SaaS Accounting & Finance: Core Definitions

I started working on internet and technology companies starting in 2006. (This doesn’t include my building websites, prototypes, etc… since childhood). My high interest in the SaaS business model started in 2009 in a mixed Undergrad/MBA class at the University of Wisconsin School of Business called Entrepreneurial Finance, where my final project was to do the work of an Investment Banking team preparing a client for their IPO roadshow. That client was pre-IPO OpenTable. 

After learning OpenTable’s business model and revenue model - even building the financial model and charts that allowed me to really internalize it - I was hooked on the recurring revenue model. I decided I would try to build a company with that model and have been involved with helping build SaaS business since. 

As the industry grew and evolved, I was shocked by how many companies misunderstood and misused accounting principles (every company wasn’t considering the Matching Principle until ASC 606). Additionally, the amount of miscommunication and issues in SaaS organizations caused by a lack of shared industry-specific accounting definitions was numerous. Because of that, I suggested with each company I worked that the team review all uses of accounting and finance terms at that point in time and write what theirs would be for their employees to reference. 

Around 2019 - 2020 the industry began to see some convergence in the use of these terms and definitions and I outlined what I believed they should be for the startup I was going into as their Chief Revenue Officer. I outline the related core metrics in SaaS in another article including important notes on their application and very important nuances that users should consider. 

Below are my consolidated Accounting and Finance definitions. 

1. Booking Metrics

Bookings are signed contract commitments from customers to pay for services over a specified period at a set price. Sales organizations typically track and pay commissions based on these figures.

• New Bookings: Commitments resulting from the acquisition of new Customers. This does not include new commitments from existing Customers.

• Renewal Bookings: Commitments from the renewal of existing contracts. This includes the baseline renewal amount plus or minus Expansion and Contraction.

• Expansion Bookings: New dollar commitments specifically from existing customers.

• Churned Bookings: The dollar value of Renewal Bookings completely lost when a customer does not renew. This does not include downgrades (contraction).

• Contraction Bookings: The specific dollar amount lost when an existing customer reduces their current spend. This reflects only the downgrade amount, not the new gross contract total.

2. Revenue & Cash Management

• Recognized Revenue: Under GAAP, revenue is recognized ratably over the life of the subscription. For a 12-month contract, 1/12 of the total is recognized each month.

• Cash Collections (Billings): The actual collection of money from the client for contracted services. The date of collection often differs from the Booking or Recognition dates.

• Deferred Revenue: A balance sheet account representing contract payments received that have not yet been recognized as revenue under GAAP. This balance increases with new bookings and decreases as revenue is recognized over the contract length.

3. Recurring Revenue Metrics (MRR & ARR)

Monthly Recurring Revenue (MRR) is the aggregate amount of revenue recognized each month from current Customers.

• Today’s MRR: The sum of recognizable monthly revenue from all Customers currently under contract and "live".

• Contracted MRR: The sum of all current and future recognizable revenue, including contracted future upsells, downgrades, churn, and new contracts.

• New MRR: Incremental MRR from new client contracts only.

• Renewal MRR: MRR resulting from the renewal of existing customer spend, including Expansion and Contraction adjustments.

• Expansion MRR: New MRR specifically from existing Customers.

• Churned MRR: MRR lost from customers who discontinue their entire contract.

• Contraction MRR: The amount of lost MRR from existing customers who downgrade.

Annual Recurring Revenue (ARR) tracks the total recurring subscription value of contracts with a term of at least one year. It excludes one-time or variable fees to focus on predictable revenue.

• Implied ARR (iARR): Also known as Annualized Recurring Revenue, this is a normalized measure calculated as $MRR \times 12$. Unlike ARR, which represents committed annual contracts, iARR is a run rate of current recurring revenue regardless of individual contract lengths.

4. Advanced Contract & Acquisition Metrics

• Committed MRR/ARR (CMRR): A forward-looking metric that adjusts recognized revenue for new bookings and pending changes (upsells, contractions, churn) before they impact the General Ledger.

• Formula: $\text{Last Period Recognized Revenue} + \text{New MRR/ARR Bookings} + \text{New Expansion} - \text{Contractions} - \text{Churn}$.

• Annual Contract Value (ACV): The annual amount of a specific subscription agreement. A $30,000 3-year contract has an ACV of $10,000.

• Total Contract Value (TCV): The total dollar commitment over the entire specified time period of a contract. A $10,000/year contract for 3 years has a TCV of $30,000.

• Average Contract Value: The average annual contract dollar amount across a customer base or segment.

• Customer Acquisition Cost (CAC): The total sales and marketing (S&M) spend required to acquire new customers.

• Formula: $\text{Total Cost of S\&M} / \text{New customers acquired}$.

• Inclusions: Salaries, commissions, ad spend, content, and software. It does not include costs for supporting or expanding existing contracts.

Side note: I almost nailed the pricing on the IPO. Check out this a16z podcast with then-CEO Jeff Jordan about the IPO roadshow preparation process, market, and pricing.