A key part of the role of a CFO is to demonstrate the future growth of the business to the CEO and other stakeholders. A software-as-a-service (SaaS) financial model can prove extremely useful for this purpose because it forecasts future financial performance.
Whether you’re launching a SaaS start-up, or your existing financial model needs some much-needed TLC, building the best financial model for your SaaS company doesn’t have to be difficult.
In this article, we’ll cover how to build a SaaS financial model and answer your most pressing questions, such as:
- What is a SaaS financial model?
- Why is a financial model so important for SaaS companies?
- What KPIs and metrics should you include in a SaaS financial model?
- What are the main components of a financial model for SaaS?
- What are the steps involved in creating a financial model for SaaS?
What is a SaaS financial model?
Before we dive into the good stuff, let’s take a moment to make sure we’re all on the same page.
Here’s a simplified definition of what a SaaS financial model is…
A SaaS financial model forecasts the future financial performance of a company. For SaaS companies, this usually focuses on three key statements:
1. Income statement
2. Cash flow statement
3. Balance Sheet
As far as financial plans and models go, these three financial statements are nothing new. However, it's worth noting that SaaS financial model templates also include vital KPIs such as churn rates, subscription rates, average revenue per user (ARPU), and tier-based subscribership.
Why is a financial model so important for SaaS companies?
A SaaS financial model provides a deeper understanding of the financial viability of a company. Finance teams use the model to forecast future profitability and manage cash flow.
SaaS companies typically don’t have fixed costs associated with individual users. In the early stages of business, SaaS companies usually incur higher costs acquiring new customers.
Therefore, revenue accumulates over time. Because of this, SaaS companies must work hard to retain customers and reduce churn. Hence, it’s important to track those metrics and create a tailor-made SaaS financial model.
If the churn rate increases, the data from the SaaS financial model can be used to find out the exact percentage. From there, CFOs and their finance teams can use the data to come up with a strategic business model plan to turn things around.
There are two main reasons why every SaaS business (especially an early stage SaaS) needs a financial model:
1. Gain a deeper understanding of your business
Make better-informed business decisions to lower expenses, and improve cash flow and revenue growth.
2. Increase your chances of getting support and funding from investors
A well-structured financial model can do wonders for attracting investors. If investors see that you’ve created a financial model for things like verified assumptions and relevant benchmarks, it’ll boost your chances of securing fundraising.
What KPIs and metrics should you include in a SaaS financial model?
An effective SaaS financial model includes key SaaS metrics that reveal insights about each user. These metrics reveal answers to questions like how long users hang around, how much revenue each user generates, and so on.
Here’s a rundown of metrics that most SaaS companies include in financial forecasts:
Average revenue per user (ARPU)
The total revenue generated per user. You can work this out by dividing the revenue by the number of users within a specific period.
This reveals how quickly users cancel their subscriptions. To figure out your company’s churn rate, divide the number of customers that canceled their membership or subscription by the number of customers your company had at the start of the specified period.
Customer acquisition cost (CAC)
This metric reveals how much the company spends on generating new customers divided by the number of actual customers gained. Again, you’ll calculate this within a certain time.
Customer lifetime value (LTV)
How long are customers remaining as customers? The LTV refers to the revenue generated by a customer throughout their time as a customer.
LTV: CAC ratio
3:1 is the ideal LTV: CAC radio (per industry standards). If your SaaS company has a lower ratio than this, consider how much you’re spending on acquiring customers and see if you can reduce that cost.
To figure out your company’s LTV: CAC ratio, divide the LTV by CAC.
SaaS financial models almost always include a payback period metric. This refers to how long it takes the company to make back the expenses of an investment. For example, how long it takes to recover the expense or pricing of acquiring a new customer.
What are the main components of a financial model for SaaS?
How you build a SaaS financial model depends on the individual company. Your SaaS financial model should reveal key insights about your business such as what’s growing the business, what milestones you need to hit, financial outputs, average conversion rate, and the organizational structure of the business.
Although your SaaS financial model may vary slightly, there are a few key components that tend to be in most (if not all) SaaS financial models:
Profit and loss (P&L) statement and income statement
The P&L report is vital to evaluate the financial health of a company. A P&L report will accurately show both the company’s revenues and expenses during a specific period. Finance teams use this report to work out how the revenues are transformed into either the net profit or the net income.
SaaS companies rely on the P&L statement to get a clear view of profits before taxes, expenses, and gross profit.
Digging a little deeper, unit economics focuses on the costs and revenue for various units in the business. This includes metrics such as CAC, CLV, CAC payback period, and the LTV: CAC ratio we discussed above.
Don’t skip these important unit metrics, they’ll indicate just how efficient your SaaS operations are and where you may need to improve.
Tracking your recurring revenue using revenue forecasts within your Excel model is crucial to help you predict the future revenue growth of the business.
There are various metrics to track related to revenue, including Annual Recurring Revenue (ARP) and Monthly Recurring Revenue (MRR).
5 steps to build a basic SaaS financial model
If you’re a startup SaaS company and you need to build a SaaS financial model (and business plan) in the early stage of your SaaS company, here’s a basic run-through of the steps:
Step 1 – Create a new spreadsheet in your spreadhsheet software of choice such as Microsoft Excel or Google Sheets, etc. Include aspects such as the start date, weighted average cost of capital, the cash balance you had in the beginning, marketing, sales percentage, etc.
Step 2 – Move on to recurring revenue assumptions and financial projections and enter data for metrics including customer churn, MRR, customer growth, average renewal amount, revenue expansion, etc.
Step 3 – Add headcount assumptions and data related to wage expenses including benefits and taxes, etc. Adding further details such as job titles and start and end dates for each position can also prove to be very useful for startup SaaS companies.
Step 4 – Include non-wage assumptions in your SaaS financial model. This includes things like commissions, professional services, travel, and so on.
Step 5 – Review the summary and the P&L report, which provides a basic and easy-to-understand breakdown of your SaaS company’s financial forecast. Use the P&L report to assess SaaS gross margin and operating expenses, as well as higher-level financial metrics.