Here we will discus the SaaS financial model but first lets look into what SaaS is. SaaS or software as a service is an internet-based approach for the distribution of software. SaaS provides a way for users to buy services of software online as opposed to the traditional method of physically owning the copy of the software. For many years, traditional software companies have ruled over the world however, with the shift towards the digital world, everyone is moving towards SaaS. Software providers develop software through collective servers, databases, and codes. These 3 components are very important for any digital software provider. With SaaS, you can use the services from anywhere in the world if you are authorized to use it.

Normally, traditional software requires a user to physically go to a brick and mortar company and then buy software with its authorized key, etc. SaaS eliminates the need for all those requirements and shifts the responsibility for licensing to the cloud provider. With SaaS, you pay online for software which may be located in an entirely different country. The service provider will authorize you to use the software for an agreed amount of time.

Most of the software comes with a pricing plan for 1 year, 2 years or more. These price plans determine how long the users are allowed to access the software. After the plan expires, users can always extend their software use if they are satisfied with the service. Also, if users are not satisfied with the service they receive, there is always an option for a refund (if the service provider guarantees money back within a specific time).

Another advantage of SaaS is multiple logins across all devices. Usually, in traditional software, you are limited to one device only. However, in SaaS, your software is automatically updated and allows multiple logins because the cost of multiple devices is very small and all the files are saved in the cloud environment.

SaaS and its Benefits

The biggest reason why SaaS is so successful is its cost. The overall cost of a SaaS business environment is very low compared to its traditional method where you have to open a brick and mortar company and license every product or service you offer. Let’s look into some benefits of using SaaS.

  • Scalability – unlike the traditional method of business, you don’t need to put in a lot of money and effort if you want to expand your business. You can just ask your SaaS provider to provide you with more cloud space and with one click, it will be done. Therefore, scalability for SaaS is good.
  • Availability – With SaaS, your employees are never out of the loop because of its availability. Whether you are at the office, on a plane or out of the country on a business trip – you will always stay connected through SaaS.
  • No Hardware Costs for Cloud-Based SaaS – the cloud provider gives all the process power for SaaS business which means that no additional cost is incurred.

What is a Financial Model?

Financial models provide an overall picture of your organization. They are comprehensive and provide the company with an estimation of the future. These models are crucial for an organization because they help management in making a sound decision based on past performances. For a financial model to be successful, the analyst must have expertise in reading the data and presenting in such a way that others can understand it as well. For financial data, some of the figures are estimated based on the past performance of a company. This data helps in projecting the future regarding the profit or loss of a company. There are several accounts in a financial model however, most important is the revenue and expenses accounts. In a financial model, if the sales growth is expected to be 10%, the company can get an estimation of what the costs and revenue will be if the sales hit 10% growth.

SaaS and Financial Model

All financial models have one thing in common, they turn out different from what you expected. However, the main goal for early startups using SaaS financial model is to show investors that the company knows what drives cost and what drives revenue. Early-stage planning is crucial even though the reality might turn out to be different than expected. If the investors already assume you do have the power to execute your model, they will not be interested in investing in the company. However, with proper financial modeling and realistic assumptions – you can sell the idea to the investors easily.

The Model

All financial models are nothing but assumptions or hypothesis all in one place. These hypotheses can be divided into 2 categories

  • Revenue Growth Hypothesis
  • Cost Growth Hypothesis

The revenue growth hypothesis shows what drives revenue. This is the most different hypothesis out of the two. Since you never know how much sales the company will have or how many customers the company will have – it is very difficult to reasonably estimate the MRR or monthly recurring revenue. However, it is the most important component of the SaaS financial model. Estimating the cost revenue is quite easy as you can get the value of the expense after a little bit of research. You can find out what your budget should be.

Those startups which are successful, grow their MMR between 10%-25%. However, these numbers are just so you have a benchmark for your own model. There is a number of ways that help companies achieve their desired MoM growth rate.

Here are the additional hypothesis that you can use in order to increase MoM growth rate.

  • The number of customers – if the customer pool increases, your MMR is directly impacted and you can see better results in terms of revenue.
  • Average transaction value – this hypothesis focuses on increasing the average revenue per new customer. Ideally, you should try to keep it higher in order to achieve a better MMR.
  • Frequency of repurchase – If your churn rate is lower and repurchasing is higher, you will see a higher MMR. The company should focus on keeping their users happy in order to have a higher repurchase.

All these hypotheses are important to focus and they should be your primary goal because these hypotheses will directly impact your MMR.

Steps to master your SaaS financial Model

Before you even think about investors for your startup, you need to put the financial model together so that investors can take you seriously. The financial model is like a path to profitability. You will find many SaaS financial models on the web; however, you need to ensure that only the model closest to your SaaS startup is selected. The chosen model can be adjusted in order to match your needs.

Here, we list down steps in order to make your SaaS financial model as effective as possible.

Step 1 – Separate Your Signups

Try separating your Facebook ads, Adwords, etc. from other methods such as word of mouth, public relations, and branding. Online signups are different because they are trackable signups.

You can create a separate category for each acquisition channel. For example, if you get signups from Facebook Ads and Adwords, there should be a separate category for both of these. This way, you can monitor which channel is the most effective and which is the slowest. Ads are probably faster in terms of getting you signups however, you should not rely only on paid Ads.

Step 2 – Calculate Conversion Rates

Conversion rate is the time it takes for a user to convert into a paying user. Many companies offer 30-day free trial period after which they start to charge for the service. The trial period may vary from company to company. You need to ensure that all the converted customers are calculated at the end of the trial period. In order to make things simpler, you can calculate each customer acquisition channel by its percentage or you can calculate all of the sales at once.

Step 3 – ARPA Calculation

ARPA is the average revenues per account which are calculated by dividing MRR or ARR (monthly recurring revenue or annual recurring revenue) by the number of users within that specific time.

You can also calculate ARPU which is the average revenue per user. This number can show you how much revenue one user is generating. You should separate the categories for new and existing users. For example, if your company put out a new pricing structure – you need a category for old and new price structures.

There is one problem with the ARPA numbers, they tend to make your accounts look good or bad depending on the types of accounts. For example, if you have a few massive accounts, your numbers will project a more profitable amount which might be far from reality. Similarly, if u have few low revenue accounts, your numbers will indicate bad image, even if the company is doing well.

Likewise, a few accounts with very low revenue can make your ARPA figures look bad, even if you’re doing well. In order to avoid such situations, you should track LTV: CAC ratio (lifetime value: customer acquisition cost) and Net MRR growth rate as your additional key indicators.

Step 4 – Calculate Your Revenues

In order to calculate your revenues, you should multiply your ARPA by your ACPM or an average number of customers per month.

Step 5 – Figure in Your Expenses

You should have realistic figures for your expenses. As mentioned earlier, you can get the closest figure of expense budget after doing some research. Make different categories for one-time startup expense. For example, the phone installation charge will only occur once.

Step 6 – Keep It Simple

For startups, it is best to keep things simple. For example, you can assume your EBIT to be same as operating cash flow. EBIT figures are operating profit because they show whether the company is able to generate profits or not.

Step 7 – Review Your Assumptions

Your assumptions must be achievable and realistic.

Calculate SAAS Customer Churn

Customer churn refers to the number of users who cancel your subscription after a certain amount of time. In order to calculate churn rate, you have to divide the number of customers who left your service by the total number of customers at the start of this period.

Customer Churn = ∆C / ∆T x C

Compare Customer Churn and MRR Churn

MMR or monthly recurring revenue churn is different than customer churn because it calculates the amount of revenue you are losing as a result of cancellations. These numbers provide you will detail about the real costs of losing a customer. Whereas, customer churn will only provide you with a number of customers leaving your service. Consider this example, if you have a loyal customer base at the basic price level, even if u lose your premium subscriptions, your MMR churn would be higher than your customer churn.

In order to calculate MMR churn divide the amount of MMR lost within a specific time by MMR at the beginning within the same period.

MMR Churn = ∆M / ∆T x M

Final Words

In order to successfully show your investors that you know what you are doing, you need a solid financial model. A SaaS financial model will give you a good estimation about the future and help you in growing your SaaS business. You need to focus on churning rate as it indicates the money you are losing as a result of canceled subscriptions. These customers may not be satisfied with the service being delivered, therefore you need to ensure that all customers are satisfied with the service. You can ensure this by keeping in touch with them and asking them if they need help with anything. They might not be happy with little things which can be easily fixed. This practice is good because you are proactive in trying to reduce the churn rate. Your customers are the most important part of the company therefore, all your efforts should be directed at keeping them happy. Follow the steps and create your own SaaS financial model that fits your SaaS organization.

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