January 12, 2022 by Adam Hoeksema
Do you know what makes companies like Salesforce, Slack, and Dropbox rule the SaaS (software-as-a-service) space? Well, it’s their exceptional customer service and ability to manage finances smartly. The former entirely depends on the latter because you can only make sound decisions about every business aspect when you're clear about finances.
So, if you also want to be successful in the SaaS industry, you need to drive your finances smartly. This is what makes a SaaS financial model an essential tool for your business.
If you’re already in SaaS, odds are you’re familiar with financial forecasting models. But for start-ups, financial statements and projections can be a little overwhelming. While a good SaaS financial model template makes things a whole lot easier, it’s important to know the basics in order to create an accurate model.
Continue reading this guide to find answers to all your questions:
What Exactly is a SaaS Financial Model?
A financial model summarizes your company’s position based on certain metrics and helps forecast its future financial performance.
A SaaS financial model is like a digital balance sheet used to understand the financial position of your business and track growth rates. Most importantly, you can use this financial instrument to make future projections and hypotheses. A well-constructed model helps raise capital, present business performance to the board, or make important business decisions.
Ideally, your SaaS start-up financial model should tell the following things about your firm:
- Cost of acquiring and retaining customers
- Costs and benefits of switching to a subscription payment model
- Marginal benefits of a new subscription
- Financial sensitivity of your organization in the status-quo
- Changes needed to improve your company’s financial picture
Of course, figuring out these insights is not always easy, thanks to constant changes in variables like supply and demand, new regulations, etc. But this data puts finance teams in a better position to make informed long-term decisions. That’s why SaaS financial forecasting models are fundamentally important for SaaS firms.
Please note that a traditional or standard financial model may not work for your SaaS company. That’s because tracking financial goals in the SaaS space is different from that of other businesses.
Why do SaaS Companies Need a Unique Financial Model?
Because SaaS firms work differently compared to other businesses. Major reasons for this are:
- Recurring Revenue
For simple retail businesses, each transaction brings profit. The associated cost of the item is deducted from the money the customer pays for it, and more transactions = more profit.
But the SaaS industry operates differently. There are a whole set of unique factors that drive growth and revenue in a totally different way than retail businesses. SaaS companies earn revenue on a recurring basis.
SaaS companies incur major costs in the development phase. They allocate resources to marketing or selling to prospects, but they don’t have fixed costs associated with each user. Instead, each additional user/subscriber helps the company repay upfront costs before profit can be achieved.
So, customer retention is important for a good SaaS finance model.
- Unique Operating Costs
Standard businesses incur operating expenses, including rent, inventory costs, insurance, marketing, etc. But a SaaS company, in addition to these, incurs unique operating costs such as customer acquisition cost (CAC), customer lifetime value (LTV), LTV: CAC ratio, and more. These are particularly called SaaS metrics.
- Complex Datasets
Exploring these metrics reveals complex sets of intertwined data, working together to drive growth and revenue.
So, you need a financial model that can accommodate all these unique metrics and operating costs.
SaaS Finance: Key Metrics (KPIs)
Financial metrics for SaaS companies may vary depending on your unique business model and its specific needs. The most common ones are explained below:
Recurring Revenue (MRR and ARR)
You need to calculate recurring revenue on two bases:
- Monthly Recurring Revenue (MRR) for short-term growth: Divide the total value of each customer’s contract by the total months of their contract. Then, add the result for each customer together.
- Annual Recurring Revenue (ARR) for long-term growth: Add revenue from each active contract (12 months or longer) at the end of the timeframe that you’re calculating.
Tracking MRR and ARR help understand how consistent your revenue stream could be; how, and why revenue changes over time; and if your revenue is increasing.
Customer Lifetime Value (LTV)
LTV is the total revenue you can expect from each subscriber over the lifespan of their time with you. It helps you understand if your SaaS product is fit for the target market; customer loyalty; and whether you’re losing money on customer acquisition. Higher LTV helps uncover new growth opportunities and expand your company.
To calculate LTV, multiply the average revenue per customer over a year by your gross margin. Then, divide the result by your churn rate.
- Customer churn rate: Percentage of users who abandon or unsubscribe from your service within a given time period. Divide the number of customers lost in a specific time frame by the number of customers at the beginning of that period.
- Revenue churn rate: The monetary amount lost over a certain time frame. Subtract your MRR from the month's end from the MRR from the month's beginning. Next, from this result, subtract the MRR in customer upgrades from the same month. Finally, divide the result by your MRR from the month's beginning.
This metric helps understand your customer satisfaction, retention, and whether your marketing efforts are working. A high churn rate means customers aren’t satisfied.
Customer Acquisition Cost (CAC)
CAC shows how much money you spend to acquire a new customer. CAC helps understand whether or not your sales are covering your expenses on marketing.
To calculate the CAC of your SaaS company, take total expenses on sales and marketing and divide it by the number of new customers acquired over a given period.
CAC Payback Period
The payback period shows how long someone needs to be your customer so that you can reach your break-even. A shorter CAC payback period means more profit per customer.
If it remains the same or longer than the contract’s length, it means your SaaS business is either breaking-even or losing money on customers, respectively.
To calculate your CAC Payback Period, divide your CAC by the total MRR, multiplied by the gross margin.
The gross margin of your SaaS is the total amount of revenue from your customers after deducting the total costs of services. These costs can include costs of customer support, web hosting charges, account management, etc. A higher gross margin means you’re retaining more money from every sale.
Besides these, it also helps track other SaaS financial metrics like:
Some software programs are meant to be used by everyone, while some are designed for a specific audience. So, understanding your target audience can help you develop a strong marketing model. Also, the market size determines the way SaaS companies will need to plan new approaches and investments.
Applying an industry-consistent discount rate makes it easier to determine how much future cash-flows are worth in the status quo.
For SaaS, the unit cost may stand for the cost per feature, per product, per message, per customer, or per dev-team. So, it’s important for you to understand the unit metrics and how they relate to your cloud costs. It will help your team make profitable engineering decisions.
Cost of Goods Sold (CoGS)
Finding solutions to reduce the cost of goods sold is one of the best ways to improve your profit margins. The more data you get, the more accurate financial models can be built.
Types of SaaS Financial Models
A financial model for SaaS start-ups focuses on user and feature standards. It's not related to the one-time purchases. Instead, it's dependent on the revenue generated by the users. It also combines three financial statements: cash flow, income statement, and balance sheet. While there are numerous SaaS financial models, here are the main ones listed for you:
3-Statement Operating Model
As the name suggests, a 3-statement operating model contains three accounting statements of your business:
- Cash flow statement
- Balance sheet
- Income statement
Together, these statements represent a company’s financial position as a whole. Since all three statements are connected, if there is a change in one, then the other two should be adjusted accordingly.
The operating model forecasts the financial status of your SaaS company and potential issues. It serves as the base model for other financial forecasting models in the list.
Financial forecasting models forecast the ultimate financial performance of any business area (like revenue, income statements, capital expenditures, etc.). Results are then added to the final financial model.
The forecasting model is useful for cost estimation, resource allocation, and appropriate budgeting for any SaaS start-up. All this information and prognosis helps a SaaS business to come up with data-driven strategies for better growth. It also gives a comparative study of past performance with future ones.
The financial forecasting model is also helpful when you're seeking investments. Potential investors review your statements and forecasts to decide whether your business aligns with their investment goals. Mergers and acquisitions also involve reviewing the results of financial forecasts. All in all, a SaaS forecasting financial model helps make major business decisions for future growth.
Five types of forecasting models for SaaS include:
- Bottom-up financial forecasting model: This model uses current financial statements and sales data. Using this model, you can review the company's lowest point and calculate future scenarios accordingly.
- Top-down financial forecasting model: Useful for start-ups, this model helps assess the market size and determine how much of the market you can secure. It’s a perfect model for evaluating potential growth opportunities in any new space.
- Correlation forecasting model: This model helps identify and track correlating variables, such as supply and demand or pricing and costs. By looking at the relationship between variables, you can determine how growth in one area might influence another.
- Statistical forecasting model: Also known as the quantitative forecasting model, this method helps compare your operations with your competitors. It's also useful for assessing profitability, growth rates, and benchmarks in the industry.
- Delphi forecasting model: In this model, you get your business forecasts from industry experts with a facilitator leading the group. It involves iterating on hypothesis and analysis collaboratively to reach a consensus point. Experts also answer a series of questionnaires. All of these insights help your SaaS firm make informed decisions and discuss relevant issues.
Check out video walkthrough on how to make a full financial forecast for a startup or scale up Saas business:
Reporting models have similar fundamental characteristics as other financial models. This means they have the same designs, structures, and principles as others. This model features the entire finance history, including all three financial statements, costs, and revenues.
The model is also effective for generating a comparative report between the real and budget reports. Also, it aims to track, examine, and report the income of a SaaS start-up to help them manage and make informed business decisions.
Discounted Cash Flow Models
Discounted cash flow is a financial model that predicts and discounts the cash flow of SaaS companies to reach the current values. It is also considered a valuation method where it uses these predictions to analyze the company's worth. Simply put, it evaluates the intrinsic value and illustrates it as per-market value.
The base of this model comes from the Integrated Statement model that we mentioned earlier. It sources the cash flow from the base model and makes the necessary modification. After that, it discounts back to the current value. These models are well-detailed and include major assumptions along with future expectations of a SaaS business.
Leveraged Buyout Models (LBBO)
The LBO model is a type of transaction where any SaaS company is acquired through debt. It's where any organization borrows maximum funds from lenders and sources the remaining amount from their own end. The borrowed amount could be anywhere around 70-80% of the cost-price.
The LBO financial model is comparatively more complex and advanced than other models. To build a thorough and insightful LBO model, you need the following:
- Assumptions on inputs include financing, operating metrics, uses of cash, and operating scenarios.
- Financial statements: Income statement, balance sheet, and cash flow statement
- Transaction balance sheet: It lays out the capital structure of your SaaS business after the LBO transaction is completed.
- Debt and interest schedules: Debt and interest payments associated with line of credit, term loans, and subordinated debt.
You also need to be prepared with your credit metrics, sensitivity analysis, charts, and graphs.
What Makes a Good Financial Model for SaaS Start-ups?
Besides selecting an appropriate financial model for SaaS start-ups, there are certain standards that make it a good model. For example, it should be insightful and easy to understand yet not haphazard. Your financial forecasting models should pass on the following hallmarks:
- Accurate Assumptions
In a financial model, an assumption gives a clear idea of the company's growth as-per the current performance. Not only is it the starting point, but also an implication of the company’s upcoming financial statements. A good financial model should provide accurate, realistic, and quantitative assumptions of your SaaS business.
The model should provide equitable data that correlates with current performance and past values. It should be clear, without any irrelevant data. That's why it’s important to always check the values you are adding.
Your SaaS financial model should be error-free and precise. The formula you use should be consistent, and the numbers should be accurate. Keep values clearly visible and free from fatal errors such as intricate models, lack of data integrity protection, illogical layouts, hiding rows/columns, complex formulas, etc. Also, it should not feature hard values as it makes the formula more complex.
Your SaaS financial model should be flexible and adaptable both in the present situation as well as in the long term. A dynamic model allows users to add various values into cash-flow projections, debt services, inflation rate, and other sections. In addition, different analysts can add different data based on their unique projections. So, your model should be adjustable and manipulatable across different fields.
- Simple and Easy to Understand
A good financial model doesn't have to be complex. Rather, it should be easy to read and understand, organized using a well-structured layout. Be consistent with page breaks, color schemes, columns, fonts, and every other element you use. Please remember that consistency and formatting make even complex models simple to understand.
By now, hopefully, you've become much more familiar with SaaS financial models. Understandably, creating insightful and flexible models can be challenging for SaaS start-ups. In this case, you can use a reliable SaaS financial model template.
For example, you can use the CPA-developed SaaS financial model template by ProjectionHub. It's well-developed for multiple scenarios, including worst and best-case projections. As you see, sophisticated models require lots of inputs like SaaS financial metrics, assumptions, financial history, and many more. The template simplifies this process and helps make sure you produce an accurate model.
With ProjectionHub SaaS financial model template, you get smart dashboards and tools to keep everything at your fingertips. You can also watch a quick video demo of how ProjectionHub’s SaaS financial projection template works here: