Revenue Backlog

What is Revenue Backlog?

Revenue backlog is the amount of unrecognized and uninvoiced revenue a subscription or project-based business is scheduled to earn over the term of a service agreement. It isn’t reported on a financial statement, but companies use it to show investors and stakeholders proof of future revenue.

Characteristically, revenue backlog is…

• Not recorded. It isn’t a GAAP reporting number, so it doesn’t appear on the balance sheet. Public companies don’t need to keep a backlog, and it bears no relevance to your bottom line. How a business chooses to record its backlog is entirely up to them.
• Not invoiced. SaaS companies will bill their customers for access to their platform on a monthly basis. Contract-based businesses invoice for work at specific intervals (milestones). Since the value of the full contract is the same irrespective of the time frame, you won’t include your backlog in invoicing processes.
• Recognized over time. Revenue backlog is a running total of revenue you anticipate receiving over time as your contracts or subscriptions run their course. It generally spans years and multiple accounting periods. It’s only recognized as revenue once your business fulfills its obligations to the customer and meets all criteria for recognition.

Your backlog and recognized revenue from an agreement add up to its total contract value (TCV), which investors and stakeholders can use to value your company. If you’re fundraising, you can use it to demonstrate why you need the money (e.g., to fulfill performance obligations you don’t have the resources for).

Synonyms

• Unrecognized revenue
• Sales backlog
• Order backlog
• Unfilled orders

Importance of Accounting for Revenue Backlog

Although it isn’t a requirement for financial reporting, accounting for revenue backlog internally can help you:

• Understand your company’s future financial performance
• Set a reasonable revenue target based on the contracts you expect to fulfill and the deals you expect to close
• Identify areas of risk or potential issues in fulfilling your obligations to customers
• Make more informed business decisions, such as hiring or investing in resources to meet demand and fulfill contracts on time

If you’re pitching to investors, it also speaks to your financial responsibility and long-term potential. A healthy backlog demonstrates that your business has a solid foundation for future growth and revenue.

Deferred Revenue vs. Revenue Backlog

Revenue backlog is not deferred revenue. They’re often confused because they both refer to revenue the company hasn’t earned yet.

The difference between the two is that:

• While revenue backlog is unpaid and unearned, deferred revenue refers to an advance payment for a product or service.
• Deferred revenue appears as a current liability on the balance sheet since the company has already received payment for it. Revenue backlog is an internal financial metric (that doesn’t affect the balance sheet).
• Deferred revenue is inconsistent and unpredictable compared to revenue backlog. It goes up and down, depending on when and how you invoice your customers. Backlog gradually reduces as your contract runs its course.

It helps to think of backlog as pending revenue. You know it’s coming, it just isn’t in your account yet. And it entering your account is contingent on fulfilling your obligations to the customer.

Deferred revenue, in that sense, is the opposite — you already have the money, and all you need to do is fulfill your end of the bargain.

As an example, let’s say you’re selling a SaaS and just inked a $100,000 one-year contract with a new customer. If you haven’t charged them for the subscription agreement, that $100,000 goes in your backlog. If they’ve paid you upfront for 6 months of the service, $50,000 would go into your backlog and the $50,000 you received would be deferred revenue.

How to Calculate Revenue Backlog

Calculating revenue backlog is simple:

Revenue Backlog = Total Contract Value (TCV) – Recognized Revenue

A backlog revenue calculation includes revenues customers have committed to pay, but haven’t received an invoice for because their contract is still running its course. As the company fulfills its end of the agreement by providing access to its platform or completing a job, it invoices the customer and recognizes the revenue it receives. Each time this happens, the backlog amount reduces.

Briefly, your backlog can include:

• Active subscriptions
• Committed or contracted revenue that cannot be recognized yet due to the customer’s pending acceptance criteria
• Unfinished professional services delivery
• Future implementation, training, and consulting services
• Paused or pending subscriptions
• The future value of investments

To ensure an accurate representation of your company’s financial health and future revenue performance, it’s best to only include items in your backlog if there’s strong evidence both you and the customer will fulfill your obligations.

How Revenue Backlog Impacts SaaS Financial Health

Depending on the exact situation, a backlog can have positive or negative implications for your business.

• On one hand, a substantial backlog can show investors your company is in high demand. It can also help you manage cash flow and plan for future growth.
• A large backlog could also indicate an inability to fulfill obligations on time, potential issues with customer retention, or inefficient internal processes.

Revenue backlog is especially important for SaaS companies because they use a subscription model, and subscriptions naturally create a backlog. Although it doesn’t impact your financial reporting on paper, it does impact the future of your business, potential investors, and stakeholders.

For example, will you hit your revenue targets this quarter with your current backlog? Do you need more resources to fulfill obligations and maintain customer satisfaction? Or do you need to supplement it with a lot more sales? If you do, do you have the infrastructure to support it?

Since backlog can either be good or bad depending on context, paying attention to it can help you diagnose problems with product/service delivery, billing/payment issues, and customer satisfaction.   It can also help you create an accurate revenue forecast you can use to plan investments.

Causes of Revenue Backlog

Long-Term Contracts

Contract-based companies in industries like SaaS and B2B manufacturing will always have revenue backlog. As soon as they lock in new customers at a contracted price, backlog is automatically created as the total contract value goes onto the books.

Low Production or Delivery Capacity

If your backlog starts to build up as you sign more customers, pay close attention to your delivery times, ability to hit deadlines, and fulfillment across your entire customer base. More deals closed will automatically increase your backlog, but that’s only a good thing if you can actually deliver.

If you notice certain items sitting in your backlog for a longer-than-expected period or you’re reducing it at a slow pace, it’s either an efficiency or capacity issue. Maybe you bit off more than you could chew. Or, perhaps your development and implementation teams can’t set new customers up fast enough.

If your backlog is piling up and you notice you’re falling behind on multiple contracts, it’s time to look closely at the reasons behind that.

Unexpected Customer Churn

Your churn rate significantly impacts your backlog. If customers frequently exit their contracts before completing the entire purchase, the TCV you’ve calculated from active contracts won’t accurately represent the state of your business. You’ll overestimate their potential, and the expected revenue they represent won’t materialize.

Poor Billing or Payment Processes

Billing and payment issues can cause a discrepancy between what’s in your backlog and what should be recognized as revenue. If customers are paying late, it could skew the data and give an artificially inflated amount. Make sure to track billing and payment metrics closely so you can address the issues that would otherwise negatively impact cash flow or future revenue.

Inadequate Pricing Strategies

If you’re constantly in a position where demand for your product/service exceeds supply, it may be time to re-evaluate its pricing. Aligning your prices with market demand can help you attract and retain more customers, then use your backlog as a tool to attract investors and plan out investments in growth initiatives.

Market Conditions

Recessions, supply chain shortages, and other global issues can throw things off, even if you don’t think they impact you or your customer directly. The COVID-19 pandemic is perhaps the most obvious example — it caused severe disruptions in almost every industry.

• In the SaaS world, customers backed out of long-term subscription agreements as part of dramatic budget reductions (and changes in needs with remote work).
• Manufacturers faced supply chain issues as many companies halted production. This means they might not be able to deliver products on time.
• Lower demand for certain products and services completely removed the customer’s motivation to complete a purchase in the first place.
• Some businesses closed for good, meaning they were never able to complete the contract duration.

Layoffs are another example of something that could impact customers’ need to subscribe to your service. If you’re the one doing the layoffs, it could also affect your ability to carry out your contractual obligations.

Best Practices to Reduce Revenue Backlog

Fulfill Contractual Obligations On Time

Of course, the easiest (and most obvious) way to reduce your backlog is by delivering your service on-schedule.

For SaaS subscription agreements, this means:

• Making your customer onboarding process as efficient as possible
• Keeping implementation and training processes on-schedule
• Tracking your customers’ time to value
• Improving collaboration across teams/departments to reduce bottlenecks
• Retaining your employees to avoid disruption
• Eliminating external or internal risks that could slow down delivery time
• Tracking and analyzing customer feedback to identify areas of improvement
• Investing in automation tools to streamline processes and increase efficiency

It’s also a good idea to hire additional personnel on a contract or part-time basis to handle any influx in customer demand and pick up the slack if certain projects fall behind schedule.

Focus on Customer Retention

Some long-term contracts will have clauses preventing you or your customer from cancelling for at least a certain period. Whether or not yours do, customer retention is essential to reduce your backlog (especially if you’re a recurring revenue business).

This means that, although it’s a financial reporting metric, reducing your revenue backlog is a product and customer success issue. The more you focus on making sure customers are getting the maximum possible value from their agreements, the less likely they’ll be to exit early.

Here are a few ideas:

• Share best practices, features, and product tips/how-tos to help customers get more value from your product/service
• Create customer communities where they can interact with you and each other, share ideas, and ask questions
• Respond to customer inquiries as quickly as possible

Streamline Billing

From a retention standpoint, you can save yourself a lot of the hassle simply by ensuring customers are paying on-time. This also means you’ll need to make it as easy as possible for them to pay.

• Accept a wide range of payment methods
• Send invoices and reminders automatically
• Offer self-service options that allow customers to update their billing information or change their plans without involving your team

Using a subscription management or invoicing platform with automated billing will save you from missed and late payments, which can help you reduce your backlog at the rate you’re supposed to.

Optimize Pricing

How closely your pricing aligns with your value proposition and customers’ willingness to pay significantly impacts whether your backlog will actually turn into revenue.

Price optimization is about striking the perfect balance between enabling you to meet your business goals and making it attractive to your target buyer. To determine the optimal price, consider price elasticity, competitor prices, and your own costs.

You’ll also want to experiment with different pricing models (e.g. different product tiers or usage terms) to see which one resonates best with your customers and are easiest for you to support at scale.

Effective Cash Flow Management

Even if everything goes according to plan, it’s still possible to run into cash flow problems. If you don’t have enough funds to operate, investing in growth initiatives (like hiring more employees or expanding your marketing efforts) becomes almost impossible.

To avoid this situation, make sure you’re managing your cash flow effectively.

• Accurately forecasting expenses and revenue
• Creating a budget that allows for fluctuations in revenue
• Having an emergency fund or backup plan in case of unexpected financial challenges
• Using your backlog to make conservative estimates of your expected future revenue and plan accordingly
• Implementing risk management strategies to mitigate potential financial risks from external factors (e.g. economic downturns, global pandemics)

If you don’t interpret your backlog correctly, you’ll struggle to make accurate projections and practical business decisions.

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