Bookings vs Annual Recurring Revenue: Understanding Key Financial Metrics

What are Bookings?

Bookings represent the total value of contractually committed orders received by a company during a specific period. These orders represent promises of future revenue that have yet to be earned since the company still has to fulfill its obligations by providing the promised service. Once the company provides the service, then the bookings will be converted to actual revenue. Bookings capture all sales transactions, regardless of when the revenue will be recognized or the cash collected.

What is ARR (Annual Recurring Revenue)?

Annual recurring revenue (ARR) is a key metric used to measure the recurring revenue a company expects to generate annually from its customers. It is especially important for subscription-based businesses like in the Software-as-a-Service (SaaS) industry. ARR represents the stable, recurring portion of revenue from customer contracts.

What is the Main Difference Between Bookings and ARR?

The main difference between bookings and ARR is that bookings include all potential revenue, including non-recurring revenue, while ARR only captures recurring revenue.

For example, consider the SaaS business model and how companies in this industry generate revenue:

• Subscription Services: The main revenue stream for SaaS companies is the subscription-based model. Customers pay a recurring fee (typically monthly or annually) to access and use the software. The subscription-based model ensures a predictable and consistent revenue stream for the SaaS company.
• Other Services: SaaS companies often generate additional revenues by offering other services alongside their core subscription service. These other services may include consulting services such as custom integrations, or technical support. SaaS companies may also offer training programs or certification courses.

Bookings include both subscription revenue and revenue from other services. ARR only includes subscription-based revenue (assuming revenue from other services is one-time in nature).

It’s important to note that neither bookings nor ARR are metrics that are recognized under United States Generally Accepted Accounting Principles (US GAAP) or International Financial Reporting Standards (IFRS).

What is the Importance of Bookings?

Bookings are important because they provide a forward-looking view of the business’s potential future revenue growth and the demand for products or services. Bookings also help stakeholders judge a company’s sales performance and sales pipeline, as well as how effective the sales and marketing teams are performing.

What is the Importance of ARR?

ARR is a critical metric for both a company’s management and its investors. Managers can use the measure to evaluate the company’s likely future recurring revenue. This, in turn, will inform the company’s long-term business strategies. From an investors’ perspective, the predictability and stability of ARR ensures that the metric can be used to compare the company’s performance against its peers, as well as to compare it with its own performance over time.

Additionally, ARR is useful for the following:

• ARR helps companies better understand customer retention and growth prospects
• ARR is often used to value subscription-based businesses

Valuation using ARR

An ARR multiple is often used in the valuation of SaaS businesses. The multiple would be calculated as Enterprise Value divided by ARR (EV/ARR), making it very similar to EV/Revenue. The key difference between the two multiples is that ARR only includes recurring revenue while the revenue number used in the EV/Revenue multiple includes all revenue, whether it’s expected to recur or not.

For example, assume that a SaaS company has an ARR of $13 million. A detailed valuation analysis suggests that the appropriate EV/ARR multiple is 5x ARR. Applying this multiple to the target company’s ARR implies an enterprise value of $65 million.

How are Bookings Recorded?

Bookings are typically recorded when a contract is signed, or an order is placed. However, depending on the transaction, the contracted amounts may or may not impact the financial statements. While the accounting recognition of bookings (and revenue) can be quite technical, the contracted amounts may only be recorded in a system that tracks a company’s orders and not in the accounting general ledger.

If the company does receive cash ahead of providing the subscription or service, then the entries would look like the following (assuming the contracted revenue is $10,000 per month for one year):

Dr Cash $120,000

Cr Deferred Revenue $120,000

Since cash has been received but the service has yet to be provided by the company, the company will create a liability account known as deferred revenue (also known as unearned revenue).

Revenue Recognition

As the company provides the service, it will then recognize the appropriate revenues. After one month, the journal entries would be:

Dr Deferred Revenue $10,000

Cr Revenue $10,000

At this point, the deferred revenue account falls from $120,000 to $110,000 (assuming the initial deferred revenue balance is zero and there is no new deferred revenue).

After another month, the company would record the following journal entries:

Dr Deferred Revenue $10,000

Cr Revenue $10,000

The deferred revenue would fall by another $10,000 to $100,000. By the end of the 12-month period, the deferred revenue balance would fall to zero, while total revenue would equal $120,000.

How is ARR Calculated?

Subscription revenue is usually calculated on a monthly basis in which case it’s known as monthly recurring revenue (MRR). From here, MRR can be converted to ARR by multiplying the MRR by 12:

ARR = MRR × 12

Alternatively, ARR can be calculated by summing up the annual contract value of all active subscriptions, excluding one-time revenues.

It’s important to note that ARR is not directly recorded in a company’s financial statements and is calculated separately as a key performance indicator (KPI).

Drilling Down on ARR

Companies prefer breaking ARR (or MRR) into separate components. The most common ARR components include the following:

• ARR added from new customers
• ARR added from renewals of current customers
• ARR added from upgrades of current customers
• ARR lost from downgrades from current customers
• ARR lost from churned customers

Breaking down the total figure helps a company identify which customer segments contribute the most to its ARR.

Finally, it’s important to note that ARR is a non-GAAP metric so it will be virtually impossible to calculate from reported financial statements. However, companies may report ARR in earnings announcements or presentations, as Adobe did below.

What are Billings?

Yet another metric to be aware of is known as billings. Billings are the amounts of money the SaaS company has actually billed customers during an accounting period.

Bookings, Billings, and Revenue

Billings differ from bookings in that bookings are the total sales value of a contract, while billings represent the amount that is actually billed. For example, if a company signs a three-year contract for a total of $300,000 ($100,000 per year), and the customer is billed annually, then bookings are $300,000 but the billings are $100,000.

Billings are also different from ARR. Billings, like bookings, consists of all revenue, not just recurring revenue.

Billings are also not the same as revenue. Revenue recognition allows revenue to be recognized and generated before sending a bill to a customer. However, billings and revenues should generally trend in the same direction over time.

The book-to-bill ratio is a metric that can quickly give stakeholders a direction on future revenue. The calculation is:

Book-to-Bill Ratio = Bookings/Billings

For example, a company generates $1 million of bookings during the second quarter while billing $750,000 in the same period. The book-to-bill ratio would be 1.33x ($1,000,000/$750,000).

When the book-to-bill ratio is greater than 1, it indicates that a company has a strong backlog of new orders. Conversely, if the ratio is less than 1, it is an indicator of a potentially weak backlog. Of course, these metrics should be compared over time and against similar peer companies to really form any judgment.

It’s important to note that the bookings and billings numbers used in this ratio should cover the same period (for example, the second quarter); otherwise, the timing is off, leading to a flawed analysis.

Key Differences Between Bookings and ARR

It’s important for analysts to have a deep and thorough understanding of the differences between bookings and ARR. Below are the main differences, along with a discussion of the analytical implications.

Recognition Timing

ARR is considered a point-in-time metric, similar to amounts on a balance sheet. This means that ARR reflects the annual recurring revenue at a specific moment, typically at the end of a financial reporting period (quarterly or annually). It is a snapshot of what the company expects to generate in recurring revenue over the next 12 months based on the contracts in place at that time. Because of this, ARR is recalculated whenever new contracts are signed, renewed, expanded, or churned, meaning its value can fluctuate over time.

Bookings are also a point-in-time metric as they reflect the total contract value at the moment a contract is signed. Of course, ARR focuses on recurring revenue, while bookings consider all revenue.

In contrast, revenue is not a point-in-time calculation as it is the amount recognized over a period (usually quarterly or annually) when the product or service is delivered to the customer.

Financial Implications

Bookings and ARR both have significant implications for a company’s future financial performance.

Bookings provide stakeholders insight into future revenue potential, but there’s usually no immediate impact on company financial statements.

ARR reflects recurring revenue, which is considered a more accurate measure of a company’s long-term financial stability.

Use Cases

Both bookings and ARR have specific use cases for analysts to consider.

Bookings are mostly useful for short-term forecasting, understanding the company’s upcoming sales pipeline, and evaluating the sales team. Many analysts believe that bookings are a better indicator of a company’s growth profile compared to revenue, since complicated revenue recognition policies must be achieved before revenue is actually recognized.

ARR is more useful for long-term financial planning, given the recurring revenue stream, as well as evaluating the growth trajectory of subscription-based businesses. ARR is also used in the valuation of SaaS businesses.

Impact on Business Strategy

It’s critical for decision makers to understand bookings vs ARR to better develop strategies for growth.

Bookings are considered more of a short-term metric, so they guide decision-makers to better enable the sales team to focus on increasing contract volume. Additionally, increasing bookings usually requires a greater resource allocation to sales and customer acquisition.

ARR is considered more of a long-term metric. Generating recurring revenue requires a focus on customer retention, expansion, and upselling opportunities. Retaining customers also influences long-term product development so a company will also need to focus on research and development efforts.

Practical Examples

How Bookings and ARR are Handled in a SaaS Business

• Example 1: A SaaS company signs a one-year subscription contract for $200,000, with $80,000 of one-time integration revenues. The contract is payable when it is signed. In this case, the bookings value is $200,000, and there will also be the recognition of $200,000 in deferred revenue. The deferred revenue will gradually reduce over the next 12 months as revenue is recognized on the income statement. However, the ARR is $120,000 since ARR excludes one-time revenues.
• Example 2: In this example, the SaaS company signs a two-year subscription contract worth $300,000, and all revenue is considered recurring. In this case, the bookings value is $300,000, but the ARR is $150,000. This is because the contract is for two years while ARR is only calculated for one year ($300,000/2 = $150,000).

Differences in How Bookings and ARR are Tracked and Utilized in a Service-based Business

In contrast to SaaS, bookings in a service-based business may not translate to ARR unless there’s recurring revenue (for example, retainer fees). Because of this, service-based companies often have more irregular revenue patterns, given the project-based nature of their work, whereas ARR at a SaaS company tends to be more predictable and stable.

• Example 1: A consulting firm contracts to work on a project worth $50,000 for six months. The bookings value is $50,000, but there is no ARR unless the contract is renewed annually.
• Example 2: A consulting firm signs a one-year contract with $200,000 in retainer fees and the potential to generate another $100,000 in project work. The consulting firm believes the project work is highly likely to occur. In this case, the bookings value is $300,000, and the ARR is $200,000.

Importance of Understanding Both Metrics for Accurate Financial Analysis

Understanding bookings and ARR is crucial for accurate financial analysis, especially when evaluating companies with a mix of recurring and non-recurring revenue streams. When used together, both metrics can offer a detailed view of the company’s financial health and growth outlook, helping stakeholders make informed decisions.

Bookings provide analysts with a snapshot of sales momentum, while ARR provides a reliable measure of longer-term revenue potential.

Key Analytical Considerations

• Growth analysis: Analysts can compare growth in bookings with growth in ARR to potentially reveal trends in customer acquisition and retention. Ideally, over time the value of bookings will move towards the value ARR as a company focuses on recurring revenue and customer retention.
• Valuation: A sustainable and predictable revenue base is more highly valued by analysts than volatile revenues. Consequently, ARR is often used as a key driver when valuing subscription-based businesses. Bookings are less commonly used.
• Performance measurement: Bookings are critical for evaluating and benchmarking the performance of a company’s sales team. ARR is important for understanding and assessing a company’s overall stability and longer-term growth potential.
• Investor communication: Both metrics are often communicated to investors and other stakeholders. Together they can offer a more complete picture of current performance and future potential.

Conclusion

Bookings and ARR are complementary metrics and, when used together, provide an excellent view of a company’s revenue and growth prospects. Bookings offer insights into sales trends and future revenue-generation potential, while ARR provides a picture of stable, recurring revenue streams. It’s important for analysts and other stakeholders to understand the differences between these metrics for financial analysis, strategic decision-making, and effective communication.

Additional Resources

Thank you for reading CFI’s guide on the difference between Bookings and ARR. To keep advancing your career and skills, the following CFI resources will be useful:

• The SaaS Rule of 40
• Customer Acquisition Cost
• SaaS Quick Ratio
• Internal vs External Reporting
• See all accounting resources
• See all valuation resources