In the recent past, there were speculations about the future of software-as-a-service (SaaS) as a mere trend or significant success in the corporate world. The reservations ranged from security and stability issues to the ambiguous nature of the “cloud”, as it was considered too incomprehensible to be regarded as a secure infrastructure. But, despite the skepticism, The business world was swayed by its acceptance as a reliable infrastructure. It revolutionized the operations for many of the business-to-business and business-to-consumer companies.

THE SAAS BUSINESS MODEL IN ESSENCE

The framework of SaaS is very complicated; however, the basics are pretty comprehensible. The first concept to grasp is that the products and services offered by the SaaS companies are on a cloud-based set-up.

There are no such software installment requirements or additional onsite servers. Through this cloud-based infrastructure, the sellers provide their services and support to their clients, manage and maintain systems and data.

With the advances in digital and information technologies, you can easily get your hands on any type of application as per your requirements. However, SaaS companies with a complex infrastructure require unique approaches to financial modeling. The SaaS business model brings a wide range of advantages for both the sellers and customers. In this blog we are going to break down the financial complexities of the SaaS financial modeling.

The rather traditional financial models have comparatively simple procedures of incurring a predictable stream of revenue and expenses. On the other hand, Saas companies have complex scenarios such as churn rate and deal with tier-based subscription models that generate a diverse set of revenue or no revenue at all if there’s no subscription fee. The SaaS financial model must encompass all such differences and complexities to give a more authentic business overview and establish its priorities.

WHAT ARE THE TYPES OF FINANCIAL MODELS FOR SAAS

There are five financial models for SaaS companies

Bottom-up financial model: This financial model is based on the existing financial statements and data to draw conclusions regarding the lowest and highest points in terms of revenue generation and predict the future performance accordingly.

Top-down financial forecasting model: For aspiring entrepreneurs and young startups, such a financial model can help assess the market dynamics and size, and determine how much market share the startup can secure. It predicts the potential growth and opportunities in a new market.

Correlation forecasting model: This financial forecast model can identify and manage variables such as supply, demand, pricing and costs that correlate with each other. Keeping a track of such variables can help you understand how growth in one variable can ensure equal increase in the corresponding metric.

Statistical forecasting model: This is an important model as it helps compare your financial performance and operations with your competitors. It can play a vital role in understanding your potential growth, profitability and market share in the relevant market, and help you devise strategic plans to outgrow your competition.

Delphi forecasting model: Unlike the rest of the models, you base your business forecasts on the insights provided to you by the leading market experts, with a facilitator monitoring them. It includes repeating the devised collaborative analysis till a consensus is ensured. The answers and reviews provided by the experts help you in making more informed and accurate financial decisions for your company.

WHY ARE FINANCIAL MODELS SO SPECIAL for SAAS STARTUPS?

The most significant expenses are incurred during the development stage for SaaS companies. They may allocate a certain percentage to each department; however, they don’t have fixed costs assigned to each customer. Every new addition to the customer base helps the company cover the upfront expense before the profitability stage.

Since there is no streamlined source of revenue, the profit is achieved on a recurring basis over a period of time, reducing or maintaining the churn rate ( The percentage of customers a company loses in a given amount of time) and retaining the existing clientele is a major part of the business model that must be incorporated in the financial model.

SaaS businesses have a unique opportunity when analyzing the costs. They can quantify every aspect of the business, and determine customer acquisition costs (CAC), customer lifetime value (CLV), CLV/CAC ratio, and payback period.

THE BASICS FOR MAKING A FINANCIAL MODEL FOR A SAAS COMPANY

A number of unique parameters are considered for evaluation while drafting a financial model for a SaaS company. Unlike the rest of the traditional models, there is a consistent recurring revenue generated from the customers in the SaaS business model instead of a one-time product or service purchase.

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 number of customers can fluctuate each day making it crucial for the financial advisors to keep a close check on the churn rate as well as the additions to the current clientele. A Platform like Numberly, can make it a lot easier for you to devise your financial model and make more sense of your data.

Key Metrics for Financial Models

A SaaS business would need the following metrics to create the financial model.

1. AVERAGE REVENUE PER USER

The average revenue per user (ARPU) represents the total revenue divided by the number of customers for a given amount of time. The ARPU is crucial for SaaS companies as their revenue typically depends and varies with each user based on the subscription tier, subscription term and upgradation. ARPU is the parameter for SaaS companies to analyze their product growth as well as their performance as compared to their competitors.

2.CHURN

In a SaaS business model, the churn rate refers to the percentage of users that cancel their subscription in a given period of time. The churn rate is equal to the number of users who canceled their subscription divided by the number of users present at the beginning of the given time period. It is a crucial parameter for the SaaS companies as the customer retention and acquisition is crucial for their sustenance. .

3.CUSTOMER ACQUISITION COST

The customer acquisition cost refers to the total cost incurred for generating users divided by the total users acquired during the given time period. The expenses include the marketing, sales and advertisement expenses for the acquisition. Attracting new users may be relatively difficult and costly for SaaS companies, so financial advisors need to know the exact cost incurred for each user as well as making sure the average revenue per user is high enough to ensure a profit.

4.CUSTOMER LIFETIME VALUE

The customer lifetime value refers to the total contribution a customer would make to the revenue for the company over the course of their time as a user. This parameter is crucial for companies as it would let them know how much they should be investing in ways to retain the existing users. Retaining the users is more favorable for the companies as acquiring and attracting new customers is costly in terms of finances and time.

5. LTV:CAC RATIO

The LTV:CAC ratio can be calculated by dividing the Customer lifetime value by the Customer acquisition cost to determine the total value in terms of revenue a customer adds to the cost of acquiring that customer. The desirable LTV: CAC ratio as per the industry is 3:1. The higher the ratio the more ideal it becomes; however, a lower ratio might indicate the company is spending too much cost on acquiring customers that are not adding the same amount of value if not higher.

6.PAYBACK PERIOD

The payback period refers to the amount of time that will be spent on recovering the costs incurred. The SaaS companies keep a close eye on the payback period as it allows them to estimate the time it would take [ to reach the breakeven point after a customer has been acquired. It also helps them in evaluating how many customers they must acquire before reaching the breakeven point pertinent to the incurred development expenses.

These parameters are crucial to be incorporated in the financial models for SaaS companies to gain a realistic and insightful overview of their users, which is essential for predicting and ensuring a steady and ideal revenue flow.

Conclusion

In conclusion, a SaaS financial model like the traditional models predicts the company’s financial performance based on historical data. It is considered unique in nature as it has a long-term sales cycle as well as it generates revenue in more complex ways all dependent upon the users instead of the one-time product sales. For this particular reason, we have tried to enlighten you with the user-centric parameters such as ARPU, churn rate and LTV: CAC ratio. Such a financial model reflects and ensures growth and unveils loopholes in the existing system or suggests new techniques to increase the revenue flow.

Here at Numberly, we help aspiring SaaS companies build a financial model that helps them achieve their goals. they can show to their investors or stakeholders and make sense of their actions in the pursuit of growth and more investment.

Feel free to reach out to us for a no-obligation consultation session with our team of expert financial and business analysts.