized Recurring Revenue, where they multiply their Monthly Recurring Revenue by 12 and just call it ARR. You see this all the time in startups trying to inflate their company value. If you mostly sign annual enterprise contracts use ARR, otherwise stick to MRR.
• GMV: A retailer’s revenue is the value of everything they sell. This is called Gross Merchandise Volume. While GMV is technically revenue, it isn’t an accurate picture of a retail business. The real business is what is leftover from the GMV after the companies who manufacture the goods take their cut. This how you see e-commerce startups say they have absolutely booming revenue but suddenly shut down. GMV was up but the rest of the business didn’t work.