When you start a business, there are specific metrics you should monitor to evaluate its financial performance. A financial model defines these metrics to measure the success of an organization. This proactive approach delivers impeccable results and long-term sustainability.
Employers need to consider specific acronyms and calculations when discussing the SaaS business financial model. These metrics provide real-time insights into the financial performance of a SaaS company. However, the nature of the SaaS industry is different from traditional sectors. Therefore, SaaS financial modelling needs to be separated from conventional financial modelling.
In this guide, we will detail some of the key metrics involved in the SaaS business financial model and their impact on corporate growth.
So, let’s get started!
What is SaaS Business Financial Model?
SaaS business financial model is a comprehensive document that outlines the financial performance of a SaaS company. It also outlines future projections for investors and stakeholders to make informed decisions. A good understanding of this model is essential to make accurate forecasts.
Overall, this model aims to address four key challenges. First, it helps SaaS companies predict future recurring revenues based on previous data. Secondly, entrepreneurs can determine the impact of customer churn rate on revenue projections.
The third challenge the SaaS financial model addresses is to effectively managing various costs associated with organizational management. Lastly, the model can accurately estimate the customer lifetime value to acquisition cost ratio.
Why SaaS Companies Need a Financial Model?
The ultimate goal of the SaaS business financial model is to contribute to organizational success. To achieve this goal, the model assists key stakeholders in:
1. Financial Planning
Effective financial planning requires a deep understanding of a company’s economic performance. Financial modelling can help SaaS business leaders identify potential issues and build long-term strategies that drive success.
2. Pricing Mechanism
A flexible and transparent pricing mechanism plays a vital role in the success of a SaaS company. Financial models provide necessary information about expenses, revenues, and net profit. Besides, employers also get data on the approximate lifetime of a customer. Eventually, they can use this information to determine and adjust pricing for SaaS services.
3. Business Planning
No business plan is 100% perfect. There are certain limitations and inefficiencies that leave room for further improvement. SaaS business financial model is the best source to uncover those inefficiencies and make necessary adjustments. Eventually, SaaS business leaders can devise long-term business plans that improve operational efficiency.
Key Metrics to be Included in SaaS Financial Model
Employers should consider adding the eight most common metrics to their SaaS business financial models. Let’s discuss these metrics one by one:
1. Average Revenue Per User (ARPU)
ARPU is a critical metric for calculating the pricing of the revenue per customer. It helps leaders determine whether their SaaS business model is viable or not. In other words, are they earning reasonable profits or losing consistently?
How to Calculate ARPU
TO calculate the ARPU, divide your company’s revenues by the number of customers acquired within a specific period. The revenues include subscription fees, upgradation fees, and income from add-ons.
For instance, if a SaaS company generated $2 million in revenues in one year from 500 customers, its ARPU will be:
$20,00,000 / 500 = $4,000 ARPU
2. Customer Acquisition Cost (CAC)
CAC refers to the estimated amount of money a SaaS company spends to acquire new customers. It highlights the success of sales and marketing campaigns targeting potential customers. Besides, the CAC directly impacts the pricing models, lead conversion rates, and revenue forecasts.
How to Calculate CAC?
To calculate the CAC, divide all your expenses (marketing + sales) by the total number of new customers acquired within a specified period.
For example:
$100,000 / 500 = $2000 CAC
3. Churn Rate
Not all subscribers keep using your SaaS product for a lifetime. You will retain some customers and lose most of them over specific periods. The churn rate tells you how many users cancelled their SaaS subscriptions within specified months. This metric is directly linked to ARPU, MRR, and CLV.
How to Calculate the CR?
Churn rate has two types: Gross and Net.
The gross churn rate is calculated by dividing the number of subscribers that stopped using your SaaS product by the total number of customers.
For example:
50 (former users) / 500 (total users) = 10% churn rate
On the other hand, the net churn rate is calculated by subtracting the downgrades from the total revenues (recurring + upgrades) and dividing them by the total amount renewed over a specific period.
For example:
$10,000 (recurring revenue) + $6,000 upgrades) – $4,000 downgrades / $10,000 (Total recurring revenue) = 120% net churn
4. LTV to CAC Ratio
Some customers are loyal and committed to your SaaS company while others don’t stay long. LTV tells you how much revenue you generate from each user. Similarly, by comparing the LTV to CAC, you can determine the net profit or loss per customer.
Hence, LTC to CAC is an important metric. It helps you determine the success of your SaaS organization and assists you in building future strategies.
How to Calculate LTV to CAC Ratio?
It is a simple ratio of lifetime value (LTV) and customer acquisition cost (CAC). Hence, it is calculated as follows:
$10,000 (LTV) / $2,000 (CAC) = 5:1 LTV:CAC ratio
5. Payback Period
The payback period, also termed the CAC payback period, is the approximate time an organization takes to repay an initial investment. In the SaaS industry, the payback time is referred to the time taken to recover customer acquisition costs.
Ideally, the payback period for SaaS companies should not exceed 5-7 months. It usually depends on your profit margins, target audience, and the industry you sell your services.
How to Calculate the Payback Period?
The payback period is calculated by dividing the initial investment by the monthly cash flow.
For example:
If your SaaS business spends $200 to acquire a new customer for a $20 monthly subscription, your payback period would be:
$500 / $20 = 10 months.
Creating SaaS Business Financial Models
An all-inclusive financial model has all the metrics mentioned above in a well-organized format. When creating a financial model for your SaaS business, follow these five steps to get your desired results:
- Consider all possible scenarios (Best, most likely, and worst)
- Divided your model into multiple sections
- Use headings, subheadings, and descriptions
- Carefully calculate your revenue projections
- Consider headcount assumptions for more accuracy
Wrapping Up
A financial model is the most comprehensive document for any business. It lays down the foundation for the growth of an organization and gives a clear picture of financial performance. A well-structured SaaS business financial model empowers stakeholders to make informed decisions for long-term sustainability.
Five metrics are essential for every financial model. These include average revenue per user (ARPU), customer acquisition cost (CAC), churn rate (CR), LTV to CAC ratio, and the payback period. Employers can use these metrics to calculate the net profit or loss for specified periods.