As a SaaS (software-as-a-service) founder, you already know that the SaaS financial model presents a win-win scenario for both customers and companies.
All you need is to build an excellent SaaS product. Then, the company will collect monthly (or annual) revenue from its customers for the rest of eternity. Or at least as long as the users continue to perceive the value.
Imagine that your product is ready and released. The first customers are already on board and loving it. Everything is going great.
You’ve achieved success, right?
Yes and no. That’s a great start, but consider a few points before celebrating too much.
What’s your pricing strategy? When does the company reach profitability? How long can you continue to operate without securing additional investment?
For those answers, your SaaS business needs a financial model.
What is a SaaS Financial Model?
A financial model combines your current finances with the business’s forecast.
In short, a model is a plan for the company’s finances that can also serve as a decision-making tool.
But, like most things in life, the “garbage in, garbage out” principle also applies to financial modeling. An economic model is only as good as the information you put in it.
The validity of the model’s assumptions significantly impacts the value of the information generated by the model. Using the model as a decision-making aid requires the numbers behind it to be anchored in reality.
How Can Founders Use a Financial Model?
A startup needs to grow to achieve profitability and succeed.
Forecasts help founders grow startups by allowing the team to get clear about expectations.
Through forecasting, you have the opportunity to plan your company’s future. Modeling multiple scenarios allows you to simulate how internal and external events will impact the business and its trajectory.
The SaaS financial model can also be used to value the business and compare it to others in the industry.
Once your model is in place, use it to make decisions about the company’s direction. According to your growth plans, you’ll know in advance how you need to build the team and underlying infrastructures to achieve the startup’s goals.
What’s Unique About a SaaS Financial Model?
SaaS companies typically incur the most cost at the start of the business. Unlike physical product businesses, a SaaS product typically has no variable cost per user.
Once you have the product, aside from hosting, customer service, and product improvements, there’s minimal additional cost per unit delivered.
However, profit doesn’t start to occur until later down the line.
SaaS products require a considerable upfront investment paid off through a high per-unit margin.
This business model relies heavily on customer-related metrics. To name a few, a useful SaaS financial model needs to include:
- Subscription rates
- Customer retention
- Customer churn rates
- Average revenue per user (ARPU)
When combined, these customer metrics will show how the customer base will develop and how tweaks to each one can drastically impact your model.
What Should a SaaS Financial Model Include?
For a good model, you need to make sure you’re tracking these metrics:
- Customer Acquisition Cost (CAC): the average cost of acquiring a new customer. Calculated by dividing your total marketing cost by the number of new customers, this can be a valuable metric for determining your level of organic growth.
- Average revenue per user (ARPU): the amount of revenue generated by each user. ARPU is exceptionally informative when you have multiple tiers or a freemium model.
- Lifetime value (LTV): the total revenue generated by an average customer before they churn and stop using your service. After building an initial customer base, your objective should be to keep your LTV three times (or more) higher than your CAC.
- Churn rate: the monthly percentage of users who stop using your product because it no longer fits their needs. This metric measures customer satisfaction and assists in growth projections.
- Cash flow: a show of how well you’re managing cash. Your bank accounts should also reflect this net position of all in- and out-flows.
- Runway: derived from your monthly cash flow, the runway is the amount of time (in months) your company has left before running out of funds. Securing additional funding or becoming cash-flow positive can both extend your company’s runway.
Need Help Building Your SaaS Financial Model?
A financial model is an essential tool for getting your startup’s financials on track and keeping them there. Defining your roadmap to success can be a significant challenge without a model outlining where you’re going.
But, building your own SaaS financial model can be highly complex. There are a lot of moving parts and many interdependent factors that need to come together.
At Founder’s CPA, our experienced accountants can help build a financial model that reflects the intricacies and challenges of your startup.
Set up a free consultation with our startup finance experts if you’re ready to get started.