When you’re considering putting together a Software as a Service (or SaaS) business model, it can be difficult to make sense of all of the acronyms and calculations involved. To combat this, we’ve put together a comprehensive guide that explains what you need to know in order to understand how a SaaS financial model works. 

In this blog, we’ll cover the key metrics that are commonly used in SaaS financial models and explain how they’re calculated, the different types of financial models and when they’re used, the best practices for designing your SaaS financial model, and all the steps involved in creating it. 

The Key Metrics To Include in a SaaS Financial Model

When determining financials for a SaaS startup, understanding common metrics can help entrepreneurs create several documents, such as a business plan, financial forecast, financial plan, and beyond. A strong understanding of how figures are calculated can play a crucial role in determining financial benchmarks like early-stage operations, cash flow, and financial projections

Below is a quick overview of some of the most common metrics and how they’re calculated.

Average Revenue per User (ARPU)

As one of the SaaS metrics, or key performance indicators (KPIs), commonly used by SaaS companies, ARPU helps the company look at the pricing and revenue per customer. This helps determine whether the customer is providing a business with a worthwhile profit. 

It’s calculated by dividing the total revenue by the average number of customers over a chosen time period. This is different from looking at figures for a specific customer, which is more commonly used in sales and marketing to determine whether to continue pursuing a reluctant prospect or let the opportunity pass.

For example, if a company had $100,000 in revenue and 500 customers, the average revenue per user would be $200: 

$100,000 revenue / 500 customers = $200 ARPU

Churn Rate

It’s important to keep track of your organization’s churn rate because it impacts customer lifetime value, monthly recurring revenue, revenue growth, and similar metrics. There are two ways to look at churn: gross and net. 

Gross churn rate is the rate at which customers stop doing business with a company or unsubscribe from their service. As you lose customers, you have to allocate more significant resources to bring in more customers to replace those you lost. This increases your expenses and lowers your profits. Gross churn rate typically offers a better understanding of how many subscriptions were up for renewal over a given time period and how many of those actually renewed. 

You can calculate your gross churn rate by dividing the number of customers who leave your company by your total number of customers.

For example, if you have 200 customers and 10 customers leave, you would have a churn rate of 5%:

10 former customers / 200 total customers = .05, or 5% churn rate

Net churn focuses on revenue and is calculated by taking the total dollar amount up for renewal over a given period and dividing that by the total dollar amount renewed. Ideally, this number should be greater than 100%, which indicates that your business is healthy and growing versus merely maintaining — or losing — revenue.

For example, say that a business has $5,000 up for renewal during a one-month period. They expanded their business through upgrades and cross-sold by $3,000 but lost $2,000 due to churn and downgrades. Here’s what the calculation would look like:

$5,000 recurring revenue + $3,000 upgrades – $2,000 downgrades and churn / $5,000 = 1.2, or 120% net churn

It’s important to track both gross churn and net churn because they reflect two very different numbers. Net churn can often look strong, but tracking gross churn as well will help give you a more accurate picture of your organization’s growth.

Customer Acquisition Cost (CAC)

Customer acquisition cost is the total cost of acquiring a customer — an important figure that impacts your ideal conversion rate, pricing models, and revenue forecast. It’s worth noting that CAC can vary greatly depending on the customers you’re targeting, as the sales and marketing spend in some industry verticals is much higher than in others.

If you have a low churn rate, spending more money on customer acquisition might make sense, but if the churn rate is high, it doesn’t make fiscal sense to spend a lot of money on acquiring new customers. Calculate CAC by dividing sales and marketing expenses by the total number of new customers in a business over a set period of time.

For example, if you spend $1,000 on sales and marketing to acquire 50 new customers in a month, your CAC is $20 per customer: 

$1,000 S&M budget / 50 new customers = $20 CAC

LTV:CAC Ratio

Lifetime Value (LTV) is the total revenue each customer brings to your company. By comparing the LTV to the cost of acquiring that customer (Customer Acquisition Cost, or CAC), you can determine if you’re making or losing money on that client. 

This is one of the reasons why reducing churn rate is so important, because having a high churn rate means that you’re quickly losing the money that you spent acquiring that customer. Calculate LTV:CAC ratio by first finding the value of LTV and CAC separately, then dividing LTV by the CAC.

Let’s say that a customer has created $50,000 in revenue for the company. That customer cost the company $10,000 to acquire. The LTV:CAC ratio for this customer is 5 to 1 (5:1):

$50,000 LTV / $10,000 CAC = 5:1 LTV:CAC ratio

While technically anything greater than 1:1 is profitable, 3:1 is considered healthy or preferable.

Payback Period

Payback period is the amount of time it will take to repay an initial investment. Depending on the profit margin on your services, the payback period could be weeks, months, or years.  You can calculate the payback period by dividing your initial investment to acquire the customer by your monthly cash flow. The resulting number is your payback period expressed in a number of years.

In the world of SaaS, this metric usually refers to the CAC payback period. For example, when a customer that had a CAC of $500 creates revenue for the company at or exceeding $500, the length of time it takes for this to happen is the payback period. If you receive a monthly revenue from a client of $50 per month, it would take 10 months to pay back the CAC from the LTV. This may also be referred to as a break-even point. Here’s how that looks: 

$500 initial investment / $50 per month revenue from client = 10 months to payback

SaaS Financial Model Types

Though these key metrics are very helpful in determining a number of factors for your company’s financials, your CFO may require more details in terms of your financial model. In some situations, they’ll use a financial model template to determine the valuation of the company. 

This can be something as simple as an Excel template or a Google sheets document, to more sophisticated programs that provide greater functionality. This will depend on your company’s specific needs and the CFO’s experience with creating financial models.

1. Operating Expense Model

Your operating expense model takes a variety of information, such as cash flow statements, cost of goods sold (COGS), and similar financial data, and then condenses it into a single model. This provides you with a look at both forecasted and actual financials. By approaching operating expenses this way, you get a more solid look at your budget versus your actual spend, along with several other details that can help you make smarter business decisions.

2. Forecasting Model

Forecasting models are projections of where you anticipate your financials to be within a specific period of time. This type of SaaS model considers a number of future financials, such as payroll, business expenses, customer revenue, and cash flow projections.  Forecasts are not set in stone, but when done correctly, these models can provide you with a good idea of where your business is heading. 

3. Reporting Model

Because SaaS companies often have unique KPIs that fall outside the usual three-statement structure (balance sheet, cash flow statement, and income statement), it can be beneficial to utilize a model that takes these unique metrics into account. Reporting models do exactly that, allowing for a range of assumptions to be tried, creating different forecasts that are specific to SaaS startup concerns. The beauty in Reporting Models is that they are able to pull data from other models into a single, easily digestible format.

4. Headcount Planning Model

A headcount planning model allows you to create projections for future labor-related expenses as your company grows. It gives you a rough idea of what it will cost if you scale suddenly, including office expenses, payroll, COGS, rented office space, and similar expenses. Headcount planning models also allow you to forecast expenses versus the additional revenue that would accompany your growth, giving you a clearer picture of what scaling your business would look like.

5. Recurring Revenue Model

As its name implies, a recurring revenue model is a type of financial model that provides you with a forecast of subscription-based services. This type of model shows which clients are providing recurring revenue, rather than clients who make one-time purchases. 

Recurring revenue models are commonly used for recurring revenue periods, including monthly recurring revenue (MRR) and annual recurring revenue (ARR), which can impact your cash flow statements depending on when your customers pay their subscriptions.

Best Practices for Creating SaaS Financial Models

When you’re trying to stage SaaS financial models, following the best practices we outline below can help ensure that you’re getting an accurate picture of your company’s financial health.

Consider the Best, Most-Likely, and Worst-Case Scenarios

When creating your financial model, consider the three major scenarios: best-case, most-likely, and worst-case. These will help lay the foundation for your model. The best-case scenario is the most profitable, the most-likely scenario is the most probable outcome, and the worst-case scenario is the most severe negative outcome. Performing scenario analysis helps proactively plan for the future, avoid risk, and minimize the potential for failure. Financial models that consider more than one scenario are the most comprehensive and informative.

Clearly Define the Purpose of the Model

Next, you’re going to want to clearly define why you’re creating the model. Are you working on a large contract that, if won, will require you to hire more people and use more resources? Is there a temporary lag in the market that you need to weather? Are you concerned about the accuracy of your cash flow statement? Would your company suffer a loss of business if a key individual left? Understanding what the model is supposed to forecast ensures you’ll get more accurate results.

Divide Your Model Into Three Sections

If you want to be able to quickly determine exactly what is impacting your model, you’ll need to separate certain pieces of it: your inputs, or financial drivers; your calculations, or the projected financial statements for your business; and the expected outputs. By separating these elements, you’ll be able to see how each of the changes to your inputs will impact your final calculations.

Have a Practical Structure

Having a quick way to view all your data (while keeping it separate) is a practical way to set up your structure for your model. This is true regardless of the tracking method — whether you’re using Google Sheets, an Excel template, or another means of compiling your information.  The easiest way to do this is by including separate tabs within your spreadsheets, including tabs for coverage, drivers, model, outputs, and sensitivities. This allows you to quickly make changes without impacting the other tabs in the spreadsheet.

Include an In-Depth Cover Page

The cover page of your SaaS financial model provides all of the various details of the model, so that it can be evaluated at a glance for future use. It should include the model’s name, purpose, version history, an index, the author’s contact details, and any legal disclaimers that may be needed. 

This is also where you should clearly lay out the model’s assumptions. Assumptions (which we’ll cover in  greater detail in the next section of this article) are your presumptions about your business’s future growth based on historical data. Including them on the cover page provides anyone scanning the report with an at-a-glance understanding of its contents.

5 Steps To Build a SaaS Financial Model

Now that you have a good understanding of the KPIs involved in SaaS finance, how they are calculated, and how to best use them in your financial model, it’s time to start building your financial model. 

As we mentioned earlier, there are a number of spreadsheet programs you can use to input your data, whether it’s with an Excel template or a cloud-based program like Google Sheets. No matter what platform you choose, you’ll want to adhere to the following steps for the best results:

1. Start With Global Controls

You’ll want to start with your company’s global controls, which include concrete data such as the start date for the model, weighted average cost of capital (WACC), your beginning cash balance, and similar details. This allows you to input the information that governs the limitations of the revenue model, future income projection, or financial model that you’re creating.

2. Work on Your Revenue Assumptions

There are several factors that can impact your revenue projections. These include churn rate, which can impact your LTR:CAC ratio and your overall profitability. There’s also the impact that MRR and ARR will have on your cash flow statements. For example, if most of your money comes in once a year (say that your renewals are scheduled for January 1), you’ll need to remember that this revenue will need to cover the bulk of the year’s expenses, which may be difficult if you experience sudden growth.

3. Enter Your Headcount Assumptions

Will your model create growth for your business? If it does, it’s vital that you take your headcount assumptions into account, as this figure may fluctuate wildly based on how many new people you bring on board, their expected wages and benefits, the additional expense of office space, and similar costs that can impact your model.

4. Add in Your Non-Wage Assumptions

Outside of what you’ll need to estimate for growth based on your headcount assumptions, you’ll also need to consider non-wage assumptions. Generally speaking, this will include a range of information based on historical data from your financial statements, such as your balance sheet, cash flow statement, and income statement. This information is then used to project details into your model.

5. Summarize the Above

Once you’ve finished entering these details into your model, you’ll want to take the resulting information and summarize it. This makes it much easier for most people to be able to read and comprehend, rather than requiring an accountant’s level of expertise. By laying this information out in black and white, you provide solid answers to the questions posed in the model.

Scale Your Business With Sales Assembly

When you have a firm understanding of how to complete your SaaS company‘s financial forecasting, you’ll have a better grasp of what the model’s output will tell you — which makes it easier for you to make smart decisions about scaling your business. Sales Assembly works with expanding businesses to help them scale successfully. 

If you’re anticipating growth, contact us today to schedule a  consultation with one of our experienced professionals.

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For more support in Scaling Better, Scaling Faster, and Scaling Smarter, Sales Assembly can help. Contact us for more information.