Remaining Performance Obligation (RPO) in SaaS: What it means

Have you heard the acronym RPO but aren’t entirely sure what it means?

This primer will explain the concept of remaining performance obligations. We can help you manage them easily and avoid costly mistakes. 

We’ll cover:

• A definition of RPO and why it matters in SaaS
• The formula used to calculate RPO
• How reporting RPO works in financial statements 
• RPO vs. deferred revenue
• Benefits of tracking RPO
• Challenges of managing RPO and how to overcome them
• Best practices for managing RPO

Let’s get started.

What is remaining performance obligation (RPO) in SaaS?

RPO in SaaS is a financial metric representing the total contracted revenue from services or products. Importantly, these services or products have yet to be delivered to customers or recognized as income by the company. 

In short, it provides valuable insights into a company's future revenue streams and growth potential.

RPO is a blend of two key components:

1. Deferred revenue: This is money you've collected upfront for services or products that still need delivery. It's a liability on your books until those promises are fulfilled.
2. Unbilled revenue (also called backlog): It's the revenue you still need to bill for, but it's locked in through customer contracts. It's like knowing a big check will eventually hit your mailbox.

Together, deferred revenue and backlog give you the total RPO. In other words, it gives you the complete picture of contracted future revenue.

Short-term vs. long-term RPO

• Short-term RPO: This portion is how much you expect to recognize as revenue within the following year. It's a good indicator of the company’s immediate financial health.
• Long-term RPO: This is revenue contracted for delivery beyond the next 12 months. It's a glimpse into your long-term growth potential.

By understanding both, you gain a clearer vision of your financial journey. You can see both the near-term milestones and the distant horizon.

Why RPO matters in SaaS

RPO in SaaS is a window into the future for your company. Let's explore why it deserves a front-row seat in our decision-making:

• Predicting future revenue: RPO shows the revenue already in the pipeline but hasn't hit our income statement yet. This allows you to gauge the upcoming financial performance more accurately than relying on historical data alone.
• Investor insights: RPO signals a company's future revenue trajectory. A healthy RPO indicates a more robust and more predictable income stream. This can make investors more confident and willing to back your business.
• Comparative metric: Comparing your RPO to industry peers can provide valuable insights into your market position. It's like peeking at the answers during a test without the negative repercussions. 

How to calculate RPO

RPO is a straightforward addition of two components we discussed earlier:

RPO = Deferred Revenue + Backlog

While the formula is simple, keep these points in mind:

• Timing is key: RPO is a snapshot in time. It can fluctuate as you deliver services, bill customers, and sign new contracts.
• Track it closely: Calculating your RPO helps you monitor your financial health and predict future revenue trends.

A sample calculation

Imagine you're a SaaS company with:

• Deferred revenue of $100,000 (from annual subscriptions paid upfront)
• Backlog of $50,000 (from multi-year contracts not yet invoiced)

To calculate your RPO, you’d have to express it like this:

RPO = $100,000 (Deferred Revenue) + $50,000 (Backlog) = $150,000

This means you have $150,000 in future revenue waiting to be recognized. 

Reporting RPO in financial statements

Reporting RPO is key to financial transparency and disclosure for SaaS companies. It provides insights into a company's future revenue and helps investors make better decisions.

GAAP requirements

GAAP stands for Generally Accepted Accounting Principles. They are the accounting standards that companies in the U.S. must follow when preparing financial statements. GAAP includes specific requirements for reporting RPO. This helps make sure that financial statements are accurate and consistent.

Under GAAP, companies are required to disclose their RPO in the notes to their financial statements. The notes should describe the company's RPO and some key info:

• They should have information about the amount of deferred revenue and backlog that make up the RPO.
• They should explicitly state when the RPO will be recognized as revenue.
• They should include significant risks and uncertainties associated with the RPO.

Companies may also choose to disclose their RPO on the face of their financial statements in addition to the notes. However, this is not required by GAAP, and company requirements might vary. 

Transparency and disclosure

There are several best practices for disclosing RPO in financial statements and reports. 

These best practices help guarantee that stakeholders understand a company's RPO and its potential impact on its future financial performance.

When disclosing RPO, follow these best practices:

• Provide a clear and concise definition of RPO.
• Disclose the RPO at the beginning and end of each reporting period.
• List the changes in RPO during the reporting period.
• Explain the reasons for the changes in RPO.
• Provide a breakdown of the RPO by product or service line.
• Disclose the risks and uncertainties associated with the RPO.

By following these best practices, companies can ensure that their RPO disclosures are transparent. This helps investors and other stakeholders make informed decisions about the company.

RPO vs. deferred revenue

Now, you might wonder, "Isn't RPO just a fancy way of saying deferred revenue?" Not quite. While they're related, they play distinct roles in understanding a SaaS company's financial future. Let’s look at them side by side:

• Deferred revenue: This isn't just about upfront payments. It's also any revenue you've billed to a customer for services or products not yet delivered. 
  
  Think of it as an "IOU" from your company. It's a liability because it represents work you still need to do to earn it. As you complete those services or deliver those products, that deferred revenue transitions into earned revenue on your income statement.

• RPO: It includes both the deferred revenue and the backlog. It's the full scope of future revenue that's locked in through contracts, whether invoiced or not.

Why they are complementary metrics

Deferred revenue gives insight into the revenue you'll recognize as you deliver the services. Backlog offers a glimpse into the potential revenue waiting to be unlocked as you invoice for future obligations.

Together, they paint a complete picture of your revenue trajectory:

• Deferred revenue: Shows the immediate, recognized revenue you can count on.
• RPO: Gives you a broader perspective, including immediate and potential future revenue.

Why you should be tracking RPO

Tracking RPO isn't just about number crunching — it's about gaining a competitive edge. 

Here's how this financial metric can steer your SaaS ship toward smoother sailing:

• Better financial planning: You can plan your budget by having a clear picture of your future contracted revenue. You can also allocate resources and make informed financial decisions with greater confidence. It's like having a GPS for your financial journey.
• Customer relationship management: Analyzing the contracts contributing to your RPO helps you spot your most valuable customers. You can then tailor your engagement strategies accordingly.
• Strategic decision-making: Whether considering a pricing change or venturing into new markets, RPO data can be your guiding light. It provides insights into customer preferences, market trends, and your company's financial strengths. 

Challenges in managing RPO

While RPO is a valuable metric, it has its challenges. Let's dive into some of the common hurdles SaaS companies face when managing RPO and explore potential solutions to keep you on course.

Data accuracy issues

In finance, precision is paramount. Guaranteeing accurate tracking and reporting of RPO can be a meticulous task. Especially when dealing with numerous contracts, diverse billing terms, and evolving customer relationships.

A slight miscalculation can lead to misleading financial projections and misinformed decisions.

Solution: Implementing a robust revenue recognition system that integrates with your CRM and billing platforms can improve data accuracy. Reconciling your RPO calculations with your financial statements can help fix any discrepancies.

Complex contracts

SaaS contracts can be intricate, with various terms, renewal options, and pricing structures. This complexity can make calculating RPO challenging. 

Misinterpreting contract terms or overlooking key provisions can result in inaccurate RPO figures. This could, in turn, lead to financial misstatements.

Solution: Contract templates, clear documentation of contract terms, and regular contract reviews can help mitigate the challenges posed by complex contract structures. Investing in legal counsel with expertise in SaaS contracts can also prove invaluable.

Remaining compliant with regulations

Accounting standards and regulations governing RPO can be intricate and subject to change. 

Failing to comply with these standards (GAAP in particular) can lead to reputational damage and trust issues from investors. Staying informed about all the latest regulatory requirements for your company is crucial. You should confirm your financial reporting adheres to these standards, too.

Solution: Working with experts in SaaS revenue recognition can help you stay compliant. Reviewing and updating your accounting policies and procedures can also help with compliance. 

RPO management best practices

Managing RPO effectively is like having a compass to guide your SaaS journey. Here are some best practices to make sure your RPO is always on point:

• Regular monitoring: Keep a close eye on your RPO. Regular monitoring allows you to spot trends and make informed decisions based on real-time data. It's like having a finger on the pulse of your future revenue.
• Integration with CRM and billing systems: Your CRM and billing systems contain valuable customer data. By integrating them with your RPO tracking, you can create a seamless flow of information, which ensures accuracy and saves you valuable time.
• Training and awareness: Ensure your finance and sales teams are well-versed in the importance of RPO. Regular training sessions and open communication can create a culture of awareness so that everyone is on the same page.

Next steps

A robust and reliable billing infrastructure is key to leveraging RPO in SaaS. A simplified billing process reduces friction and minimizes revenue leakage. It also guarantees accurate RPO calculation and reporting. 

This is where Orb steps in. It empowers SaaS businesses to optimize their RPO management and unlock their full revenue potential.

Orb is a billing management platform that provides an all-around solution to the challenges of RPO tracking and analysis:

• Seamless data consolidation: Orb integrates with your existing data sources, including popular platforms like S3 and Segment, and through its flexible REST API. This ensures that your usage data, a crucial input for RPO calculation, is accurately captured.
• Tailored usage Tracking: Orb allows you to define and track the specific usage metrics that drive your RPO. Whether it's API calls, data storage, or other relevant activity. Orb provides the option to tailor your RPO tracking to your unique business model.
• Adaptable pricing models: With Orb, you can design and implement a wide range of pricing models, from granular per-unit charges to tiered pricing based on usage levels. This confirms that your RPO calculations accurately reflect your pricing strategy.
• Effortless billing automation: Orb automates the entire billing process. We cover everything from usage tracking and calculation to invoicing, payments, and adjustments. This frees up valuable time and resources and minimizes the risk of errors.

Learn how Orb can help you establish a hassle-free consumption-based billing model.