CFO Bridge Insights September 2023

Navigating Growth Dilemmas in SME Tech Companies - Booking a Lead Indicator and Revenue Projection Synthesis

Overview

4 IT players commentary on Order book, in their recent Annual report. We observe that there is no consistent representation of the Order book, book to bill ratio, large deal wins, etc., from the quarterly results, analyst calls, annual reports to do a bench mark or to estimate revenue growth using the inputs. It becomes a judgemental approach for analysts while companies are better placed with their own structured database to estimate revenue and growth.

We closed the year with an order book of $34.1 Bn. This along with the strong pipeline replenishment gives us a good visibility for the medium term. …. TCS in its Annual Report FY23 TCS states their Book to Bill ratio is 1.2, which means they hold an Order book of $34.1 B in FY23, against $27.9B Revenue in FY23.

Our large deal intensity was strong during the year. We had 95 large deals with a value of US$9.8 billion in the year…. Infosys in its Annual Report FY23

A consistent and sustainable pipeline resulted in winning $8.85 billion new deals in FY23, an increase of 6.6% over FY22…. HCL Tech in its Annual Report FY23

Order bookings in Total Contract Value terms grew 28% YoY; we finished the year with two consecutive quarters of bookings of over $4.1 billion each. We signed 55 large deals with a total contract value of $3.9 billion, growing 66.5% YoY…. Wipro in its Annual Report FY23

Lets note that ideally the Order book on hand should witness YOY similar growth like revenue growth, by this a company would ensure that the revenue growth for future period would be higher. If Order book growth is low then the company would end up depleting its order book unless a much higher new order book is added in the next year. Consistent monitoring and review of order book (future revenue coverage) and Sales pipeline, a lead indicator of growth, is a very important action for decision making.

Essential data points for Forecasting Revenue

To predict the revenue there are a couple of inputs which are essential to capture by every company. ( the list is indicative and not exhaustive)

a. Orders in hand

a. Customer, Project Type

b. TCV (Total Contract Value), ACV (Annual Contract Value)

c. Project Tenor (start date and end date) and balance open tenor

d. If recurring or T&M nature – probability of renewal/ extension

b. Sales Pipeline

a. Qualified leads

b. Stage of the deal closure

c. Expected date for deal signing

d. Expected date of Project start

e. Probability for win

c. New book and Bill (a blue sky estimate based on past pattern of something happening not planned)

How to go about Revenue Projection

• Using the above three major inputs, the ground up forecast is done for a period which can be month, quarter, half year or full year.

• Using Orders in hand one has to estimate the revenue for the balance tenor using judgment for various types of projects. Few suggested approaches on estimation are as below:

• T&M Projects/ Rate card based projects – If there is any staffing ramp up or ramp down plan: no. of resources (Q) * Rate card (P) for each month would be the estimated monthly revenue. If a staffing plan is not available then take effort estimates from delivery or take current resource count and extrapolate.

• Monthly recurring billing: Spread evenly if monthly phasing is not pre-defined.

• Fixed Price Projects : Estimate monthly based on the effort estimation sheet – P * Q ( which would reflect the % completion method of revenue recognition).

•  Unit pricing: Estimate monthly based on the Volume estimation sheet used in the deal pricing ( P * Q) ; if no input available, then estimate evenly and progressively, keep correcting based on actual volume ( like a true-up or true-down process).

• Assets / SI deals: Based on deal pricing sheet.

• Any other engagement model: First take reference to deal pricing sheet, else ask delivery to give estimates to reflect the revenue recognition failing which use a even spread of the revenue or do basis best judgment.

By consolidating with monthly phasing the order book on hand is built.

Maintenance of the Order book

• Post that the Order book needs to be maintained by adding fresh orders won and their projection.

• After every month passes by the Order book projection vs. Actual revenue recognized needs to be analysed for any variance. The variance can be a permanent loss or a temporary loss. Say for e.g. If it is a Fixed Price project and the revenue recognition is delayed then it is a timing loss so the project end date may be extended or efforts of delivery may happen in future period. This is a temporary loss and one need to do an adjustment to the order book by reflecting the new phasing of the order book. In case of a staff augmentation work if the resource is not supplied in that month or partly supplied and client is very clear this cannot be rolled over then it is a permanent loss in TCV/ACV so reduce the order book by making necessary adjustments. Like this there may be multiple types of order book adjustments which need to be done every month as a process to reflect the right closing Order book at the end of the month and Future Order book coverage.

• When we start the quarter, one will know very clearly if the Forecasted revenue is 100 then how much is the Firm in hand revenue through Future Order book coverage say 70, in which case the balance 30 would have to come through new booking.

Projection using Sales Pipeline

• Using the CRM tool (which needs to be updated regularly or if volume is not high have the same updated or tracked in spread sheets) extract the active database of qualified leads by existing/new customers , by Sales person , segment – product / vertical / horizontal ; TCV/ACV , deal stage , expected project start date and deal closing date, probability of win etc.,.

• The quality of CRM tools is very critical to aid better forecasting.

• Using the probability of win extrapolate the revenue recognition for the future months. Do keep in mind the probability can change either ways so monitoring the lead conversion is very important.

• Review of the sales pipeline on a weekly basis is very essential to have a good forecasting control.

Projection of blue sky estimates

• Many times, the Sales pipeline might not be updated or as a pattern some clients would give business or a random deal can fructify suddenly much ahead of time. All these could be about x% percent, every company could see this as a pattern and probably use this as a stretch revenue estimate.

Establishing the Revenue Gap

• We will illustrate how we approach doing a revenue guidance and gap analysis for a quarter at the beginning of the quarter.

• From the regular maintenance of Order book one will have clear firm orders in hand and hence the revenue through future order book coverage. (A)

• Next using the Sales Pipeline the probability based estimated qualified leads pipeline will give the next set of revenue estimates of the quarter (B)

• Using judgment the blue sky estimates may be predicted (C)

• Total estimated revenue would be D = A+B+C

• Suppose market expectation says 2% QOQ growth then as a company if D gives X% growth then company needs to explore actions to mitigate the gap failing which the unmitigated action will leave a gap.

Revenue Gap estimates – mitigation – some scenarios to watch out

• First the Gap between market expectation and “D”(ground up estimate would be established by vertical / horizontal / region etc., to know the problem statement doing slice and dice.)

• One would also check deeply the growth or degrowth at customer level to be sure there are no slippage, if yes it needs to be addressed

• Further the qualified pipeline should be closely reviewed for conversion into executable delivery, whether the resources are in place etc.,

• Sometimes the prospective orders may come in last 15 days of the quarter, one need to be clear whether it is too late for mitigation. There needs to be a clear runway to onboard people , deliver the project, get client acceptance to see the certainty of revenue. If there are gaps here then the forecasting will fail. Be watchful of the same.

• Unaccrued revenue can be a filler ( backlog from past): At times there can be projects which may have been delivered in anticipation of PO/SOW or pending customer acceptance. In such cases the revenue recognition would be kept pending and these are low hanging fruits which need to be chased for conversion into revenue. At the same time one should not allow new unaccrued created in the current quarter too.

• Avoid all scenarios where revenue recognition can slip to next quarter by pro-actively taking decisions , co-ordination with teams and customers as the case may be to ensure the forecast is met 100%. If some cases are bound to slip, immediate mitigation would be needed to address the gap.

• These activities are driven by operational business finance in collaboration with Sales , delivery , Work force teams and leadership in most of the well run organizations.

• In some scenarios there can be open discussions with clients , issues in contract clauses , client acceptance of stage of completion, legal dispute etc., Try to put the same on top priority and attention to get the same close for getting the revenue recognition in the quarter.

• Some new deals , methods of revenue recognition would need closure with auditors, do it early proactively and not leave it till last minute, you may have limited reaction time.

Summing up

• We understood the need for maintaining the Order book and computing the Future order book coverage, and needed to review the Sales qualified leads pipelines and blue-sky estimates.

• While we explained the near-term quarter view, we can follow the same approach for the Budget and rolling 12 months forecast.

• While doing so one can clearly see patterns emerging in the form of x% of the revenue achieved in a quarter was on hand at the beginning of the first month in the quarter or beginning of the first month in a year. Progressively keep track of this % and a mature model will emerge if the nature of business is the same.

• Say for e.g., if every quarter beginning the 70% of revenue is firm on hand and in a particular quarter the firm on hand turns out to be 75% and the sales pipeline is having normal trend then we can reasonably be sure we will overachieve forecast and vice-versa will happen if it is below 70%. Do note to achieve the budget estimates, being a 12 month window, mitigating actions can be taken but in a quarter window the speed of decision making and mitigating actions are very essential and if one slackens the chances of missing the guidance/ forecast is quite high.

Building this as a consistent model in the dashboard and making it viewable by all stakeholders to take pro-active action with a high level of data integrity and data definition is a major change management. Once done these companies will cruise on the process strength very seamlessly , take quick decisions and mitigation actions. They can make booking as a lead indicator for growth comfortably.

Hope you found the inputs valuable, feel free to share feedback or share your queries too. We have attempted to keep this content focused to get the right attention on the specific topic, so were constrained to elaborately discuss scenarios.

Should there be a need for any professional guidance to feel free to reach out to us and we can share our knowledge and set up the systems and processes too. Happy Forecasting.