Breaking down your REVs

Revenue. It’s the most important factor to any business, but it’s also a catch-all word that can mean almost anything. We all want to talk about big revenue numbers, but in the land of REVs all sales are not the same, and understanding what $-related metrics are relevant for your business is essential.

Instead of getting lost in semantics, let’s embrace the nuance and define what Revenue /ˈrevəˌn(y)o͞o/ really means.

GMV / GTV

So ‘revenue’ means any money my company touches, right? Wrong. Many companies facilitate transactions and channel money through their platforms which is NOT Revenue. They may very well be part of a transaction with your consumer, but that doesn’t necessarily justify them as Revenue to your company. Instead such transactions are defined as Gross Merchandise Value (GMV) or Gross Transaction Value (GTV), and refers to the total sales volume transacting through the platform. It is basically the aggregate spend by the company’s users during a defined time-period. This is frequently seen in marketplaces like Airbnb, where GMV is the booking price paid by the users, while Revenue is Airbnb’s commission on the transaction. For payment platforms like iZettle, GTV means total money processed, and Revenue is rather is the single digit percentage points collected by the company. Needless to say, don’t be a n00b and mistake your GMV or GTV as your Revenue!

MRR & ARR

Recurring Revenue is a business model which involves selling someone access to a product over time — you see this frequently used in software sales. This metric is attractive by the financial market because it involves predictability and to some extent stickiness.

Recurring Revenue is often referenced against time frames. Monthly Recurring Revenue (MRR) is your total REVs during a month, and Annual Recurring Revenue (ARR) is simply your MRR multiplied by 12. However, all companies does not have Recurring Revenue. Companies who don’t operate with a recurring nature of their revenue instead have “Monthly Sales” or “Monthly Revenue”. Uber’s REVs from their ride-sharing business is not MRR, since each trip is purchased in a non-recurring nature (although many of us use their service frequently enough to question the non-recurring nature of it…). Great companies can be built using recurring and non-recurring REVs. Hence don’t refer to your monthly revenue as MRR unless your business model truly justifies this.

New, Expansion, Downgrades & Cancelled MRR

If you operate a business with Recurring Revenue, it’s critical for you to understand and break down the nature of such REVs. The natural way to look at your aggregated MRR is to separate this into New, Expansion, Downgrade and Cancelled MRR. New MRR is additional MRR from new clients who you haven’t done business with before. Expansion MRR is additional MRR from existing customers often triggered by upgrades. Downgrade MRR is the opposite of Expansion MRR with existing customers spending less money with you this month compared to before. And lastly Cancelled MRR is existing customers who stopped using your services during this month. We naturally like businesses which has a lot of New and Expansion Revenue.

Contract Value (TCV & ACV)

When a company closes a large sale, especially in enterprise environments, there is often a contract duration to the transaction. Total Contract Value (TCV) is the total value of such contract, meaning the total money the client will spend with your company during its duration. Annual Contract Value (ACV) instead measures the total money they commit to spending with your company over a 12-months period, in case the expected client engagement exceeds 12 months.

Even if you closed a sale and in the same month collected the full TCV, you most often most likely should not account for all such Revenue in the same month.

Instead with Contract Values and durations, accounting principles becomes highly relevant. Often this means recognising Revenue on a monthly basis. Exactly how and when Revenue is recognized is regulated by official accounting standards (GAAP in the US & IFRS in Europe). But in, short Contract Value and collected $ isn’t REVs.

Net Revenue & Gross Margin

To determine the health of your business you should also not look purely at your Revenue. Instead also you have to understand your Net Revenue and Gross Margins. Net Revenue is the actual money remaning after you deducting the cost of selling such products from your (Gross) Revenue. This is mostly applicable for ecommerce companies where your Net Revenue often involves deducting costs associated with discounts and returns.

Gross Margin is the percentage of total sales that the company retains after deducting costs of goods and services associated with producing the items sold. It is calculated by taking Revenue minus its cost of goods sold, divided by Revenue. The higher the percentage, the more the company retains on each dollar it makes. Many software business experience high Gross Margins around 70–90%, while ecommerce companies often experience significantly lower gross margins in the 20–40% range because of the relative low margins they have on the products they sell. Hence, depending on the company ratio between (Gross) Revenue, Net Revenue and Gross Margin the same Revenue amount can mean very different things.

Revenue is important. It’s not about knowing the right metrics to talk to VCs about, it’s about understanding your business.

If successful, you may not even need external funding to pursue your dream. But even if you plan on raising external capital, the key here is to get REVs.

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This post was originally published on fritjofsson.com. Follow me on Twitter @fritjofsson.