What is Remaining Performance Obligation in SaaS?

What is Remaining Performance Obligation (RPO) in SaaS?

RPO, or Remaining Performance Obligation, is a measure of the revenue a company expects from executed contracts that haven't been fulfilled yet by the end of a reporting period. It includes deferred revenue (advance payments for services not yet delivered) and backlog (money contracted but not invoiced). RPO is crucial for SaaS businesses as it gives potential investors a quick look at future revenue.

In this guide, we’ll dive into what RPO is, how to calculate it, and why it’s so important for SaaS businesses today.

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Importance of remaining performance obligation for SaaS companies

Understanding future revenue

RPO, or Remaining Performance Obligation, is crucial for SaaS companies because it helps calculate the total revenue expected from existing contracts and gives investors a clear view of future revenue. This is especially important for companies with long sales cycles. For example, if a SaaS company shows strong RPO growth over four consecutive quarters, it suggests higher future revenue growth in the upcoming fiscal period.

Having insight into this calculation allows SaaS companies to make more accurate financial projections and better financial planning. With RPO calculations, they can provide more context to their revenue run rate based on trends in customer demand.

Simplifying investor insights

Typically, SaaS companies report billings in their financial statements to give investors a view of future revenue. However, billings is a non-GAAP metric and doesn’t account for changes in deferred revenue, which complicates the reconciliation with GAAP revenue.

Deferred revenue is the sum of payments received before delivering services, representing cash in the bank but with no guarantee the company can keep it if they fail to deliver. This makes it harder to analyze the prospects of a fast-growing company.

In contrast, RPO offers a straightforward number for investors, providing instant insights into a company’s future revenue potential without the need for complex reconciliations.

Tracking future revenue

RPO is an effective way to track future revenue, encompassing both invoiced and yet-to-be invoiced business. SaaS companies often report a metric called current remaining performance obligations (cRPO), which is the section of RPO expected to be recognized as revenue in the upcoming 12 months. Growth in cRPO quantifies growth in billings and revenue over that period.

While some public SaaS companies also report billings to provide more visibility into future revenue, RPO offers a clearer picture of growth and momentum. This makes RPO a more accurate measure of a company’s future prospects for investors.

Adapting to various business models

SaaS companies use different pricing models and billing frequencies. RPO provides investors with a better picture of a company’s prospects regardless of these variables. Unlike billings, which only considers changes in deferred revenue, RPO includes both deferred revenue and backlog, offering a true picture of future revenue.

For instance, if a company switches from annual to semi-annual invoicing, deferred revenue numbers decrease while backlog increases. RPO captures both changes, providing a consistent and accurate view of future revenue.

In summary, RPO is a valuable metric for SaaS companies because it simplifies investor insights, serves as a leading indicator of revenue, and accounts for various business models, making it a comprehensive tool for financial analysis and planning.

Is RPO a GAAP metric?

Yes, RPO is a GAAP metric, and it's traditionally reported by public companies in various industries. However, you won't find it on the income statement or balance sheet. Instead, it's disclosed as a note to the financial statements.

It's important to note that GAAP RPO only includes non-cancellable backlog. On the other hand, non-GAAP RPO (which some SaaS companies report) includes cancellable backlog as well. Reporting both numbers provides investors with a clearer picture of the company's backlog and future revenue potential.

Related reading: Benefits of multi-currency accounts.

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How to calculate RPO: A step-by-step guide

Calculating Remaining Performance Obligation (RPO) might seem a bit tricky at first, but it’s a valuable metric for understanding your company’s future revenue. Let’s break it down step-by-step, including the formulas and calculations for deferred revenue and backlog.

Step 1: Understand the components of RPO

RPO consists of two main components:

1. Deferred Revenue
2. Backlog

Deferred revenue is the money you’ve already received for services that you haven’t delivered yet. Backlog is the total value of contracted services that you haven’t yet invoiced.

Step 2: Gather your data

To calculate RPO, you need:

• Total deferred revenue at the end of the reporting period
• Total backlog at the end of the reporting period

Step 3: Calculate deferred revenue

Deferred revenue is typically found on the balance sheet under liabilities. It represents payments you’ve received for services you haven’t delivered yet.

Formula: Deferred Revenue = Payments Received − Services Delivered

Example:

• Payments received for a 12-month subscription: $120,000
• Services delivered for 6 months: $60,000
• Deferred Revenue: $120,000 - $60,000 = $60,000

Step 4: Calculate backlog

Backlog is the total value of services contracted but not yet invoiced. It includes future billings that will be invoiced as services are delivered.

Formula: Backlog = Total Contract Value − Invoiced Amount

Example:

• Total contract value for the year: $200,000
• Amount invoiced to date: $50,000
• Backlog: $200,000 - $50,000 = $150,000

Step 5: Calculate RPO

Now, add deferred revenue and backlog to get the RPO.

Formula: RPO = Deferred Revenue + Backlog

Example:

• Deferred Revenue: $60,000
• Backlog: $150,000
• RPO: $60,000 + $150,000 = $210,000

Step 6: Differentiate between GAAP and Non-GAAP RPO

• GAAP RPO: Only includes non-cancellable backlog.
• Non-GAAP RPO: May include cancellable backlog as well, providing a broader view of future revenue.

Step 7: Report the RPO

Include the calculated RPO in the notes to your financial statements to give investors a clear picture of your company’s future revenue potential. Make sure to specify if you’re reporting GAAP RPO or Non-GAAP RPO for transparency.

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RPO vs. Billings

How does RPO fills the gaps left by billings?

RPO fills several gaps that billings doesn't cover. While SaaS companies often report billings to give investors an idea of future revenue, billings can pose an accounting challenge.

When a company lists billings as a key metric in its annual SEC report (the 10-K), it has to reconcile this number with actual revenue. This involves calculating the change in deferred revenue, which can be complicated for investors to follow.

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Financial reporting with RPO

From an accounting standpoint, reconciling deferred revenue is straightforward, but investors often find it cumbersome. As discussed earlier, investors prefer RPO because it provides a clearer picture of future revenue without the need for complex reconciliations.

Deferred revenue poses its own challenges for investors. RPO simplifies things by capturing future revenue with an easy-to-calculate formula, eliminating the need for detailed reconciliations.

Relying on billings as a key metric can create bigger issues for SaaS companies because it often leads to an unfair devaluation due to its lack of transparency. Let’s look at an example:

Example: SaaS Company B records the following subscriptions:

• $150 for a one-year contract paid upfront.
• $300 for a three-year contract paid annually.

From an ARR perspective, both contracts generate $150 annually. However, deferred revenues on the financial statement will show $450. Here’s the breakdown:

• $150 for the one-year contract
• $150 for the first year of the three-year contract
• $150 for the second year of the three-year contract

Deferred revenue doesn’t account for the backlog of $150 for the third year of the three-year contract, giving investors an incomplete picture of the company’s financial prospects. By reporting RPO, companies can include the backlog in the mix, providing a more complete picture of their revenue.

Using RPO helps SaaS companies avoid the pitfalls of billing-based metrics, offering investors a clearer, more accurate view of future revenue potential.

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RPO vs. ARR and RPO vs. Annual Contract Value

RPO vs. ARR (Annual Recurring Revenue)

RPO (Remaining performance obligation): RPO represents the total future revenue that a company expects from existing contracts that haven't been fulfilled yet. This includes both deferred revenue and backlog, giving a comprehensive picture of what’s in the pipeline.

Example: If a SaaS company has $200,000 in deferred revenue (services paid for but not yet delivered) and $300,000 in backlog (contracts signed but not yet invoiced), the RPO would be $500,000. This indicates the company expects to earn $500,000 from these contracts over time.

ARR (Annual Recurring Revenue): ARR, on the other hand, is a measure of the recurring revenue an organisation expects to receive annually from its customers. It’s a snapshot of the revenue generated from subscriptions over a year.

Example: If a SaaS company has 100 customers each paying $1,000 per year, the ARR would be $100,000. This figure helps understand the company's stable, recurring revenue stream.

Key differences:

• Scope: RPO includes all future revenue from existing contracts, whereas ARR focuses only on the annual revenue from subscriptions.
• Time Frame: RPO considers the entire length of the contracts, while ARR looks at the yearly recurring revenue.
• Insight: RPO gives a broader picture of future revenue potential, while ARR provides insight into the company's recurring revenue health.

RPO vs. Annual Contract Value (ACV)

RPO (Remaining performance obligation): As mentioned, RPO is the total expected revenue from current contracts, including deferred revenue and backlog.

Example: Using the previous example, the RPO of $500,000 reflects both services paid for but not yet delivered and future billings under existing contracts.

ACV (Annual contract value): ACV measures the value of a single customer contract over a year. It helps in understanding the revenue contribution from individual contracts on an annual basis.

Example: If a customer signs a contract worth $3,000 over three years, the ACV would be $1,000. This breaks down the total contract value into annual increments.

Key differences:

• Granularity: RPO provides a macro view of all future revenues from existing contracts, while ACV gives a micro view of individual contract contributions per year.
• Usage: RPO is used for forecasting total future revenue, whereas ACV helps assess the value of individual customer relationships and their annual impact on revenue.
• Perspective: RPO looks at the entire portfolio of contracts, while ACV zeroes in on specific contracts.

Both RPO and ARR, as well as RPO and ACV, are critical metrics for SaaS companies, but they serve different purposes. RPO offers a comprehensive view of future revenue from all existing contracts, providing valuable insights for long-term planning and investor transparency.

ARR and ACV, on the other hand, focus more on the recurring and annualised aspects of revenue, helping to gauge the company’s current performance and customer value on an ongoing basis.

Understanding these metrics helps in making informed strategic decisions and providing a clear picture of the company’s financial health to stakeholders.

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