One of the most important things SaaS companies need to think about in order to be successful is financial modeling.
To succeed in the increasingly competitive SaaS space, finance teams need to carefully consider a wide variety of KPIs and find ways to effectively manage both present and future cash flows. Cash flows and liquidity are two of the most common challenges faced in this industry — if effectively addressed, your company can position itself for long-term success.
Having a robust SaaS financial plan can help give your business a lasting competitive edge.
In this article, we’ll discuss the most important things you should know about SaaS finance, including the keys to financial modeling and the financial metrics that all SaaS teams need to pay attention to. Additionally, we will discuss some of the most useful software that can help your team address its growing financial needs.
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SaaS Finance is a term used to describe the financial plans and operations of any company involved in the SaaS space. Many of the companies in this space offer software that is billed on a monthly or annual basis. Regardless of the pricing model employed, SaaS Finance remains abundantly important to ensure profitability.
Two key components of SaaS finance are financial modeling and key performance indicators (KPI). As the terms might suggest, financial modeling helps firms forecast future financial changes and discover ways to improve their bottom line. Furthermore, KPIs can be used to help firms develop a greater insight into their financial operations and identify opportunities to change for the better.
As stated by the Corporate Finance Institute, “Building a financial model for a Software as a Service (SaaS) company typically requires creating a monthly model that forecasts users, subscription rates, churn rates, and average revenue per user (ARPU).” These models are designed to address the unique challenges inherent to the broader SaaS industry.
SaaS finance, like most types of professional finance, relies on three key accounting statements: the income statement, the balance sheet, and the statement of cash flow.
Each of these statements plays a crucial role in the reporting and decision-making process and can help enterprises address various challenges, such as liquidity, profitability, tax obligations, expansion, and more.
Ideally, a good SaaS financial model can help firms answer a variety of important questions:
Of course, answering each of these pivotal questions is not always easy. Sudden changes in supply and demand, new regulations, and other variables can all make it difficult to predict what the future has in store.
However, what remains clear is that with better data, finance teams can put themselves in a position to make better long-term decisions. This is why financial modeling for SaaS firms is so fundamentally important.
As suggested, the basis of financial modeling in the SaaS industry — as is the case in most industries — will typically require the use of the three key financial statements.
The balance sheet offers a “snapshot” of the company’s assets (which can include subscriptions, licenses, patents, and other “digital entitlements”), liabilities, and equity. The income statement will report the company’s revenue and expenses over a specific period of time, typically the year. The statement of cash flows will illustrate how cash has moved into and out of the company and will categorize each of these cash flow movements.
From there, the company will need to forecast its future activities, including changes in users and subscribers (whether positive or negative), churn rates, and expected revenues from each user.
It is not always possible to know these figures with certainty, but a good model will make it possible to “plug and chug” different scenarios and see how your business might be affected. For example, suppose your company was to double subscribers. Would that also double your bottom line?
Sensitivity analysis is a key component of SaaS finance. Essentially, the purpose of sensitivity analysis is to determine how changes in one variable (the input) will cause changes in another variable (the output). In some cases, this sort of analysis is called the “What-If” analysis.
Discounted Cash Flow Valuation is also commonly used by CFOs and other key decision-makers within the SaaS industry. DCF valuation accounts for the value of all expected future cash flows, adjusted for the time value of money (TVM). Because the subscription model used throughout the SaaS industry causes cash flows to be rather predictable, DCF valuation is usually rather straightforward.
Having reliable financial models will not only make it easier for companies to make better internal decisions, but these models will also be used by other relevant parties, such as venture capitalists, lenders, tax authorities, investors, and more.
By now, it should be clear that what enables SaaS finance to thrive is monitoring the right financial metrics. Though the metrics that make the most sense for your business will depend on your specific needs and business model, these are twelve of the most common:
For your financial models to be accurate, you will need to accurately forecast how many people will be subscribed to your SaaS in any given month.
The churn rate is the percent of customers that abandon (or unsubscribe from) the service within a given period of time. High churn rates might indicate there is something fundamentally wrong with the software.
Understanding the revenue that each user typically provides will make it easier to make decisions regarding expansions, entering new markets, and consumer outreach.
Customers, unfortunately, are not free. How much is your business spending for one additional user?
Higher lifetime customer values will make it easier to expand the company and find new opportunities for growth.
The ratio between the lifetime value (LTV) and the customer acquisition cost (CAC) is a crude way for CFOs to determine the return on investment for each customer.
The payback period, simply, illustrates how long someone will need to remain a customer in order for you to “break even.”
While some software might be used by just about everyone, others will have a much more targeted possible audience. Understanding who might eventually be a customer can help you develop a better marketing model.
Applying an industry-consistent discount rate will help make it easier to determine how much future cash flows are worth in the status quo.
Ultimately, your enterprise was created to someday produce a profit. Even if you won’t break even for several more years, net profit margin is always something that is worth keeping in mind.
For SaaS, unit cost may include cost per feature, per customer, per product, per message, or even cost per dev team. It’s important to understand the unit metrics that matter to you most and how they map to your cloud costs so your team can make engineering decisions that ensure profitability.
Finding ways to reduce the cost of goods sold is often one of the most effective ways to improve profit margins and potentially lower prices.
The more data your business can use, the more accurate your financial models will be.
Anyone who is familiar with SaaS knows just how valuable software can be. Here are some of the most popular platforms used across the industry:
As the most popular accounting software currently in use, QuickBooks makes it easy to generate financial statements, track accounts, plan your taxes, and plan for the future.
Cloudzero’s cloud cost intelligence platform enables SaaS companies to understand exactly how their AWS costs drive their specific features and products. By mapping cloud costs to products, features, dev teams, and more, engineering and finance alike can identify unit cost like cost per customer (e.g., answering questions like, “Who are our most expensive customers?”) and understand their SaaS COGS.
An oldie but a goodie, Microsoft Excel is a standard tool for anyone hoping to build flexible financial models and test various “What-If” scenarios.
Oracle NetSuite is useful for analyzing invoices, streamlining compliances, making calculations, and adjusting your general ledger.
ChartMogul, which uses a monthly subscription model, is a useful platform for tracking key SaaS metrics, such as LTV, MRR, cashflows, and churn rates.
As the SaaS industry continues its impressive rate of growth, more financial software and tools are likely to emerge. The industry presents a tremendous amount of potential and those who are willing to invest in better financial models, will be in a position to succeed.
Using some or all of the tools mentioned above will help put your brand in a position to have a strong understanding of the financial metrics that matter to you most. When it comes to identifying unit cost, SaaS COGS, and seeing how your AWS bill maps to your specific products and features, CloudZero’s cost intelligence platform provides SaaS teams the data and cloud cost visibility to find the answers they need.
Request a demo to see how CloudZero can help your team answer questions about your cloud spend and uncover the cloud cost metrics that matter to your bottom line.