This article is a primer for founders without finance backgrounds who want a sense of what should be on their minds when developing a financial plan for their SaaS startup.
There are plenty of free spreadsheet templates online, but without an understanding of how or why to customize them, they aren’t particularly useful. It’s like the difference between copying someone else’s homework and doing it yourself.
This article will cover key performance indicators, two growth forecasting techniques, and common pitfalls facing founders.
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Key Performance Indicators
Your business will likely sell a subscription with a low-touch sales model, where you promote yourself with a free trial and convert customers with little human involvement, or one that depends on the efforts of a higher-touch sales team. In either case, measuring progress comes down to the following key metrics.
Churn: Percentage of customers who stop using a product. It’s a key indicator of customer satisfaction, and savvy startups will seek feedback from customers who cancel.
Monthly recurring revenue (MRR): A business’s predictable revenue from subscriptions in a single month.
Annual recurring revenue (ARR): Annual equivalent of MRR. Early-stage startups will have to make a reasonable assumption for churn rates, while more established companies can rely on their historical data.
Customer lifetime value (CLTV): Total revenue a business expects to earn over the duration of a relationship. Most SaaS businesses will have multiple service tiers, so CLTV calculations incorporate both churn and upgrade rates.
Customer acquisition cost (CAC): Total cost of acquiring a single customer. CAC calculations only include costs directly related to acquiring a customer, such as sales team costs or marketing spend. Incorporating all business costs would dilute the metric and make it less meaningful to decision-making.
Lifetime value vs. acquisition cost (CLTV vs CAC): Ratio of the cost to earn a customer vs the revenue that customer brings. As a rule of thumb, acquisition costs being one-third of lifetime value is good.
Burn rate: Rate a company spends its cash reserves to cover expenses, usually expressed monthly. Growth-stage startups are often unprofitable and use this metric to guage how long they can operate before needing additional funding.
Runway: Amount of time a company can continue operating at its current burn rate before running out of cash.
| Important: Since Saas revenue often involves prepayment, understanding how to account for deferred revenue is critical. In fact, it’s one of the more common reasons startups reach out to us for help. Read our article on deferred revenue to learn more. |
Growth Forecasting Techniques
When developing projections, it’s best to overestimate costs and underestimate revenue rather than vice versa. All financial models are best guesses that will inevitably be wrong to some degree. Still, with diligent planning, they’re also useful tools to guide decision-making and communicate your progress to prospective investors.
To use a top-down approach, assume your established monthly user growth rate will hold, albeit with diminishing returns. Then, use upgrade, downgrade, and cancellation data to make a reasonable estimate of customer lifetime value. With these figures, you can estimate future revenue.
The bottom-up approach starts with customer acquisition costs. Calculate your spend per sales channel, how many customers that investment yields, and work upwards to estimate revenue. Data for this method may be difficult to get, but is easiest if you use a lot of pay-per-click or other measurable lead-generation techniques.
Each approach has merits, but can yield dramatically different results when applied in isolation. Consider the following:
Using a top-down approach, a SaaS startup assumes its 10% month-over-month user growth rate will gradually decline to 5% as they saturate their market. With an established $500 customer lifetime value, they project a smooth growth curve, estimating they’ll reach $5 million in annual recurring revenue by year’s end.
However, the bottom-up approach paints a different picture. When analyzing customer acquisition costs, they realize their most cost-effective channels are reaching saturation, with additional spend yielding smaller returns. Accounting for increased CACs and slower onboarding rates, this method projects just $3.5 million annual recurring revenue by year’s end.
The discrepancy highlights the importance of combining both approaches. The top-down model may be too optimistic, while the bottom-up may be too conservative. By comparing results, your startup can refine assumptions, adjust for risks, and present a more balanced projection to investors and stakeholders.
| Related Article: Learn how to conserve limited resources by compensating key advisors with startup advisor equity rather than cash. |
Cost Considerations
You’ll find that, while many spreadsheet templates need to be customized to account for unique revenue-generating scenarios, they’re actually pretty good at listing potential costs. Instead of listing every possible cost you might need to account for, let’s look at some lesser-known pitfalls.
Personnel is likely your largest expense, so pay particular attention to this category. The more detail you break employee expenses into, such as benefits, taxes, training, and employee stock ownership, the more easily you’ll be able to make adjustments in the future. Don’t forget to include annual raises in your projections; forgetting them can lead to significant discrepancies.
One mistake startups make is failing to account for how growth impacts personnel costs.
To better understand, ask yourself: What will happen to the workload for every person in the company if we double our customers in the next year?
For instance, your engineering team will grow and be juggling multiple simultaneous product releases. Each requires coordination, QA testing, and maintaining documentation. Is it reasonable to expect your one project manager to oversee all of this without additional help? As another example, double the customers means double the customer support tickets you receive. Can your existing team handle that?
Infrastructure costs are unlikely to grow linearly. As customers use more advanced features, such as larger storage or HD streaming, these costs can balloon unpredictably. If you lack historical data, multiply early infrastructure cost estimates to account for underestimations.
Another mistake is assuming that marketing channels scale infinitely when many have bottlenecks and growth ceilings. Even if you had an unlimited pay-per-click budget, the number of available customers that fit your ideal market is limited. Conferences may be a great sales channel, but there are only so many relevant ones you can attend.
Conclusion
Financial planning is complex, especially when it comes to deferred revenue, scaling costs, and balancing optimistic and conservative projections.
At indinero, we specialize in helping startups grow with our fractional CFO services. With over 100 years of accounting expertise on staff, we’re ready to help you master the books and navigate funding rounds. Contact us for a complimentary consultation and take the guesswork out of financial planning.
