What are the financial models for SaaS?
Software companies use SaaS financial models to predict how their businesses will do financially in the future. They are based on how the business has done in the past, how the market has changed, and what people think will happen with future growth.
As you work on your financial model, it should tell you three main things about your SaaS business:
Revenue drivers—financial modeling tells you which business activities and goods bring in the most money and help your company grow. Some examples are upselling, attending webinars, and features that customers like.
Financial goals: Your SaaS financial model will give you a list of steps you need to take to reach your goals. You can use them to set sales goals, tell buyers what the company will be worth, and plan for long-term growth.
Company structure: The financial modeling data will help you determine the best way to set up your SaaS business. This includes figuring out which areas need to grow, shrink, or be outsourced.
There should be a financial model for your SaaS startup that tells you how fast you can grow and how. It should also tell you whether you should be aggressive or conservative with pricing and product development, how much money you need to raise (if any), and how to handle your cash flow.
Like words
- Predictions for SaaS
- SaaS business model
Why financial modeling is essential for SaaS businesses
Predictions about money
Making financial predictions is the main reason you’d use a financial model. It’s hard to make tough investment choices when running a small business. It’s like throwing darts while blindfolded and hoping you hit the target. With a financial model, you can try out different options and see what might happen before you decide on a course of action.
Making a budget for resources
Once you know that a certain amount of growth will happen over a certain amount of time, you can start to answer two questions:
“What must we do to reach the growth we want?”
Based on these numbers, what money do we have to spend on X, Y, and Z?”
When you make a budget, you’ll start by listing the most important things. Then, you’ll move on to the extra inputs needed to grow at least as fast as expected. From there, you can make goals for marketing, sales, software, and other company-wide projects.
Let’s say your MRR is $1 million, and you expect it to grow by 50% next year. Once you know you’ll be making an extra $500k; you can figure out what strategies will help you reach your goals, like hiring a new salesperson or putting more effort into a marketing channel that is already working well. More money will be spent in those areas over the next twelve months.
Guess the Revenue
SaaS companies already have a huge edge because they make money repeatedly.
They have a reliable and pretty stable source of income as long as they keep their customers. So, it’s pretty simple to figure out what to do next: compare their past progress to the rate at which they’re getting new customers.
Still, many things can affect both income growth and customer retention rates. These include, but are not limited to, seasonality, competition, market saturation, and changing customer tastes.
You can prepare your business for challenges and opportunities using a financial model to predict what might happen in different situations.
Get investors to give you cash.
People who want to invest in a SaaS company want to know how much money they might make back. One of the first things they’ll look at is your financial health. They’ll use rules like the Rule of 40 to determine your business worth based on growth and profit rates.
The facts are used in financial modeling, which is the next step. They help you figure out how much money you need to get to a certain level of growth and then prove it mathematically. This makes it easier to pitch investors and helps them know where their money is going. If it raises the company’s value, the founders probably won’t have to give up as much power.
Reporting on finances
SaaS financial models are built on bank, income, and cash flow statements. When you use those lines to make a financial model, you look at how the business will do financially over time.
You can find problems or places to improve by comparing these reports to how things went during the year. This helps business owners keep track of their money and make choices based on accurate information.
There are different kinds of SaaS business plans.
There are five different ways for SaaS companies to make financial predictions. Each looks at different parts of the business, like how much money it makes, how much it spends, and how profitable it is.
Model for Making Financial Forecasts
Financial projection models use information about a company to guess how well it will do financially in the future. They look at cash flow, running costs, customer income, and payroll.
You can make a financial projection model from the top down or the bottom up.
Looking down from the top
With top-down planning, you start with a big-picture view of the market’s potential (your total addressable market) and work your way down to the level of acquiring a single customer.
Think about a SaaS company that wants to work with the healthcare business. They would first figure out the total addressable market (TAM) to make a top-down estimate. Let’s say there are 500,000 possible customers in this area.
Then, they would guess what share of this market they could get by looking at their product offerings, competition, and marketing strategy.
That’s 5,000 possible users if their goal is to get 1% of the TAM in the first year. Next, they’ll guess how much money they’ll make from this group of customers by looking at their prices, the cost of getting a new customer, and the projected customer lifetime value (CLV).
Forecasting from the bottom up
Top-down forecasting is different from bottom-up forecasting. It starts with specific teams, customers, and ways of making money, then moves on to more enormous market figures.
To use the same example, the SaaS company would first guess how many salespeople they’ll have (10, let’s say). Then, they would guess how much each rep would have to sell based on past sales data or averages for the business. Then, to get an idea of how much money they will make, they will increase the total sales by the average deal size.
With bottom-up forecasting, SaaS companies can break their goals down into smaller, more doable pieces they can work on. It also helps them determine what needs to be fixed in each department or team.
Model for Operating Expenses
Operating expense models mostly look at how operating costs affect making money. It’s only used in SaaS financial modeling because the costs of running a SaaS business differ significantly from those of other companies.
Along with the average costs of sales, administration, marketing, and customer service, SaaS companies also need to think about:
- Server fees. It takes a lot of bandwidth for software to run. When adding a new customer or user, they must ensure their system can handle the extra traffic.
They are taking care of subscriptions. Many SaaS providers use a mix of flat-rate, usage-based, and tiered prices. Since every customer uses different resources, they need software that can handle it all instantly.
I am building up. It takes ongoing development work to build, grow, and manage a SaaS product, on top of fixing bugs and listening to customer feedback. Developers are also some of the most expensive people to hire.
The operating expense financial model is helpful for SaaS businesses because it helps them keep a close eye on their costs so they can keep growing at a healthy rate.
The Report
Reporting models show investors, leaders, and board members how your business is financially doing. You will need information from three financial accounts to make one:
- Sheet of accounts
- Statement of cash flow
- Statement of profit and loss (P&L)
They show what your business owns and what it pays. The cash flow sheet tells you where the money for these things comes from and where it goes. That’s why P&L statements show income, costs, and earnings.
Planning for headcount
As your customer base grows, your computer bandwidth needs to grow, too. That capacity, however, costs less and less as your business grows.
When the number of users grows, software companies make more money per user because it costs them less to add more space. That means each customer will bring in more money if they can get more users quickly.
A financial model for staff planning can help your SaaS company take economies of scale into account. This way, you can see how changes in your margins are affected by how many customers you have.
Financial Metrics for SaaS
Indicators and standards will help you figure out if your business is on the right track or needs to make changes.
Here are the most critical SaaS metrics to look at from a business point of view:
Regular Income (MRR and ARR)
The two ways to figure out your regular income are MRR and ARR.
Month-to-month regular revenue (MRR) shows you how much money you make every month. Upsells, downgrades, new business, and customer losses that happen from one month to the next are all taken into account by MRR.
Annual recurring revenue (ARR) determines how much money you make yearly. It lets you see big-picture trends in economic growth that are hard to see when you only look at monthly numbers.
You use them for different things, but they are both critical. You’d keep an eye on MRR to see how well your steps to reach your year-end goals (like a marketing effort) are working. Year-over-year, ARR lets you know if you’re going in the right direction.
Cost to Get a New Customer (CAC)
The cost of getting a new customer, or CAC, tells you how much it costs. To figure it out, split the total amount spent on marketing and sales by the number of new customers gained during that time.
This month, you spent $50,000 on marketing and sales and got ten new customers. That means your average CAC would be $5,000.
This number should decrease as your SaaS business grows, finds the right product-market fit, and gets better at turning leads into paid customers.
The value of a customer over their lifetime
Customer lifetime value is a way to determine how much money a customer could bring in throughout their lifetime. This estimate is based on the average length of time a customer stays with you and the average value of that customer.
To find CLV, increase the average amount of money each customer makes by the years you think they will stay as a customer.
Period of Payback (CAC Payback)
You’ll lose money on every customer if your CAC is more significant than your CLV. It costs money to get a new customer, so your payback time tells you how long you need to keep them as customers to break even.
To figure it out, just split your CAC by the average amount of money you make from each customer.
Your payback time is 12 months if it takes you that long to get each customer back into the black.
LTV to CAC Ratio
You will need to do more than keep your business. After the payback period, you should look at the relationship between the cost of getting a new customer and their total value.
If you’re breaking even, which means you lose customers at the end of the payback time, the ratio of LTV to CAC is 1.
A 3:1 LTV: CAC number means that you should get three times as much back for every customer you get.
The average amount of money made per user
The customer lifetime value equation is half the average user income (ARPU). It tells you how much each customer is worth on average at any given time.
To find your ARPU, divide your total sales by the number of customers engaged during that time.
Rate of Churn
There are two ways to figure out your turnover rate:
The customer loss rate is the number of people who stopped using your product within a specific time.
Income churn rate: how much MRR or ARR do you lose because of that churn?
Customer loss is integral to customer success because it shows how good your product is and how well your team keeps customers.
From a business point of view, revenue churn is better. It shows you how much money you lost and how much you need to make up with new sales and upsells to grow. Customers may not leave your business very often, but losing your most important customers could cost you a lot of money.
Rate of Burn
If you’re not yet in the black, your burn rate tells you how much monthly money you lose.
This is the total amount of money you lost during that period. It includes the amount you spent on loans, investments (like R&D), and business operations. It only shows how well your business is doing by comparing costs to income. It doesn’t include donations or sales.
How much does it cost to sell goods?
The cost of goods sold, or COGS, is how much it costs to make and ship your product or service. It covers direct costs like hosting fees, tools, and people who worked directly on making the product.
This number helps you set the right price for your SaaS product and determine where to cut costs simultaneously.
The Gross Margin
After paying for the direct costs of making and providing your software (cost of goods sold), the SaaS gross margin shows how much money you have left over. It shows how much money is available for running costs and support growth.
Your gross margin shows how well your business handles costs, so it tells you how efficient your business plan is and how much room it has to grow. If your gross margin percentage is high, your business makes more money per dollar of sales. If it’s low, it means that your costs are cutting into your profits.
However, it’s essential to keep in mind that it doesn’t take into account running costs. That’s why keeping an eye on your SaaS net profit and running margins is also essential.
Cost Per Unit
The cost per unit tells you how profitable it is to sell a single unit of your goods. It shows how well you’re doing financially for each customer.
It’s also written as CPU, and you can find it by dividing your income per customer by all the costs that come with that customer.
If Uber were to figure out its unit economics, it would divide the profit from each ride by the costs of giving that ride, such as driver pay.
How to Do Financial Modeling Right in SaaS
Now that you know the different SaaS financial measures and how to figure them out, let’s talk about how to use financial modeling in your business in the best way.
Think about the best, worst, and most likely outcomes. The best models are the ones that look at more than one result. This is because they help your team get ready for possible risks.
Set the goal for your model right away. There are different ways to make a financial model, so you must know what questions you want to answer to ensure you pick the suitable model and data points.
Separate your money picture. Separate it into groups based on the financial drivers (inputs), the expected results (outputs), and the projected financial success of your business (your calculations). This way, you can see how input changes affect the outcome.
Check your work by comparing it to accurate data. Over time, you can make your model more accurate by comparing your predictions to real-world financial results.
What You Need to Do to Make a SaaS Business Model
SaaS companies use Excel or Google Sheets to make simple financial models. As they get bigger, they use more complex financial modeling software to make models that are more correct and change over time.
To make a business model, do the things below:
1. Get information from the financial records.
The three main parts of your financial model are the balance sheet, the income statement, and the cash flow statement. They make it easy to see how money enters and goes out of your business.
If you use software for bookkeeping, billing, or managing subscriptions, you should be able to get this information immediately. Just download it from the software or connect it to your model.
2. Write down the problem.
Before you do anything else, you must be clear about your model’s predictions. It would be best to consider many things when predicting your SaaS business. Make sure all these things are part of the model, or you’ll have to make new ones.
You can make models for things like income, churn, website conversions, and pretty much anything else you can think of. All of these can be used to make a bigger model. Anytime you want to make a prediction, all you have to do is look at a sub-model, like income. This is why structure is so crucial for a complete financial model.
3. Figure out who will use your plan.
When making a complicated financial model, only showing users the information they want is essential. You can make a detailed model that includes directions for people working in different business parts. You can also make multiple models, each with its own goal.
4. Type in your world’s assumptions and controls.
Global rules are the main ideas and numbers that your financial model will use. It would be best to make some reasonable guesses because you can’t be sure of everything.
Some of these are:
- The model’s first day of work
- The weighted average cost of capital (WACC) is the average cost of the loan and equity financing your business gets.
- Starting with cash on hand
- Assumptions about revenue growth and headcount
- Thoughts on wages
This lets you set the limits of your model and makes it possible to make more precise changes on the fly.
5. Find out what drives your finances.
You need to know what factors affect how well your business does financially. Some of the things that would affect how well a revenue plan works are:
How many leads
Rate of conversion
Cash made from each customer
The lifetime value of a customer
Rate of turnover
6. Make a plan for your model.
Every financial model has three main parts: inputs, outputs, and calculations. It’s essential to plan each part on its own carefully.
You can make a model that makes sense, is easy to understand, can be audited, and covers everything by brainstorming the order of it.
7. Plan how you’re going to show
the results.
Depending on what you put into your financial model, it will give you more than one answer. So, it would be best to choose a way to show these results that is clear and easy to read.
You’ll also have to show them all at once or spread them over several pages. It’s usually best to show them separately for reading and ease of use.
8. Add situations to your model as you build it.
It’s time to start making your model once you know how it will be laid out. Equations, assumptions, and causes are the most essential parts of this. It would be best if you put these in cells on different tabs.
When ready, put your past data in the correct fields and make predictions based on different possible outcomes.
Setting up various possibilities (best, worst, most likely) or changing the inputs yourself lets you see how various factors affect your financial performance. You can then make changes to stay on track for success.
