The Benefits of Annual Billing for SaaS Companies
During the early stages of a saas company while determining product/market fit, it is more important to focus on winning new logos than it is to focus on billing terms (ie. the frequency that customers will pay for your product). As the company begins to scale the sales, marketing, customer success and engineering teams, signing new logos on annual upfront billing terms (vs. monthly) can be critical to helping fund the rapid growth and reducing cash burn. In the following blog post, I will show how important it is to emphasize annual upfront payments in the sales close process by comparing the cash inflows of each billing cycle (all else equal).
Here are the assumptions I used for the example B2B Saas company:
|MRR as of 12/31/16||$220,101|
|ARR as of 12/31/16||$2,641,209|
|# of Customers as of 12/31/16||100|
|Avg ACV of Customers pre-Jan 2017||$26,412|
|Starting ACV for New Logos||$24,000|
The pre-2017 cohorts of customers remain on a monthly billing plan. It is on the 81 new customers in 2017 (and their 2018 renewal) and the 127 new customers in 2018 where we will run the 3 billing scenarios.
Cash inflow is represented by the following calculation: Revenue + change in Accounts Receivable + change in Deferred Revenue
Annual MRR Growth
The following are 2 “waterfall” charts which provide a nice visualization of MRR growth for our example company. It is easy to see that the new logos are driving the increase in MRR for each year. In addition, the expansion MRR from current customers entirely offsets any decrease or churn.
Assumptions for Cash Collection
Another factor that would affect cash inflow is how quickly payment is collected. The table below shows the DSO (days sales outstanding) assumptions in days for each billing scenario:
|Billing Term||DSO (days)|
Note: Annual billing has the largest DSO because the annual invoice often has to go through more approvals on the customer’s side, given the higher amount. In addition, the first invoice that is sent to a new customer on an annual plan may have to go through procurement, which can add significant time depending on the size of the customer’s organization.
Cash Inflow Comparison
The difference between the orange bar (monthly) and grey bar (annual) shows the positive impact annual upfront payments can make to monthly cash inflows. For example in the month February 2017, the difference between the annual billing cash inflow ($331,633) and monthly billing cash inflow ($232,583) is +$99,050 (all else equal).
If we look at the cumulative difference between monthly and annual billing, the benefit is even more compelling. Over a two-year period, when compared to monthly billing, annual billing on new logos would provide over $2.3 million more in cash to fund operations. This amount is the equivalent to venture debt or an equity funding round!
Note: cumulative cash inflow = cash inflow(t = 0) + cash inflow (t +1) …. + cash inflow (n)
t = 1 month
n = 23 or 2 years
Customers Want a Discount If Selecting the Annual Plan
It is very likely that potential customers will require a discount for paying the entire annual amount upfront. Furthermore, your sales team will want to have some flexibility when negotiating the final redlined contract. So will providing a discount affect our conclusion above?
Most discounts are 5-10%, but since this example is hypothetical and for illustrative purposes only, let’s apply a 25% discount to the annual billing plan and see how it compares to monthly and non-discounted annual pricing (all else equal - ie. same # of new customers in 2017 and 2018). The blue bar for discounted annual pricing continues to show a cash inflow benefit over monthly pricing, which means it is definitely a good business decision to agree to a reasonable discount.
If we look at the cumulative difference between monthly, annual billing and annual billing with 25% discount, there is still a benefit for the discount scenario. Over a two-year period, when compared to monthly billing, annual billing with a 25% discount on new logos would provide just over $800,000 more in cash to fund operations. That is the power of upfront payments!
In summary, while it is not always appropriate to focus on the payment terms in contracts, when the company is at the right stage of growth, encouraging the sales team to win contracts with annual upfront payments can provide a sizable benefit to operating cash flow. If customers are hesitant to agree to annual billing, it is still possible to see higher cash inflows by agreeing to a reasonable discount. Implementing an annual billing option in the quote-to-cash process can potentially mean the avoidance of a time-consuming equity funding round in the future!