Revenue Modeling for a Subscription vs. Non-Subscription Business
Revenue Modeling for a Subscription vs. Non-Subscription Businesses
Revenue modeling. It’s the most difficult aspect of financial planning, especially for startups that don’t have historical data to extrapolate future revenues. If you’re new to SaaS, you may be wondering what the differences are between revenue modeling for subscription businesses as opposed to non-subscription companies. This post outlines the two primary differences between revenue modeling for each type of business model.
The primary differences between revenue modeling for a subscription vs. non-subscription business is how revenue is recognized over time vs. up-front and how your billings will affect your balance in deferred revenue.
Revenue Modeling: Revenue Growth Over Time
For non-subscription businesses, future revenue is unknown because it depends on future sales that have not yet occurred. This can cause major headaches when trying to estimate future revenue and cash flows. Non-subscription businesses often do not have an associated term; therefore, revenue is recognized on the date of sale. See the following example:
By contrast, most SaaS companies sell subscriptions with a start and end date, and revenue is recognized over the stated term.
For SaaS businesses, forecasting future revenue is easier because the future revenue recognition is known on the date of sale. See the following example:
When modeling revenues for subscription-based businesses, think of the layers of a cake. Your Total ARR number is the entire cake, but you need to understand how that revenue grows over time, i.e., the cake layers that make up the whole. That growth is measured as follows:
New business: Number of new customers*Average ARR
Expansion: Growth from existing customers, including Upgrades, price increases, users or products added
Contraction: Declines in business from existing and continuing customers, including Downgrades, price decreases, fewer users or products
Churn: Loss of existing customers
Revenue Modeling: Deferred Revenue
Deferred revenue is an accounting principle related to the accrual method we talked about before. Deferred revenue is revenue that you can’t recognize just yet because the service hasn’t yet been performed.
In non-subscription businesses, sales are transactional, so revenue is recognized immediately. There is no need to defer revenue recognition because all revenue is recognized as soon as it occurs. See the following example:
In subscription businesses, by contrast, the service is performed over a period of time; therefore, revenue is recognized bit by bit over the duration of the term. As the term goes on, your revenue goes up, and your deferred revenue balance goes down. This is important for reporting purposes because deferred revenue is recorded as a liability on your balance sheet.
The equation becomes more calculated when you factor in billing frequencies. At many SaaS companies, customers are billed all up-front to simplify things. After all, it’s always better to have cash-in-hand sooner rather than later.
However, for companies where that’s not possible, billing frequencies have a huge impact on the cash runway, something that’s essential to budgeting for business operations and reporting to potential investors.
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- The main difference between revenue modeling in a subscription vs. non-subscription businesses is how revenue is recognized.
- Projecting future revenues from a subscription business is less subjective because they are recognized over a specific period of time, whereas there’s no guarantee of future revenues in a non-subscription business.
- Clearly understanding deferred revenue balance and how your future billing schedules may increase or decrease that balance becomes essential when projecting your future cash flows.
For more tips and tricks on how to build a revenue forecast, check out Ben Murray’s SaaS Revenue Forecast Model.