SaaS enterprises operate in a market that is evolving rapidly and is expected to cross $600 billion in revenue by 2023.
To maintain relevance, it is vital to make decisions that promptly drive growth. SaaS companies cannot rely on monthly or quarterly financial reports to make crucial decisions. In fact, they need access to the best Financial Planning and Analysis (FP&A) tools that are customized to their business model.
This would help with the on-demand completion of key operations under SaaS financial planning, such as performance management and reporting, forecasting, financial budgeting and planning, and scenario modeling.
Read on to learn more about the key aspects and why it is crucial for companies to invest in FP&A software for SaaS financial planning.
Important Financial KPIs for SaaS
SaaS enterprises must identify the key financial KPIs that are relevant to their business model. Traditional KPIs do not fully capture the complexities of SaaS financial planning as they lack coverage of the areas that rapidly expanding SaaS companies require. SaaS companies have a recurring revenue model based on monthly, quarterly, or annual subscriptions. Hence, they need to focus on some specific metrics that are crucial to driving growth.
Burn Multiple is a key metric that helps SaaS enterprises measure the money being spent for obtaining every additional dollar of ARR. It helps measure the revenue growth and capital efficiency of the company. Moreover, it also helps identify inefficient capital utilization, inefficient growth strategy, high customer acquisition cost, and several other issues crucial to SaaS financial planning.
To determine the burn multiple for a given period, divide net cash burn by net new ARR.
For rapidly growing SaaS companies, the ideal burn multiple is between 1.5x to 2x, while in the case of established businesses, this multiple should be below 1x.
Rule of 40
Rule of 40 is a metric that helps gauge the balance between growth and profitability that is interrelated with a higher valuation of revenue multiples and 15% more returns. This rule states that a company can attract investment only if the total EBITDA margin percentage and revenue growth percentage are more than 40%.
This metric is ideal for SaaS companies that want to balance profitability and rapid growth. Rule 40 helps investors understand the attractiveness and sustainability of the enterprise in the long run.
Venture Capital Efficiency Ratio
This ratio is the best measure of return on capital for a SaaS company. It compares the exit value of a company with the total capital raised. Unlike other metrics that monitor ongoing growth, the venture capital efficiency ratio focuses on the return on capital investment made during an IPO.
It is extremely beneficial for analyzing the historical performance of the company and also identifying future areas of improvement. Many SaaS enterprises looking to go public use this ratio to analyze their competitors.
Return on Invested Capital (ROIC)
ROIC is a key metric that offers an in-depth analysis of the profitability of a venture by comparing the profits against the capital investment. To get this KPI, divide the net operating profit by the capital investment.
ROIC measures the financial efficiency of a SaaS enterprise by comparing the capital cost with the returns on capital. A high ROIC indicates that the activities where the investment is being made are worth it. It is a suitable metric for SaaS financial planning, especially for companies with high capital expenses, as ROIC measures the value created by the company.
This ratio helps understand the efficiency of sales and marketing campaigns. It is obtained by dividing net new ARR by customer acquisition cost. For sustainable growth of an enterprise, it is essential to monitor every dollar of CAC and ensure that it converts into multiplied revenue growth for the SaaS enterprise. CAC ratio can highlight poor growth strategies, inefficient sales and marketing spending, and poor product-market fit.
ARR Growth Rate
ARR growth rate is a crucial metric that measures the percentage growth for SaaS enterprises or businesses that work on the subscription revenue model. It is widely used to measure the internal growth of companies.
To calculate, divide the variation between ARR at the end of a period and at the beginning of the said period by ARR at the end. Through ARR growth rate, SaaS companies can gain insights related to the pace of growth for businesses and are able to identify any roadblocks that can impact growth. Steady growth in ARR growth rate indicates better product-market fit and improved capital efficiency.
CAC Payback Period
This metric defines the time taken by a SaaS enterprise to recover the customer acquisition costs. To calculate CAC payback, divide the average customer acquisition cost by the average recurring revenue from that customer. It helps gauge the efficiency of operations, wherein the shorter the payback period, the better the marketing strategy. High-growth SaaS enterprises usually aim for a CAC payback period of between five to seven months.
Customer Lifetime Value
This metric helps understand the revenue that a company can expect from a single customer. Herein, SaaS enterprises consider the revenue value of a customer and compare it with the estimated lifespan of the company. Customer Lifetime Value (LTV) helps businesses ascertain their most important customer segments. By comparing LTV with CAC, SaaS businesses can understand how long it would take to recover the investment incurred on acquiring a new customer.
This ratio is a crucial KPI that helps SaaS companies understand how many active monthly users are using the product or service every day. In a nutshell, this metric helps measure the total number of days during which the users engaged in any activity that categorizes them as active daily users. The higher the DAU/MAY ratio, the better it is for the business, as it means that users are steadily using the app and returning to it regularly.
Net Revenue Retention Rate
NRR is a vital metric that measures the percentage of recurring revenue secured from the present customers in a given time frame. This revenue would also include downgrades, cancellations and expansion in revenues. Also known as Net Dollar Retention, NDR offers a comprehensive view related to the negative as well as the positive changes regarding customer retention. On the basis of target customer size, a suitable NDR can fall in the range of 90% to 125%.
Components of SaaS Financial Planning
Here are the key components of SaaS financial planning that leadership must focus on to ensure growth and achievement of long-term objectives:
Sales leaders need to draw up estimates of monthly, quarterly and annual revenues. It is crucial to understand the patterns in the sales cycles to plan growth strategies and marketing initiatives. SaaS companies must create a sales model that factors in the various market developments to accurately forecast growth goals.
SaaS companies must create a full-expense plan that addresses regular expenses, variable expenses, and estimated future expenses. This outlay will help identify the essential expenses and non-essential expenses, thereby assisting in the reduction of non-productive expenses. Planning for any unexpected expenses can help SaaS companies be better prepared with an informed strategy. Regular monitoring of variable expenses will also assist with the reduction of unnecessary costs.
KPIs and Metrics
SaaS companies operate in rapidly evolving scenarios; hence it is crucial to regularly report on the performance of the financial plan. This necessitates the identification and definition of crucial KPIs and metrics that can help analyze the progress of the company along the desired performance levels. Any variations will necessitate corrective actions to keep the performance on the track.
No business can survive without cash, and the same rule applies to SaaS companies. Company leadership must be able to estimate monthly, quarterly and yearly cash runway. This would help the enterprise be ahead of any upcoming financial challenges that can adversely impact the business.
Merely having financial statements is not enough for SaaS companies. They need FP&A software that integrates all crucial metrics, collects data in real-time, and enable data-driven decision-making. This will create a single source of truth wherein all decisions across departments will be based on a central database.
Benefits of Financial Planning for SaaS Companies
There are various benefits that SaaS companies can accrue through financial planning, including:
- Company Goals: Financial planning enables a company to track its performance based on real-time data and then determine company goals. This enables the creation of an operational plan for achieving those goals.
- Cash flow management: Financial planning helps with sensible cash flow management wherein companies can determine the acceptable levels of expenses and how those expenses will be financed.
- Raising funds: Most SaaS companies require considerable funds when they are in the growth stage. The investors will require a financial plan and a business plan to understand the prospects of a company. Financial planning is vital to convincing investors regarding the growth prospects of the company.
- Future Roadmap: Financial planning helps companies assess the present situation and plan for the future accordingly. With a well-defined future roadmap in place, companies are in a better position to work towards achieving those goals.
How does financial planning for SaaS companies differ?
SaaS financial planning is different from other businesses as SaaS companies have extended sales cycles, and their revenue is generated through various different models based on the number of users and the subscription plans. This recurring revenue model requires customized financial planning to address the various challenges that come along the way.
The overall revenue growth of a SaaS enterprise will depend on customer behavior. This is the reason that a SaaS financial model predicts the future financial performance of a company based on historical data. SaaS companies focus on key metrics like LTV: CAC ratio, Churn, and ARPU to measure their present performance and formulate strategies for the future.
Need for Financial Planning Software
While, as an industry, SaaS runs on the latest technologies, many enterprises still use antiquated FP&A software platforms or spreadsheets to assist with SaaS financial planning. Whereas what SaaS professionals need is FP&A software that integrates all crucial metrics, collects data in real time, and enables data-driven decision-making.
Incorporating a comprehensive FP&A platform with the existing system will help address the challenges posed by huge data volumes, rapidly scaling models and the need for integrations.
Companies can create a top-down scenario framework and revenue forecast to guide the execution of bottoms-up plans. Moreover, company leaders will get a precise understanding of the impact and cost of the programs.
SaaS financial planning is an essential operational function that is directly related to the future growth prospects of a company. With huge volumes of data available, the best approach to optimize the financial planning process for SaaS enterprises is to invest in an FP&A platform.
This will help in automating the processes involved in the financial planning, execution, and monitoring functions. Companies will surely gain numerous benefits, including optimization of cash flow, business performance, and financial management, making the investment in FP&A software worth every penny.