SaaS Finance 101: Understanding & Speaking the Language of the Industry
Recently, we sat down with Will Cordes, CEO & Founder of KPI Sense, to dive into what it means to be a CFO at a SaaS company. The discussion centered around the unique offerings of the SaaS business model, some best practices, and a breakdown of key SaaS metrics that can tell the story of your business. In the hopes of bridging the gap between SaaS language and practical, everyday execution, we covered the basics and deeper exploration in the context of an actual SaaS role.
You can watch the full recording of Will's SaaS Finance presentation here.
The SaaS Business Model
Whether this is your first role is SaaS finance or in finance altogether, you’ve likely noticed the difference in the SaaS business model and overall language. The metrics are many and intertwined, the business model is supported by recurring revenue, and the customer relationship is ongoing. The switch from one-time licenses to subscription-based cloud software has transformed the industry: customers now are given flexible and scalable solutions that meet their specific needs. In turn, your business receives continuous, predictable revenue it can count on.
While the SaaS business model offers great value and opportunity, let’s face it: finance is not easy for SaaS companies. The accounting systems that are in place aren’t built for complex revenue recognition. Analyzing the right data from inadequate systems is painful. On top of that, SaaS finance leaders are being asked to do so much more in terms of strategy and analytics. Understanding SaaS-specific best practices, as well as the key metrics and how to use them in the context of your business, will provide you with a foundation to drive well-informed, strategic direction to fuel your company’s growth.
By both a) understanding and taking the time to get your financial operations (process, structure, and data) in order, and b) understanding the nuanced language of SaaS, you’ll be well on your way to leading your company like a true SaaS expert.
Recurring Revenue: The Backbone of SaaS
What primarily sets the SaaS business model apart from legacy software companies and other businesses is the world of recurring revenue. With the subscription-based SaaS model, you earn cash by delivering a constant service hosted by your company with which your customers are interacting on a regular basis. In a sense, your customer is “hiring” you to provide a useful business component. Recurring revenue shows the predictable, repeatable revenue your business is expected to generate in the future. This is crucial for examining growth, forecasts, and business operations.
With recurring revenue, not only are you focused on new business acquisition, but also customer retention. Retaining your customer base guarantees your revenue for consecutive time periods. Think of it this way: even if you gained 0 new customers in a year, if you retained 100% of your customer base you would earn the same amount of revenue! Investing in both growing and retaining your customer base will allow your business to grow sustainably. The trick with recurring revenue: cash is king. You earn cash every day that your service is being delivered. If you are spending cash earned from one month before the month is over, you could be liable to return money if there are service or product disputes, refunds, etc. In other words: make sure you’re not spending money you haven’t yet earned!
Recurring revenue is what makes SaaS so resilient. You’ll have a more stable cash flow, and can easily upsell and incorporate more services/revenue streams into your existing customer base. With a deep understanding of recurring revenue, you can continue to analyze metrics and business performance to expand and optimize revenue.
SaaS Finance Best Practices
Chart of Accounts
The number one recommendation we’ve seen with companies we’ve worked with our clients on is building a SaaS-specific chart of accounts. Quickbooks is not optimized for SaaS, so it’s important that you have the right structure in place to analyze your information. Taking the time to build something to capture the level of detail needed to calculate crucial SaaS metrics will save you time and headaches in the long run.
SaaS businesses have unique costs. Your hosting and customer success costs, for example, go directly towards supporting revenue. Using the default categorization in Quickbooks will leave you manually searching for data when tracking KPIs. Let’s say you group all your contractors under the default Contractor account. When it comes time to calculate your Customer Acquisition Cost, you’ll need to tease out which specific contractors are for Sales and Marketing. However, grouping your accounts and tracking spend by business function will ensure that important costs are not hidden or lost in accounts. Doing the work to set up a SaaS-specific chart of accounts up front will ensure accurate metrics for analysis for investors and for your board. Looking for a step-by-step on building a chart of accounts in Quickbooks? We’ve got you covered.
Building a dashboard
A clear, effective KPI dashboard serves as a “source of truth” for your business. Analyzing your data in a clear, meaningful visualization can give you powerful insights into the health of your company that you can use. Data that shows both positive and negative aspects of your company is helpful; you need to be able to know your strengths as well as areas of improvement. There are a few important things to keep in mind to create an effective KPI dashboard:
Make sure you are starting with clean, quality data. If the data you’re using is inaccurate, missing, or incomplete, your results will be also (to a greater degree!) Simply put: garbage in=garbage out.
Understand your data sources. Be mindful of any unique data sources in addition to the standard financial statement and bookings data (QBO, Netsuite, Xero, SaaSOptics, Salesforce.) Data from additional sources or even your own platform need to be accounted for appropriately. Remember, revenue on your financial statements isn’t the same thing as MRR in SaaSOptics or bookings in Salesforce.
Define use cases. Is your dashboard going to be used as a guide to making business decisions, or is it simply a tool to convey information to investors and stakeholders? Don’t put the effort into building a dashboard just to have one; truly understanding what function it will serve for your company will help you move forward with clear objectives in mind.
Plan ahead and clarify ownership. Who will be responsible for making sure the KPI dashboard delivers the objectives you’ve identified? How often will it be updated? How will it be managed, handled, updated, used, and evaluated? Identify up front how you will measure the effectiveness of the dashboard against your objectives, so that you can modify as necessary.
Keep in mind: Automation
Once your company reaches scale, bookkeeping and modeling will become harder and more complex. Your role will need to evolve into focusing your time and resources on company growth as a whole. Stepping into the role of modeling, projecting, and forecasting will mean building your finance team as needed and automating processes as much as possible. Automation is critical in streamlining the process and eliminating error from manual entry.
If your company does not have the resources to build out a finance team, you can consider outsourcing those duties to a team of financial experts whose entire purpose is spent doing these types of things. These services are often available at a fraction of the cost of a full-time head or team.
When considering automation or outsourcing, consider the cost of your time. How much salaried time are you using to complete manual tasks? Investing in a product or service can eliminate costly salaried hours of your (or your team’s), making it a worthy investment.
Read Part 2 in this series: Key SaaS Metrics for Finance Leaders
As you continue to grow in your SaaS role, there’s a wealth of information to help you along the way. As always, feel free to reach out to the team at KPI Sense to review your current financial strategy, or for any questions you may have. If you’ve taken the first steps of learning to understand the SaaS business model, or even simply made it to the end of the post, you’re well on your way to effecting meaningful growth and change for your company.