🎉 Announcing the new FlowCog Canvas 🎉
The easiest finance tool you’ll ever use. Get it for free.
🎉 Announcing the new FlowCog Canvas 🎉
The easiest finance tool you’ll ever use. Get it for free.
Adam Tzagournis, CPA · 15 min read
Your pitch deck needs it. Investors ask for it. Your board wants it to justify your strategy. A credible SaaS financial model is not only useful for third parties; it should also guide your company strategy. But how do you build one you can trust?
Hint: use the spreadseet linked at the bottom of this post instead!
Financial models use key business drivers to produce:
Simple enough, right? To get credible results though, approach is everything. The right one will gain the trust of investors and give you insight into your business.
Before we dive into the right approach for your SaaS financial model, let’s talk about the wrong one. Take this example:
We see a lot of SaaS forecasts like this. A top-down approach is all too common (if you’ve done this before, no judgment, we’re here to learn!). It’s a convenient shortcut, but investors don’t buy it. They want to know how you arrived at that growth. You need to show your work to prove it to them.
Instead of top-down, think bottom-up. Work backward from the output you’re projecting. For example, customers start off as leads. And those leads come from sales & marketing efforts. So first, create inputs for those activities. Then, model the chain of events (i.e. conversion rates) that get you from prospect to customer.
You’ll use this approach for the fundamental pillars of your SaaS financial model: revenue and headcount. In short, they’re the engine that drives your projections.
Investors value SaaS companies on revenue, so focus here first. As discussed, revenue stems from both sales and marketing activities. Even though they both result in prospects, you need separate inputs for each.
If sales & marketing activities are the raw ingredients, customers are the stew (tip: don’t eat your customers, you’ll need them for renewals). Dad jokes aside, sales performance and internal systems will improve over time. Thus, conversion rates should rise and prospect-to-customer cycle lengths should shorten.
Also, don’t forget to model implementation fees and ongoing professional services.
Separate out services from your SaaS product on the P&L. That way, you don’t have a blended gross margin that looks too low. This means investors will give you credit for higher gross margins on your SaaS product.
If you have 2 or more pricing tiers it’s best to have distinct funnel inputs for each one. This lets you set customer acquisition costs, conversion rates, and deal sizes by market segment. Ultimately, this prevents oversimplifying your future customer base and keeps projections realistic.
Good retention rates are the magic of SaaS companies but also the trickiest to model. Here are some tips:
Separate projected customers into cohorts based on their contract start month.
Give each cohort a retention rate.
As their tenure increases, each cohort should have a higher chance of renewal. The longer a customer’s been with you, the more likely they’re getting value from your product.
Raise the retention rate of future cohorts at the start of their contract. Product improvements over time mean that new customers stick around longer.
Your SaaS projections won’t be credible if headcount doesn’t track with growth. Don’t think of headcount as just another expense. On the contrary, sales hires must drive your SaaS revenue growth. As mentioned above, the more SDRs and AEs you have, the more prospects you’ll get each month.
The ideal approach here is to map hiring tempo to business milestones. For example:
Unfortunately, most SaaS financial models break down here (not all). Spreadsheets don’t auto-generate hires for you according to a rule set. Instead, enter your best guesses through trial and error. Then, use these ratios to check your work. Without this gut check, revenue per employee may paint an unrealistic picture.
SaaS companies also need product and back office staff too:
Don’t forget about managers and VPs for each department:
Finally, expect to tack on “load” of 15–20% on top of salaries for payroll taxes, health insurance, and other benefits.
Ok, we’ve laid the groundwork for a credible model (easy, right?). Now, it’s time to interpret the outputs. They should reveal which parts of your business are thriving. Conversely, you may see red flags for parts that need more work. Let’s talk about how to spot those.
One of your model’s outputs will be months of cash runway remaining. In other words, it’ll show how low your cash balance goes and how long it stays that low. A good rule of thumb is to have 18 months of runway on hand.
Capchase analyzed 200 SaaS companies to show cash runway remaining:
Cash runway is useful, but doesn’t tell the full story. The standard calculation takes current cash balance and current net monthly burn. However, last month’s burn won’t be the same as future burn. In short, it won’t account for swings from new revenue growth, or new hire payroll. As the adage goes, past performance doesn’t dictate future results.
Instead, a 3 statement financial model hones in on the direction of the cash burn. Look at the cash line item on your model’s projected Balance Sheet to see what your trajectory is. To take it a step further, we recommend building in prediction intervals. That way, you have a worst-case scenario given certain assumptions.
In doing so, you’ll know if your hiring plan is too aggressive for a given level of growth, or even if you’ll need layoffs. You can also plan for your next fundraising round.
Side note: consider debt (the cheaper choice) instead of equity. Use it if you have solid unit economics (more on this below) and a path to profitability. In these cases, it can bridge the gap and buy time for your sales & marketing engine to hit full throttle.
A good SaaS financial model calculates your unit economics. Here are the most important ones.
Lifetime value (LTV) measures how profitable a customer is to you over their lifetime. As such, it’s dependent on your retention rates and gross margin.
In theory, your gross margin should be at least 80%. This level signals to investors that you serve customers efficiently.
Customer acquisition cost (CAC) is the sales & marketing spend to get a single customer. CAC payback is the time it takes for a customer’s contract to “pay back” your CAC.
Your CAC payback should be < 12 months if your annual contract value (ACV) is around $10k. If ACV is closer to $25k though, it should be < 18 months.
Think of LTV : CAC ratio as the profitability from your average customer vs. the amount “invested” to acquire them. For SaaS companies, this should be 3:1 or higher.
Remember, LTV and CAC change over time as your business improves. Product improvements and better customer success translate to higher retention rates. Similarly, your CAC will improve as the marketing team finds more effective channels. For SaaS projections, these compounding effects accelerate your growth rate.
Keep in mind, these unit economics only make sense in the context of a full SaaS financial model. For example, CAC payback doesn’t account for faster cash recovery with contracts paid upfront. To make matters worse, it ignores collections timing. As a result, your Cash Flow may tell a different story.
If you’re cash flow negative, burn multiple is your most important SaaS metric, full stop. Why? Because no metric captures your growth efficiency like burn multiple does. It’s also simple to calculate:
your net cash burn in a period
Ă·
net new ARR in that period
For example, let’s say you had a net cash loss last quarter of $2mm. If your ARR grew by $1.5mm, your burn multiple would be 1.3, which is great. To be clear, you’re still burning cash in the short term. In the long run though, ARR will outpace your burn.
In a nutshell, burn multiple is easy to understand and catches all weaknesses. There’s no hiding from it:
Here’s a useful rubric for evaluating your burn multiple:
If you don’t project your Balance Sheet and Cash Flow, you won’t have a good grasp of your cash flow timing. Consider these factors:
In reality, only a handful of levers dictate SaaS projections. Your SaaS financial model should highlight the inputs that impact your projections the most. That way, you can focus your efforts on improving them (an 80/20 win). For instance, lowering your cost per lead won’t move the needle if your sales team fails to close deals. Instead, that time and money would be better spent on sales rep training.
A few structural checks for your financial model spreadsheet go a long way too:
Also, aggregate detailed P&L line items so your P&L is comparable to public SaaS companies:
This way, pattern matchers investors can compare your SaaS metrics against industry benchmarks.
Be careful here, since incorrect allocations can muddy the waters. Make sure to get these right:
Other checks to consider:
Keep in mind, garbage in garbage out still applies no matter how solid your model structure is. Financial modeling is a cross-functional exercise. You have to collaborate with other teams to confirm your assumptions. If you work in isolation, your model won’t reflect your business strategy.
Here are some other inputs to build into your model:
To sum up, a credible SaaS financial model bolsters the narrative for your company’s future. But the truth is they’re difficult and time-consuming to build from scratch. Most homegrown models raise eyebrows and don’t support a cohesive narrative. That’s why we’re giving you this free SaaS financial model Google Sheets template. You’ll get credible projections based on your business’s key drivers. It also produces SaaS metrics and pro forma SaaS financial statements for you.
Not convinced spreadsheets are the only tool for the job? Try our software for free instead, it’s built just for SaaS companies.
Need something much easier? Try our new, free drag & drop tool FlowCog Canvas!
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