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Ditch The Crystal Ball And Use Data To Forecast Your SaaS Metrics
By Quiet Light
Forecasting and metrics are a necessary but daunting part of running a SaaS business. Because of fudged numbers, confusion, and downright disorganization, SaaS founders are left scratching their heads, wondering how in the world they can get accurate forecasts for their businesses. Well, we’ve got good news, folks. Quiet Light chatted with CFO Ben Murray, who shares his process for calculating metrics and forecasting for SaaS businesses.
Nobody did fortune-telling quite like TV personality (and, according to some, con artist) Miss Cleo. She popularized psychic readings, where callers to her show would beg to know their future. And who doesn’t want to glimpse beyond the veil, seeing events that are to come?
But the thing is, no matter how hard you try, psychic readings, cards, and crystal balls fall short. That’s because they often rely on wishful thinking, not facts and data. If you’re growing a SaaS business, it’s going to take a lot more than wishful thinking to get buyers, investors, and SaaS customers on your side.
The thing is, you do need to become a fortune teller as a SaaS founder. However, this type of fortune-telling involves a little less smoke and mirrors and more accounting and math.
I’m talking about forecasting. Now, if you want:
- To exit your business someday
- To give your employees a tad more job stability
…your SaaS business needs forecasting. You can peer into the future of your business with forecasting, using solid SaaS metrics to back up your predictions. But guess what? Your forecasts are only as good as your numbers. If your math is sloppy (and it often is, folks), you’re SOL.
Fortunately, you don’t need to use cruddy math anymore. Quiet Light sat down with CFO extraordinaire, Ben Murray, to chat about all things forecasting and metrics for SaaS businesses. So ditch the crystal ball, take out your calculator, and let’s get down to business.
Ben Murray went into a field of work that most people would avoid like the plague: finance and accounting. While many people shy away from numbers, Ben loved them, going as far as creating a 20+ year career in finance.
Ben’s focus was primarily in the airline and software industry, but that’s how he fell into the SaaS niche. He already did financial forecasting and complex Excel models in his airline industry job. These are skills that translated perfectly to SaaS.
Problem was, Ben saw plenty of people were writing about SaaS financials, but few were willing to cough up their processes and templates. That meant SaaS founders knew what they needed to do, but didn’t have the knowledge to actually make things happen. Ben figured, “Why not help these folks?” and started his blog, TheSaaSCFO.com, over 3 years ago to fill in the gaps.
Today Ben writes about the intersection of SaaS marketing and metrics. His content focuses on pain points he felt as a CFO, offering tons of free templates and resources to founders looking for uncomplicated answers.
Needless to say, Ben’s a whiz with math. The dude practically wrote the book (or blog, I should say) on SaaS forecasting. Although he preaches the importance of forecasting, some SaaS owners turn their noses up to it.
I mean, is there any real value in forecasts, anyway?
As it turns out, yes! Forecasting is mostly rooted in numbers. You might need to use your imagination or think outside the box to interpret those numbers, but at its heart, forecasting is all about the numerals, baby. “There’s definitely science behind forecasting because it leverages your operational understanding of your business,” Ben says.
Forecasting helps SaaS businesses figure out where in the world their money is going. If you want to scale your biz but aren’t sure if you can afford it long-term, you need forecasting. This prevents you from taking on too many expenses too soon.
Use your SaaS forecast to check that you can afford to hire more employees or invest in more development. Basically, it’s the art of un-effing your future self.
Forecasting benefits SaaS businesses in 3 ways.
1. Hire The Right Number Of Employees
You probably know this, but personnel costs are the biggest expense for SaaS businesses—to the tune of 70% of total costs. Yeowch. But few founders know when it’s the right time to hire on new talent. Guess wrong and you’ll easily go into the red on employment costs.
Instead of guessing when to hire, use your forecast data. This means you’ll scale when you can afford it, not when you think you can afford it. Like that one responsible friend at a party, forecasting keeps you from making bad decisions.
2. Highlight Your Weaknesses
Nobody likes talking about their shortcomings, but that’s the only way your SaaS business will get better. And SaaS forecast data doesn’t lie; the information will spell out loud and clear where you need to improve. “Forecasting exposes the weak areas of your business,” Ben says.
Forecasting helps you identify problematic patterns with:
- New customer bookings.
- SaaS churn.
Without forecasting, this is all a shot in the dark. Fortunately, forecasting puts the right data in your hands so you can avoid future problems.
3. Know Your Business
Feel free to guess all you want at pub trivia night, but don’t guess when it comes to your SaaS business. Can you answer these questions off the top of your head?
- What’s your monthly recurring SaaS revenue (MRR)?
- How many current SaaS customers do you have?
- What’s your customer acquisition cost (CAC)?
If you can’t answer these simple questions, you can’t scale your business (and you certainly have no business seeking investments or a business sale, either). “If you don’t understand your current financial state, it’s going to be really hard to forecast,” Ben says.
Forecasting clarifies your business expenses so you can create meaningful SaaS metrics. These are essential if you plan to sell your business one day (but more on that later).
SaaS Forecasting Without A CFO On Staff
“That’s all well and good,” you might think, “But I can’t deal with numbers to save my life.” I sympathize, friend. The thing is, Ben created templates and processes you can use, no matter how mathematically-challenged you feel. Don’t kill brain cells trying to learn Excel pivot tables; Ben did the hard stuff for you.
With that said, how do you forecast when you don’t have a CFO to crunch the numbers?
Ben says the best place to start is in a simple Excel or Google sheet. It’s not fancy, but you can start tracking your cash invoicing there. This will help you forecast your cash balance and how long that balance will last. Track things like:
- Major expenses
This will help you get an idea of your business at a high-level view. Take a peek at the sheet and see if you can find any patterns. What cash comes in when? What expenses hit you regularly, like employee salary or rent? By looking for patterns, you’ll be able to do rudimentary forecasting—sans CFO.
Now, the CFOless forecasting method can only get you so far. That’s because SaaS businesses are notorious for being hard to forecast. That doesn’t mean it’s impossible, but it means you’ll need a nudge in the right direction. Follow Ben’s 3 tips to forecast for your SaaS biz.
1. Get Organized
Forecasting is like traveling. You can’t get where you want to go unless you know where you are. You need historical financial data that you can pull to do forecasting. If you have good margins, earnings are trending, and you’re under $1 million in SaaS revenue, use this time to get organized.
If you started off in Excel sheets, now’s the time to get on QuickBooks. There’s nothing special about QuickBooks, really, but Ben says 9 out of 10 SaaS businesses tend to use this software. It’s ubiquitous, cheap, and a lot of people know how to use it.
Now, when you set up QuickBooks, you have to make sure everything is organized correctly. Aside from being a best practice, this is going to save your bacon as you scale.
“One thing I see with SaaS firms is they’re coding all of their expenses into one big bucket,” Ben explains. If you dump all of your expenses into one category (or in too many categories), your numbers are going to be all over the place. You’ll have no clue how much you spend on different aspects of your business.
Let’s keep things simple for now. Classify expenses by department, separating costs like:
- Employee salary
- Commissions / affiliate payments
- Marketing / advertising
Finalize your books every month to get square on these expenses. That’s what will give you a clean, crisp profit and loss statement (P&L) that investors and buyers need to see. Ben adds, “The big thing is getting all your wages classified correctly, by department.”
2. Choose How To Do Your Accounting
Don’t dump numbers into QuickBooks willy-nilly. You need a documented, structured plan for how you calculate these figures. These numbers have a big impact on your metrics, so don’t gloss over this!
If your SaaS biz invoices monthly and only looks at monthly recurring revenue (MRR), this isn’t as big of a deal. However, if you offer subscribers a discount if they pay annually (a metric called annual recurring revenue, or ARR), you have a messy situation on your hands. “With annual contracts, you see a lot of SaaS companies posting that revenue right to their P&L,” Ben says.
If you get a lump sum of money in an annual payment, it’s tempting to say, “I earned $12,000 in November on this one account.” But you didn’t actually earn $12,000 in one month. That $12,000 should be separated into twelve $1,000 monthly increments, not a lump sum.
But hey, plenty of SaaS founders aren’t accountants and they lump everything together, leaving messy P&Ls in their wake.
You can’t manage your business if SaaS revenue figures are all over the place. If you don’t like dealing with icky numbers, hire a bookkeeper experienced in the SaaS business model.
3. Learn Your Way Around A Balance Sheet
When was the last time you looked at your balance sheet? If it’s collecting dust, it’s time to remove those cobwebs. As a SaaS founder, you do have more barriers because SaaS balance sheets are different than other businesses.
This is because of 2 things:
- Deferred revenue: This happens when you parse out a $12,000 ARR into $1,000 monthly increments. But deferred revenue is also a liability because you “owe” the SaaS customer for 12 months.
- New rules: There are new rules about commissions, which you can now count as an asset on your SaaS balance sheet. Software development also counts as an asset, because it makes your SaaS brand, y’know, feasible.
You need to have a basic understanding of your balance sheet to run a successful business. But if the intricacies are making your head spin, you’re better off hiring a SaaS accountant to do the dirty work for you.
Forecasting is one side of the SaaS financial puzzle, but don’t jump straight to metrics until you master SaaS forecasting. Always start with your accounting so you’re pulling correct data.
To get kickass forecasts, you need to have measurable data. Without these metrics, you can’t see how your company is doing. And if you don’t know how you’re doing, you might as well hang a “Closed” sign on your door. That’s how serious this is.
While every business is different, Ben says SaaS founders should be concerned with 3 types of SaaS metrics.
1. Sales / Marketing Efficiency Metrics
The first place Ben likes to look for metrics is in sales and marketing. “Once you’re past cash flow, it comes down to go-to-market sales and marketing efficiency,” he says. Whether you’re an inbound or outbound kind of marketer, these metrics have big implications for your MRR/ARR.
The key here is to compare the money you bring in (MRR/ARR) minus the money out from sales and marketing. This data will tell you how much it costs to acquire every dollar of MRR/ARR. Obviously, you want to bring in more MRR/ARR than you spend on SaaS marketing. Otherwise, you’re in the hole for those costs.
The right ratio depends on your business, but you can check out Key Bank’s SaaS report to see what everyone else is spending. Here’s their report from 2018.
2. Employee SaaS Metrics
Headcount is the biggest recurring cost for SaaS brands. You might try to keep these low at first, but if you want to support more clients, you’re gonna have to bring people on.
To use this metric, look at how efficient you are at bringing on new bookings versus wage costs. Like with sales and marketing, you want to be in the black with more earnings than expenses.
But this metric isn’t about driving bottom-line savings. You have to remember that employees are the folks building your company and designing your products. “You need to invest in employees because they’re creating your company and your product,” Ben says.
Do you really want to pay these people pennies for their hard work? Instead of seeing employees as a cost center, Ben recommends looking at this as an investment. You always want to invest in happy employees, who are 22% more productive than unhappy employees.
3. Customer Lifetime Value
SaaS customer lifetime value (LTV) are very important metrics. However, the nature of SaaS business skews these numbers. For example, you might have one unicorn of a customer that raises your average LTV, when in reality it’s a lot lower.
How can Saas business owners see their true costs and value?
Ben says it comes down to your denominator. To understand someone’s LTV, you have to see how the numbers break down; why did you choose the numbers you chose? Are you aggregating numbers or conveniently cherry-picking them?
SaaS brands have more leeway in LTV calculations because your definitions of a “customer” will be different. Is someone a customer when they’re brand-new? Or are they a new customer when they resubscribe six months after canceling? Every SaaS brand has a different definition that’s going to fudge the LTV metric.
Because you can fudge or easily mess up LTV, Ben recommends looking at all of your SaaS metrics together. Never look at a SaaS metric in a vacuum, because it needs big-picture context to say what the hell is actually going on. “Lifetime value can be all over the place. You have to understand what inputs they’re using to get that number,” he explains.
You aren’t going to run your SaaS business solo forever. You’ll want to bring on investors or exit the business in the future. That sounds like a far-off dream now, but the decisions you’re making right now will affect your future.
Don’t scare off future investors with a messy SaaS biz. Adjust your business right now to sweeten the pot for both buyers and investors. Ben says outside parties look for 5 things before getting involved in a SaaS business.
1. Clean Books
Remember how we talked about importing your financials into QuickBooks? Yeah, that’s not just for your own benefit; investors and buyers need to see you have clean books, too “It comes back to having a good, clean P&L,” Ben says.
Now, if you have weak books and are trying to sell right now, don’t fret. It means your buyer will have to do a little more legwork to figure out your numbers. They’ll check out a few things, including:
- Invoicing data.
- SaaS churn and other costs.
- Revenue streams.
Based on these three things, a buyer can work backward to figure out your numbers. But do you really want to make them do that? Keep your financials clean from the start to make it easier to sell your SaaS business.
2. Recurring Revenue
Recurring revenue powers SaaS businesses, after all. Investors and buyers want to know that subscribers are going to stick around for the long haul. This number is so important that it can actually affect your valuation as a company. “You must understand the value of your recurring revenue,” Ben emphasizes.
You should care about:
- Bookings data
- Gross dollar retention
- Net revenue retention
- Downgrades and SaaS churn
…for your SaaS biz. And don’t just know these numbers for your best-selling products; separate recurring revenue figures by product line to clarify how, exactly, the company makes money.
3. Business Model
What’s your business model? Even if you have a gush-worthy product, that doesn’t mean your business is going to succeed. Do you have customer support or tech support to make your product a reality? Investors and buyers need to know your biz has what it takes to keep money coming in the door from happy SaaS customers.
4. Customer Acquisition Strategy
How do you get new customers? Investors and buyers want to know not only how you get these customers, but how much they cost you. This is where LTV and CAC come into play. Use these SaaS metrics as well as your go to market strategy to explain how you get customers today, and how you plan to get more customers over the next few years.
5. Potential Dealbreakers
This is a broad category, but buyers and investors look out for red flags when evaluating any business. Make sure your SaaS biz doesn’t have any of these hair-raising warning signs that send buyers packing:
- Payback period: Payback period is the amount of time it takes for you to recoup the cost of acquiring a customer. If it takes 13 months to recover costs, some buyers might be leery.
- Cash: How are you funding the business? Do you have cash on hand or are you tied up with lines of credit? Buyers want to see cash in hand instead of mounds of debt.
- Product-market fit: Once the buyer acquires your SaaS business, are they going to have a hard time selling your product? Product-market fit matters because it looks at the viability of your product in the market. It shows you can acquire and retain customers over time.
If your business isn’t perfect right now, join the club. Most SaaS businesses have something they could improve. But instead of burying your head in the sand, do something about your deficiencies. Action will move the needle and make your business more profitable.
Miss Cleo may have had some good predictions, but they were just that: lies. Forecasting may not be a perfect science, but it’s definitely better than wishful thinking or ignorance. A combination of math and logic, forecasting helps you choose which SaaS metrics matter.
If you get organized, choose an accounting method, and familiarize yourself with a balance sheet, you’ll be able to forecast even the most annoying SaaS financials. Once you get your finances on lock, choose the metrics that matter most to you, whether they’re marketing, employee, or acquisition metrics.
Remember, your business isn’t just for you. You might be the big enchilada today, but if you plan to sell your SaaS business down the line, you need to have clean books, recurring revenue, a good business model, a proper customer acquisition strategy, and zero red flags.
The worst thing you can do is nothing. Even if it’s a learning curve for you, take the plunge and begin cleaning up your books. This will make SaaS forecasting and metrics a possibility. Stop predicting and start knowing with clean books and better metrics.