Although you can find dozens of similar apps for just about any need, each software as a service (SaaS) company faces unique challenges and requires equally unique approaches to financial modeling. When done correctly, a SaaS financial model can help executives make important strategic decisions and demonstrate a plan for growth to stakeholders.
More “traditional” financial models show simple scenarios where the business produces one product with predictable overhead and revenue. SaaS companies, however, deal with churn, tier-based subscription models generating different revenue (or no revenue if you have a free version of your system).
The SaaS financial model must reflect these nuances to give a comprehensive overview of the business and shape priorities.
What is Unique About Financial Models for SaaS Companies?
SaaS companies typically incur the most significant costs in the development phase. They may allocate resources to marketing or selling to potential customers, but they don't have fixed costs associated with each user. Instead, each additional user or subscriber helps the company repay the upfront costs before profit can be achieved.
Since revenue is incurred over time on a recurring basis, retaining customers and reducing churn is an incredibly important part of a SaaS business model and they must be reflected in financial models.
A financial model forecasts a business's future financial performance. A financial model for SaaS companies brings three traditional financial statements – the income statement, cash flow, and balance sheet – alongside unique factors to the SaaS world. This include tier-based subscribership, subscriptions rates, churn rates, and average revenue per user (ARPU).
A SaaS company's operating expenses are also somewhat unique. Customer acquisition cost (CAC), customer lifetime value (LTV), the LTV:CAC ratio, and payback period are usually factored into the expenses of running a SaaS company, rather than expenses such as material sourcing, shipping, or production costs.
How to make a financial model for a SaaS company
Making a financial model for a SaaS company requires evaluating several unique factors. The SaaS business model is based on recurring revenue from subscribers rather than one-time product purchases.
That is why financial models for SaaS companies often revolve around the user and feature metrics that tell financial advisors how much revenue each user brings in, how long users typically remain loyal to the company, and how much it costs to acquire a user.
The numbers can shift day to day, making it important for financial advisors to keep a finger on the pulse. A platform like Causal makes it easier to aggregate financial data from other systems and build dashboards you can easily share with department leaders and the C-suite when it’s time to break down the numbers.
These metrics include…
Average revenue per user
ARPU describes total revenue divided by the number of users for a given period. This calculation is helpful for SaaS companies because revenue typically varies by each user based on how long they maintain their subscription, upgrades, and subscription tier. ARPU helps by creating a single metric SaaS companies use to understand how they compare to competitors and how the product is growing over time.
In SaaS, churn is a percentage that describes the rate at which customers canceled their recurring revenue subscriptions over a given time period. Churn equals the number of customers that canceled their subscription in a given time period divided by the number of customers at the beginning of the time period.
This is an important measure for SaaS companies as it’s incredibly difficult to grow unless your customer acquisition and retention rates exceed churn.
Customer acquisition cost
CAC is the total amount spent on generating customers (i.e., marketing, sales, advertising) divided by the customers gained for a given time period. Acquiring customers can be expensive for SaaS companies, so knowing how much each customer "costs" and ensuring ARPU is higher is crucial to profitability.
Customer lifetime value
LTV describes the revenue a customer will generate over the course of their time as a customer. It’s an important metric for SaaS companies because it informs how much should be spent on retaining customers. Increasing LTV is often a big priority for SaaS companies since acquiring new customers can be expensive and time-consuming.
The LTV:CAC ratio is found by dividing LTV by CAC to reveal how the total value of a customer compares to the cost of acquiring that customer. Per industry standards, 3:1 is considered an ideal ratio. A lower ratio indicates a SaaS company is spending too much on acquiring customers.
The payback period simply describes how long it takes to recover the expenses of an investment. SaaS companies often monitor the CAC payback period to analyze how long it takes to break even after acquiring a customer. It can also be used to calculate how many users a company must acquire before breaking even on development costs.
Including these metrics when building financial models enables SaaS companies to gain a holistic view of their users, which is very important for efficient and effective revenue generation.
For early-stage SaaS companies, the financial statement must show investors and stakeholders that they understand how to drive additional growth from users. The financial model may reveal that a company needs to prioritize getting more users, keeping users for a longer time, or lowering the cost of acquiring companies. These pieces of information are invaluable to executives when making strategic decisions.
A SaaS financial model forecasts a business’s future financial performance based on historical information. It is unique from other financial models because SaaS companies have a long sales cycle and generate revenue in many nuanced ways, all centered around subscribers or users. For this reason, it includes customer-centric metrics such as ARPU, churn, and LTV:CAC ratio. A financial model demonstrates growth and uncovers areas for improvement or additional revenue generation.
By analyzing the SaaS financial model, financial advisors can advise executives on how customer behavior is impacting overall revenue growth.