As a SaaS (Subscription as a Service) startup founder, you’re likely obsessed with your big idea. It might be creating an innovative product or service, disrupting markets, or carving out a niche for your brand among the big players in your industry.
While your big idea is admirable, it isn't enough to ensure business success. To scale and grow your SaaS startup, you need powerful financial data insights that empower you to make intelligent decisions. Without proper financial planning, you're essentially flying blind, causing you to make wrong decisions that impact your business's current and future growth.
This is where SaaS financial modeling comes into the picture. It provides an accurate snapshot of your startup's financial health, helping you leverage opportunities and take your business to the next level.
What Is SaaS Financial Modeling?
A financial model is a tool to forecast the future performance of your startup. It leverages the power of accurate financial data, historical business performance, current KPIs, and the expertise of a fractional CFO to empower you to make timely decisions. You can create a simple SaaS financial model using spreadsheets or opt for specialized tools that help you build more sophisticated models.
Depending on the type of SaaS startup financial model you use, it provides you with the following information:
- Growth drivers – Gain critical insights into the factors that drive growth, like upselling, increasing conversions, or acquiring new customers.
- Milestones – Evaluate if you're on track to hit key milestones and course correct in real-time to achieve your goals.
- Organizational overview - See a complete picture of your operating expenses and the best ways to manage them.
In a nutshell, financial modeling helps you answer critical questions about your SaaS startup, including how to increase revenue, grow users, and the steps needed to take your business to the next level.
Types Of Forecasting Models
Like how meteorologists use weather forecasting tools to predict the weather, you can use financial forecasting models for startups to make accurate sales predictions for upcoming business cycles. These models can help with decision-making, budgeting, re-adjusting business priorities, tracking consumer behavior, and risk management. It also allows you to set sales and revenue goals for the next quarter or year.
There are four significant types of financial forecasting models with different benefits for your SaaS startup:
- Delphi method
- Statistical Method
You can choose from the different forecasting models depending on the data you have in hand, what you are trying to predict, and the level of precision you require. Budget forecasting software can help you quickly create accurate forecasting reports, improving your sales planning and budgeting accuracy.
Why Is The SaaS Financial Model Different?
SaaS companies typically have a subscription business model, and the highest costs occur during the product or service development phase. Unlike other businesses, SaaS companies generally wait for an entire subscription cycle before including the revenue from a sale.
Since most of a SaaS business's revenue occurs periodically over time, reducing customer churn is a critical component of the SaaS business model. Hence, it would be best if you had a financial model that reflects the recurring revenue model of SaaS companies.
Recurring revenue is why a SaaS business financial model revolves around the user and typically includes metrics such as customer loyalty, the revenue generated by each user, and the costs of acquiring new customers.
For example, if there are more subscription cancellations, the financial model shows a revenue drip alerting the CFO and CEO to what's going wrong. A SaaS model uses data from three traditional financial statements: balance sheet, cash flow, and profit & loss.
Unique factors related to the SaaS industry, such as subscription rates, average revenue per user, churn rates, and tier-based subscriptions, also come into play.
Advantages Of Using A SaaS Startup Financial Model
Here are the three biggest advantages of using a specialized SaaS financial model template:
1. Predict Recurring Revenue
The SaaS business model relies on recurring revenue rather than a one-time purchase of products, known as MRR (monthly recurring revenue). Traditional financial models do not capture this revenue accurately, so you need a specialized financial model to help you accurately predict recurring revenues.
ARR, (annual recurring revenue) measures the total amount of money made each year per recurring subscription. Traditional business models show revenue per sale which isn’t accurate for a SaaS business.
For example, if you have a five-year subscription contract at $20,000 total, your ARR is $4,000. In contrast, if a SaaS business recorded the total sale when it was signed, their total revenue for the year would be inaccurate because they are not receiving that $20,000 at the time of the ‘sale’ of the contract.
2. Track Customer Churn
Churn refers to the number of customers who do not renew their subscriptions in a particular month or quarter. SaaS businesses focus on reducing customer churn. A SaaS-specific financial model can help you predict user behavior and lower churn.
3. Raise Capital
As a SaaS startup, you will likely need venture capital to scale and grow your business. A well-developed SaaS financial model provides interested investors with a clear picture of your finances which helps them evaluate risks, estimate profits, and decide if an investment is lucrative.
How To Build A SaaS Financial Model
Building a financial model requires tracking several unique startup KPIs (Key Performance Indicators) that reflect the actual financial condition of your business. These metrics are then plugged into the correlating model to provide you with the data you’re searching for.
These metrics include:
MRR And ARR
To calculate MRR, multiply the total number of subscribers per month by the average revenue per user (APRU).
For example, if you have 20 subscribers with a monthly $5 subscription, your MRR is $100.
20 x $5 = 100
You can also find the net MRR by factoring in any upgrades, downgrades, or customer churn. It would look like this:
Total MRR each month = Existing MRR + New MRR + Upgrade MRR - Downgrade MRR - Churn MRR
Using these calculations, you can easily see where your MRR stands or where it will end if you don’t lose or acquire more subscribers. Additionally, you can set goals for subscription increases based on where your MRR is currently and where you want it to end in the next month, quarter, or year.
From here, finding ARR is pretty simple. We mentioned above a way to find ARR based on the total value of a multi-year subscription, but you can also work month-to-month to find this number:
ARR = Total MRR x 12
Ultimately, ARR is one of the easiest ways to determine how much revenue your business can expect over one year.
Churn rate is the number of customers who canceled their subscription at a particular time divided by the total number of customers at the beginning of the tracking period. Churn is an important metric as it helps you predict if your business is growing or shrinking by comparing the churn rate with customer acquisition and retention rates.
Customer Acquisition Costs (CAC)
Customer acquisition costs are the total amount you spend onboarding new customers. Often, customer acquisition is expensive for SaaS companies. So knowing this value is critical to ensure profitability.
Customer Lifetime Value (CLV)
Customer lifetime value describes the total revenue a customer generates for your business. It helps you make informed business decisions about how much you can afford to spend to retain customers.
Besides these critical metrics, there are several other KPIs to track, including the LTV CAC ratio, payback period, and ARPU (Average Revenue Per User). Including these KPIs when building a SaaS financial model helps you gain a comprehensive view of your finances, optimizing revenue generation and business growth in the long run.
Do SaaS Startups Need Financial Modeling To Be Successful?
A huge yes!
Financial models play a crucial role in driving growth, optimizing customer strategies, and lowering the expenses of early-stage startups. It provides SaaS founders with critical insights and valuable information that helps them make strategic business decisions.
Unlike other businesses, SaaS startups have a long sales cycle and recurring revenues that require a nuanced approach to financial modeling. By analyzing a well-developed and customized financial model, C-suite executives can make the right decisions that impact overall revenue and sales growth.
Your business depends on understanding trends and analyzing data to provide future insight. Using these models explicitly made for SaaS startups, you can handle any future problems and plan for growth.