What is Revenue Backlog?

What is revenue backlog?

Revenue backlog is the total amount of unrecognized revenue that a company has attained but not yet indicated on financial statements. It involves all types of revenue that a company expects to receive from varying contracts that have been signed but are still to receive or invoice for. In other words, it can be said that revenue backlog is the expected future revenue that is still to be collected from ongoing contracts, orders, or agreements.

It is a crucial metric for businesses operating in SaaS, construction, and manufacturing, where the contracts span a long time period. It is the difference between the revenue a company has recognized and the revenue it anticipates getting from signed contracts, seeking fulfillment. It is a crucial KPI for sales performance and future growth prospects.

Example:

A SaaS business that offers annual subscriptions may recognize its revenue monthly after delivery of services.   However, if there are any additional contracts signed for more subscriptions, the total value of these constitutes its revenue backlog. It is a revenue that offers a 360-degree angle view of the financial status of the business rather than the current revenue amount only. It gives a transparent view of future income that is yet to be gained.

What are the critical components of revenue backlog?

It is easier to break down revenue backlog into varying components that assist in gaining insights about its implications for financial data handling. These crucial components are

Deferred revenue: It is the portion of collected yet unrecognized revenue. It is generated from advance payments for delivery of products or services that will take place in the future.

Contractual obligations: This is the total number of contracts that have been signed but not fulfilled. It involves all the agreed-upon services that are yet to be delivered in the future.

Sales Orders: They are customer-confirmed orders that are not yet completed. They constitute a customer promise to buy products or services and are a contribution to the backlog of revenues.

Subscription Agreements: In subscription businesses, the aggregate value of future subscription payments is a significant portion of the revenue backlog because these payments usually are recognized throughout the term of the subscription.

What is the significance of revenue backlog?

Backlog revenue does not appear on balance sheets and other formal financial reports, although many companies continue to include a calculation of backlog revenue in executive and board of director reports as well as investor reports.

The calculation of backlog revenue is a part of these internal reports since it shows the total amount of all the subscription contracts the business has in the pipeline. Investors particularly like to see a backlog revenue calculation since it gives an idea of the overall financial status of the company, they have invested in.

How to compute a backlog revenue calculation?

In most cases, creating a backlog revenue calculation is a relatively straightforward process since you are merely summing up all the values of your existing contracts. The problematic aspect of it is knowing precisely which values must be factored into the calculation. Thus, to start off, your revenue calculation for your backlog must add up the entire amounts of all unrecognized revenue to be received within the terms of each SaaS agreement or subscription contract.

You must also include the non-recurring services alongside the recurring services, like training employees and implementing and integrating the software. Your revenue calculation for backlog should also take into account the worth of other professional services not yet fully provided. Also, you will need to add in any revenue contracted or committed but not yet able to be recognized on an official financial report because of outstanding customer acceptance requirements.

After you have inserted all the above in your calculation of revenue backlog, you may go further a step or two or simply do two separate calculations. One calculation will simply be comprised of the above elements, but your second calculation could also contain anticipated revenue. So you add on the value to be realized of active subscriptions as well as of subscriptions still outstanding.

The only thing necessary to incorporate such estimates into your revenue backlog calculation is that there must be adequate proof that each customer will pay and that your firm can honor the terms.

Formula

Total Revenue Backlog = Sum of (Total Contract Value Per Active Contract – Revenue Recognized for Respective Contract)

Let’s say a software company, XYZ Inc., has two active contracts:

Contract 1:

Total Contract Value: $100,000

Revenue Recognized so far: $40,000

Contract 2:

Total Contract Value: $50,000

Revenue Recognized so far: $10,000

Calculating Total Revenue Backlog:

For Contract 1: $100,000 – $40,000 = $60,000

For Contract 2: $50,000 – $10,000 = $40,000

Total Revenue Backlog:

$60,000 + $40,000 = $100,000

So, XYZ Inc.’s total revenue backlog is $100,000, representing the amount of revenue yet to be recognized from existing contracts.

What are the benefits of revenue backlog?

For any business in contemporary times, it is easier than before to manage its revenue backlog. It has several strategic advantages that include the following:

Prediction of Future Revenue

A well-managed revenue backlog offers a clear and transparent view of a company’s expected income from current contracts and active subscriptions. It offers insights about the financial status of the company, thereby assisting with budgeting, accuracy of financial planning, and future growth prospects.

Improved Cash Flow Management

When unrecognized revenue is tracked via revenue backlog, businesses can improve how they manage cash flow; it gets easier to anticipate working capital needs and also allows syncing current funds with ongoing expenses. As an approach, it allows reduced risk of liquidity and offers stable financial security for a business.

Improved operational efficacy

Keeping a close check on backlog assists in identifying any bottlenecks in the production process, service delivery, and fulfillment. By addressing underlying issues faster, a company can enhance customer satisfaction and optimize resource allocation in a beneficial manner.

Win-Win for Customers and Business

A managed backlog is an indicator of a business’s ability to meet customer needs in a continuous manner. Timely delivery of services can improve brand repute in a competitive market.

Facilitation of strategic decision-making

With insights from revenue backlog, companies can make informed decisions with regard to resource allocation and market expansion and improve sales strategy.

Attracts Investors

A healthy revenue backlog can attract potential investors and also improve trust and reliability in your offerings.

What are the challenges of managing revenue backlog?

Even though revenue backlog is important, its management can pose various challenges to organizations. Some of these challenges are

Forecasting Accuracy

It may be challenging to forecast revenue backlog accurately since it is based on a number of assumptions related to customer actions, market needs, and organizational capabilities. Useless forecasts may cause the overestimation of future revenue, which can ultimately lead to financial stress if anticipated revenue fails to occur.

Contractual Complexity

Most contracts have convoluted terms and conditions that complicate the determination of revenue backlog. For instance, contracts might involve performance milestones, compliance penalties, or variable prices subject to customer usage. Appreciating such intricacies is vital for ensuring the correctness of backlog estimates.

Market Volatility

Market circumstances can shift suddenly, influencing customer demand and contract fulfillment capabilities. Economic recessions, changes in the appetites of consumers, or competitive forces can all influence revenue backlog. Businesses have to be agile and responsive to overcome these difficulties effectively.

What are some revenue backlog best practices?

Several best practices for maintaining revenue backlog can be helpful for your business. They are:

Customer Retention

For recurring revenue businesses, it is important to focus on customer retention for reducing backlog. In some cases, some clauses will keep the customer from cancelling for some time span. Thus, reducing backlog is important, and you must ensure that customers are happy with the value attained via your services, as it can help faster delivery of services in an effective way. What you can do to expedite closing of revenue backlog is

• Create customer communities for interaction.
• Share best tips and tricks and how-tos to keep the customers hooked.
• Respond instantly to customer queries.

Enhance Billing Process

For the purpose of customer retention, you can ensure customer payments arrive on time. This means making it easier for them to make due payments in time. You can do so by accepting a broad range of payment methods, sending regular invoice reminders, and offering self-service to allow updating information without the customer support team. You must use automated billing software to avoid missed or late payments from customers.

Optimize Pricing

How closely your price tracks to your value proposition and your customers’ willingness to pay will determine very much if your backlog will actually become revenue.

Price optimization is finding the ideal balance between helping you achieve your business objectives and making it appealing to your target buyer. To find the ideal price, take into consideration price elasticity, competitors’ prices, and your own. You’ll also want to try out various pricing models (e.g., varying product tiers or usage terms) to determine which one best resonates with your customers and is simplest for you to support at scale.

Effective Cash Flow Management

Even in the best possible scenarios, cash flow issues might still arise. Without sufficient capital to run a business, investments in growth plans (such as increased hiring of staff or enlarged marketing campaigns) are virtually unthinkable.

• To preempt this, see to it that you’re having effective cash flow management.
• Forecasting expenses and revenues accurately
• Preparation of a budget based on fluctuations of revenues
• Maintaining an emergency fund or plan B in case of unforeseen financial difficulties
• Applying your backlog to create conservative estimates of your projected future revenues and planning accordingly.
• Employing risk management practices to limit probable financial hazards arising from other factors such as global pandemic, recession, and more.

What is a revenue backlog vs. deferred revenue?

Deferred revenue is a current liability account that is utilized in financial reporting. It appears on the balance sheet and is computed as:

The sum of (the total of invoices for all contract elements for a single contract — the total of recognizable revenue for all contract elements for a single contract).

Note if the calculation for a contract produces a negative number, the value is included in unbilled AR, a balance sheet current asset. On the other hand, revenue backlog is the sum of the balance of unrecognized revenue that you calculate over the span of the subscription.

For example, if a customer signs a 12-month subscription contract worth $1200, and 3 months have passed, the revenue backlog for that contract would be $900 ($1200 – $300 recognized revenue).

Revenue backlog provides insight into future revenue streams and helps businesses forecast and plan for upcoming revenue.

The differences between both are

• Deferred revenue is a part of financial reports and also shows on the balance sheet, whereas revenue backlog is not a component of the balance sheet but is an important financial metric.
• Deferred value calculation involves invoices; thus, values may go up or down based on customer subscriptions. On the other hand, revenue backlog does not involve invoices, and it reduces as soon as revenue is recognized.
• Deferred revenue initiates when the first contract invoice is sent, whereas revenue backlog starts as the contract is executed or when an order is booked.