By 2028, the global SaaS market is expected to reach a value of $720.44 billion. It’s a massive market teeming with opportunities, but you won’t get anything from it if you don’t keep a tight lid on your SaaS finances.
That’s why we’re here.
We’ll cover everything from the important metrics you need to track to see and forecast the financial health of your company through to creating your own SaaS financial model, getting ready for investment valuation and even reducing your costs as much as possible, as your financial priorities shift.
This post is split into the following sections:
- Fundamentals of SaaS finances
- 13 vital financial metrics for SaaS companies
- Creating your SaaS financial model
- How to structure your finances for the best possible valuation
- 3 techniques to turn around your SaaS finances
It’s time to grab a piece of that $720.44 billion pie.
Fundamentals of SaaS finances
The term “SaaS finances” refers to everything that’s used to track and forecast the financial health of your SaaS company. This includes financial modeling, budgets, reported financial statements, and key performance indicators (KPIs), and can go all the way up to getting your company evaluated for further funding.
Tracking your finances is important no matter what kind of company you run, but for SaaS companies it presents an especially pressing challenge.
When you’re in SaaS you’ll be racking up some of your heaviest bills in the early stages where development plays an especially large role and you aren’t even in a position to sell your software. This means that you’ll need to pursue options for getting cash injections much earlier (and search for bigger available sums) than if you were, say, running a consulting business.
You need money to hire developers to build your SaaS product long before you can think about turning a profit or breaking even. That’s where SaaS finances play a huge role.
By tracking various financial metrics you can model your current situation to see how much money you’re spending and how it compares to other companies in similar stages. From this you should also be able to model your near future, which will let you see how long you can continue before you’ll need to raise more capital, or generally see the health of your finances.
Without SaaS finances, you can’t raise money. Without money, you won’t have a company.
13 vital financial metrics for SaaS companies
Let’s start by looking at the key financial metrics you need to be tracking. These will let you build a picture of the overall health of your company (financially speaking) and see where things need to be improved if you’re to thrive.
Keep in mind, a SaaS business is expected to deliver results for its investors and owners through rapid growth.
Demonstrating this growth builds value that justifies large investment checks, and serves as a guarantee that investors and founders alike will profit. As a result, the most critical metrics in your SaaS finances are ones that reveal actual growth, or the potential for future growth.
The core metrics you need to understand and track are:
- Monthly users
- Recurring revenue (MRR and ARR)
- Customer acquisition cost (CAC)
- Average revenue per user (ARPU) or average annual contract value (ACV)
- Payback period
- Customer lifetime value (LTV)
- Churn rate
- Customer retention cost (CRC)
- Burn rate
- Market size (TAM, SAM, and SOM)
- Cost of goods sold (COGS)
- Gross margin
- Revenue growth rate
As a quick primer, remember that revenue and profit are not the same thing. Revenue refers to the total earned by the company through sales of goods or services. Profit is the remaining revenue after costs, expenses, and debts.
1. Monthly Users
The first metric you need to be tracking is the number of monthly users your product has. You’ll need this in order to forecast future user numbers, and to calculate many of the other important financial metrics.
The impact of these user numbers on your business depends on whether your SaaS products serve the needs of consumers or businesses.
For a B2C SaaS company (i.e. one that services the needs of consumers), each monthly user directly correlates with revenue. Each user is an individual decision-maker who has the potential to pay for an account directly, or add incremental value to a third-party advertiser.
For a B2B SaaS company (i.e. one that services the needs of businesses), each monthly user has the potential to influence revenue, but may do so indirectly. Some B2B SaaS contracts may be written on a per-user basis, but many others may feature flat rates or other incremental pricing models. In that case, a user metric is more vanity than a real indicator of growth.
When reporting monthly users you should also consider reporting monthly active users (MAUs) rather than just user totals. An active user in either a B2C or B2B SaaS product is usually an indicator of a satisfied user, who will continue to rely on your product for value in the future, revealing a sustainable future revenue stream.
For example, just because you have a Netflix subscription doesn’t mean you’re an active user - you may have just forgotten to unsubscribe. However, it would be reckless to rely on your continued payment to pad business statistics, as you’ll unsubscribe as soon as you remember.
2. Recurring revenue (MRR and ARR)
Recurring revenue is the lifeblood of your SaaS company, hence why you need to be tracking your monthly recurring revenue (MRR) and annual recurring revenue (ARR). This refers to the amount of money that you earn month over month and year over year, respectively.
These two figures alone let you display (albeit crudely) how much money your company is earning, forecast future earnings, show the monthly and yearly growth of your customer base, and demonstrate at a high level the financial health of your company to investors.
In other words, you need to track your MRR and ARR.
That being said, there is a major trap you should be aware of when it comes to your recurring revenue: if the revenue isn’t contracted for the full time period and it isn’t recurring, you can’t count it.
As an example, let’s use Amazon Web Services. If you spin up an EC2 instance and start using it consistently every hour of the day, the cost of that instance to you per month will be the EC2 instance pricing per hour x 24 hours x 30 days. However, AWS cannot reflect that amount as MRR. You haven’t signed a contract that locks you into usage or payment for any time period. If you buy a Reserved Instance for the same EC2 instance for a year, AWS can record the total contract value in their ARR reports.
If a customer hasn’t committed to a recurring contract that covers the entire month or year you’re looking at, it can’t be called recurring revenue.
3. Customer acquisition cost (CAC)
Customer acquisition cost (CAC) is the amount of money it takes to acquire a customer. This includes sales and marketing efforts but not development costs - that is accounted for in other metrics.
Calculating CAC is, thankfully, very simple. All you have to do is take the amount that you spend on sales and marketing in total for the year and divide that by the number of new customers you acquired during that year.
Including all customers in your CAC calculation doesn’t make sense, as there are existing customers who aren’t the target of your marketing and sales efforts. We’ll cover the cost of retaining customers in a different metric (customer retention cost).
Don’t forget! The cost of employees who perform sales and marketing tasks also count toward total sales and marketing spending. Often, human capital is the largest expense at a SaaS company.
4. Average revenue per user (ARPU) or average annual contract value (ACV)
Average revenue per user (ARPU) is the amount of money that you earn per active user per month. ARPU is calculated by taking the total revenue reported for a month and dividing by the monthly active users (MAU) for that same month. Essentially, ARPU tells you the current ongoing value of your current users, and the potential value that an individual new buyer may deliver to your company.
ARPU is only relevant when each user is an individual source of revenue, which means it only applies to B2C SaaS businesses. The equivalent financial metric for B2B SaaS businesses is average Annual Contract Value (ACV).
ACV is typically tracked and recorded for each individual contract (total value of the contract divided by the number of years committed to in the contract), and the average ACV for the company is calculated by adding up all ACVs and dividing by the number of contracts held by the company.
You’ll notice that ARPU is a monthly statistic, while ACV is an annual one. This is because consumers rarely agree to long-term contracts and are far more likely to cancel than businesses are.
Whether you’re a B2B or B2C SaaS company, these two metrics are massively helpful for business planning.
For example, your advertising and marketing strategies should be dependent on ARPU or ACV. A low ARPU or ACV means you shouldn’t be spending much per click on an ad campaign and will need to try to grab the attention of large numbers of people at a time. A high ARPU or ACV gives you a lot more budget to work with, allowing you to pay for specifically targeted messages that can capture the right buyers’ attention.
5. Payback period
Your payback period (or CAC payback period) is the amount of time it takes for you to earn back the cost of acquiring a new customer. This is usually measured in months, and is also known as “Time to Recover CAC” or “Months to Recover CAC”.
Payback period calculations depend on whether your business is a B2C SaaS business or a B2B SaaS business.
For B2C companies, you can calculate your payback period by multiplying your ARPU by your gross margin percentage (more on both of those further down), then dividing your CAC by the result of that.
For B2B companies, you can calculate your payback period by first dividing your ACV by 12 (to transform an annual statistic into a monthly one), then multiplying the result by your gross margin percentage, then dividing your CAC by the result of that.
Payback period is absolutely vital when evaluating the quality of your company’s growth.
Let’s say your revenue is growing through the roof at an 80% year-over-year clip. That’s great, but if it takes you 3 years to pay back the costs of your sales and marketing efforts (your CAC), it doesn’t look so good for you. This means you have no hope of gaining any profit off these customers for those first 3 years, and you’re likely to spend more supporting them. An investor can become concerned that the company cannot grow fast enough for long enough to support the CAC. Plus, if your average customer doesn’t stick with you for 3 years, that means your sales and marketing costs will never get paid back.
On the other hand, a company with a 3-month payback period is going to start generating real profit from customers quickly. That profit can then be invested back into the company to drive the company’s operations without having to take on additional capital. That means a bigger potential return for founders and investors, without the need to dilute (or share the returns) with other investors.
6. Customer lifetime value (LTV)
Customer lifetime value (LTV or CLV) is the average amount of money you’ll earn from a customer over the entire length of time they use your product for. This is usually measured in months, and is another great way to see roughly how much value your customers generate.
You can calculate LTV by dividing your ARPU by your customer churn rate (if you’re B2C) or by dividing your ACV by 12 and then dividing the result by your customer churn rate (if you’re B2B).
SaaS businesses are viewed by investors as excellent investments because, once the CAC is paid back, the majority of revenues can be turned into profit. The greater the revenues, the more valuable the business. Plus, revenues can be enhanced by selling to more customers and by retaining the customers you already have. As a result, a key goal of any SaaS business is to maximize LTV, by growing ARPU/ACV and by reducing churn rate.
7. Churn rate
You cannot run a successful SaaS company (or raise funding) without tracking your churn rate.
“Churn” refers to when a customer drops your service, thus no longer being a customer. Churn rate is thus a measurement of the percentage of customers that have left your product over a set period of time (usually a year or per month).
Churn rate can be reported in one of two ways: net dollar churn and customer churn.
Customer churn rate is calculated by dividing the number of customers you lost during a certain time period by the number of customers you had at the beginning of that period, then multiplying by 100 to get a percentage.
Net dollar churn rate is calculated by first subtracting the total revenue from retained customers (i.e. excluding new sales) in a month from the total revenue from the same group of customers in the previous month. Then you divide the result by the total revenue from the same group of customers in the previous month, subtract that result from 1 and multiply by 100 to get a percentage.
Comparing churn rates can be helpful in predicting your business’ health. If your customer churn rate is greater than your net dollar churn rate, you’re shedding customers that do not drive the same revenue for your business as your retained customers. If your net dollar churn rate is higher than your customer churn rate it’s time to get concerned, as your remaining customers are not driving as much value to you as the customers who have left.
Keep in mind that it’s possible to have a negative net dollar churn rate. If you do, this is a fantastic sign and indicates that the value of your retained customers is growing month over month, due to upselling or contract expansion, and that this growth is stronger than the losses you’re taking due to cancellations.
8. Customer retention cost (CRC)
Customer retention cost (CRC) is how you track the cost of keeping a customer. Calculating this metric is a bit subjective, because some costs influence customer retention and some costs directly affect it. You should consider adding in the following when calculating retention costs:
- Staff costs for customer success, account management, onboarding, training, and implementation teams
- Onboarding and training costs
- Cost of tools and software used by your team (particularly retention software)
- Cost of loyalty programs
- Marketing costs for materials aimed at existing customers
Your CRC can be calculated by summing up the costs to retain all your customers for the year by the total number of customers you currently have at the end of the year.
Once you’ve calculated it, it’s vital to make sure that your CRC doesn’t exceed the value of a customer for the year (either ARPU multiplied by 12 for B2C companies or ACV for B2B companies). If your CRC exceeds ARPU or ACV, you’re losing money just to keep your customers.
In fact, the more your company has grown, the more important it is that your CRC is significantly less than the value of a customer for the year. Expectations change once you leave the start-up phase, and your company’s ability to turn a profit depends on having some revenue left over after paying back your CAC, paying your CRC, and supporting other operational expenses like research and development costs.
9. Burn rate
Burn rate is how much money you’re losing every month, usually referring to “burning” through the money you’ve raised to fund your company until you can turn a profit.
You’ll need to calculate this so that you know how long you have until your cash reserves run out! It can take a few months to raise another round of fundraising, so make sure that your cash on hand is at least three to four times your burn rate when you start pursuing investors.
It’s hard to say what an ideal burn rate is, as investors may be skeptical of both a low and a high burn rate. Low burn rates can indicate a very cautious company, taking fewer risks to potentially gain significant growth. High burn rates can indicate irresponsibility, and a failure to connect investments to actual revenue outcomes.
That being said, the more mature a company is, the lower the burn rate is expected to be, as customer revenues should be on their way to supporting the company’s operations at some point in the future.
Remember, you’re working your way towards being profitable without any outside investment, at which point you won’t have a burn rate at all!
10. Market size (TAM, SAM, and SOM)
By measuring the size of the market you’re in (eg, process management software) you can get a sense of how much room you have to grow.
You should be careful though, as market size alone doesn’t account for how fierce the competition is within that market. Just because the money is being spent on your type of software worldwide doesn’t mean that you’ll automatically earn a significant slice of it.
To more precisely measure your company’s market opportunity, there are standard market size metrics that carry very specific meanings.
Total addressable market (TAM) refers to all the potential customers your company could theoretically sell to, multiplied by the average annual value of a customer to your company (ARPU times 12 or ACV).
TAM is an expansive measure and should include customers that your sales team may not be considering, due to industry or geography, and it should include customers for whom your feature set is not an exact fit. Investors use TAM to understand the absolute upper limit on your company’s annual revenue, if it were to be wildly successful in the future, yet companies pretty much never achieve TAM-sized revenues.
Serviceable addressable market (SAM) refers to all the potential customers your company could actually sell to, multiplied by the average annual value of a customer to your company (ARPU times 12 or ACV).
SAM is also an expansive measure, though less so than TAM. Typically SAM is calculated by filtering out potential customers from the TAM for whom the industry, geography or product feature set will limit your ability to sell to them. Investors use SAM to set a realistic target on the upper limit of your company’s annual revenue. It is quite rare that a company achieves SAM-sized revenues, though less so than TAM.
Serviceable obtainable market (SOM) refers to the potential customers you plan to specifically target within a set timeframe and a specific go-to-market plan, multiplied by the average annual value of a customer to your company (ARPU times 12 or ACV).
Typically, SOM is calculated from the bottom-up, identifying the scope of potential customers your feature set will appeal to using the sales and marketing techniques that you plan to use. Often, but not always, companies will exclude customers currently served by a competitor from their SOM. The most successful companies achieve an annual revenue roughly equal to their stated SOM, then expand their go-to-market focus to address the needs of a broader range of customers.
11. Cost of goods sold (COGS)
We’ve gone into the nitty gritty details of cost of goods sold (COGS) before, but we’ll give a brief summary here.
COGS is a combination of everything you have to spend to provide your services to your customers. This includes things like hosting, but doesn’t include any costs involved in developing the software in the first place.
A high COGS in comparison to your revenue means a lot less money available to spend on growing your business through sales, marketing, or research and development. The lower your COGS in comparison to your revenue, the more excited an investor will be in investing in your business.
12. Gross margin
Your gross margin is the percentage of your profits that are left after your COGS are deducted. In other words, it demonstrates how big of a return on investment your entire company is generating before investing in growth areas such as sales, marketing, or research and development.
You can calculate your gross margin by taking your overall revenue, deducting your COGS, then dividing the resulting number by your overall revenue once more. This will give you your gross margin percentage.
A great benchmark for a SaaS company is an 80% gross margin, though many public tech stocks report gross margins as low as 60%.
13. Revenue growth rate
Finally, revenue growth rate is a key factor for many investors in determining whether to put their money behind you or not.
Revenue growth rate is the month-over-month percentage increase in your revenue, and is thus a great way to show how quickly your company is growing.
To calculate revenue growth rate, take the revenue for one month and subtract the revenue from the previous month (eg, May 2022 revenue - April 2022 revenue). Then divide the result by your previous month’s revenue multiplied by 100 (eg, result / (April 2022 revenue x 100)).
If you’re a very early-stage startup it can be useful to measure your revenue growth rate on a weekly basis instead of monthly, but for most monthly is a good measure.
On a similar note, bear in mind that the larger your business becomes, generally the lower your revenue growth rate will be.
Creating your SaaS financial model
Another key part of SaaS finances is your financial model. This is typically a spreadsheet that shows the current financial health of the company, forecasts its future finances, and demonstrates to investors and stakeholders that you understand how to grow your company at a healthy rate.
To do this, you need to first calculate all of the metrics we covered in the previous section. Then you should decide whether to build your model from scratch or use an existing template (here’s a free template from The SaaS CFO to get you started).
There is no hard-and-fast structure to these financial plans, but it is important to start with real data. In other words, a SaaS financial model should include the past 12 months of actual income statements and a realistic budget for the next 12 months, at least. It can be very helpful to call out the 13 metrics we’ve listed above on a month-by-month basis, using the historical and projected financials to calculate these.
By inserting raw data and calculated key financial metrics, you allow an investor to both compare your company to other potential investments and make it easy for them to derive other metrics that are important to them, such as the percentage of revenue that’s recurring vs. non-recurring, for example.
How to structure your finances for the best possible valuation
Once you have a solid financial model it’s important to ask yourself whether that model is truly investment-worthy. Are there areas that a typical investor may be concerned with?
Areas of concern often fall into one of two categories:
- Revenue growth potential
- Pathway to profitability
A company could show signs of limited revenue growth potential by many different metrics, including not demonstrating a track record for growth, revealing a limited market size, or spending excessive amounts on customer acquisition and retention. An investor would be concerned about injecting more capital into a company that may not grow to a size large enough to bring the return on investment they need to justify the risk.
A company could reveal an uncertain pathway to profitability through high COGS (and therefore low gross margin percentage), a high burn rate, a long payback period, and an overreliance on non-recurring revenue, among many other indicators. While profitability is rarely a short-term goal for an early- or growth-stage SaaS company, an investor looks for a company’s fundamental operational structure to have the capacity to become profitable at some point in the future. At some point, a company must turn a profit.
If you are certain that your company has both revenue growth potential and a pathway to profitability, but some of your financial metrics are a bit out of the ordinary, it might be worth your while to spend some time improving these before going out to raise funds.
Ultimately, any improvements you could make to your metrics boil down to either increasing your earnings or decreasing your costs.
Increasing earnings is an obvious solution on paper - of course you’re trying to do it! You’re probably trying to pull all your tricks out of the bag already.
The reality is, cost savings is the area where you have far more control. For example, if your gross margin percentage is too low, start taking a look at your customer support costs or your cloud hosting spend. Are there ways you could trim the edges without affecting customer satisfaction?
3 techniques to turn around your SaaS finances
As stated above, one of the best ways you can get a more favorable valuation is by lowering your costs. However, instead of just slashing and burning, we recommend these three specific techniques that can affect your metrics strongly without harming your company’s operations or morale.
Hiring controls
The larger your company, the more your human capital builds inertia which can grow in a snowball effect. Because personnel costs are the largest line item for every SaaS company, you can affect the greatest change by using hiring policies.
We’re not talking about layoffs, though a reduction-in-force could become necessary when cost reduction requirements are extreme. Instead, we suggest implementing both a hiring freeze and a backfill evaluation policy.
In a hiring freeze, any unfilled role cannot be filled until the freeze is lifted. This keeps a lid on cost growth, and can result in cost reductions whenever an employee departs the company. Given its temporary nature, a hiring freeze can offer excellent cost savings while revenues grow, resetting the relationship between revenue and expenses.
Most companies have some sort of process for evaluating the need for new roles, but not many have a process for evaluating backfills. A backfill evaluation policy requires that management identify whether a role truly needs to be filled when an employee departs the company.
Perhaps the responsibilities can be shouldered by other employees, or perhaps the employee’s former responsibilities are no longer a priority for the business. Either way, a backfill evaluation policy can create long-term cost control as well as foster higher strategic alignment in the business.
Subscription streamlining
Just as SaaS revenues keep your company generating cash month-over-month even without new customers, the SaaS vendors you buy from are pulling cash month-over-month from your bank account, often without much oversight.
Many companies implement strict purchasing processes that limit subscription purchases as part of their regular operations, but few ever re-evaluate a subscription once the purchase has been made.
Think of all the times you’ve forgotten about your Netflix or Amazon Prime membership whether you use them or not.
Thus, conducting a line-by-line analysis of all subscriptions is likely to uncover a great deal of savings for your company. Just remember that the fine print of your contracts may force you to keep paying until the term runs out.
Hosting optimization
The mantra behind most engineering teams is to build highly reliable, highly available software efficiently. Engineering teams that focus on these principles can drive SaaS companies to incredible success.
At the same time, sometimes future-proofing the company against the potential for downtime or high traffic can result in excess spending on your cloud hosting, storage and computing costs.
At times of cost transformation, it’s important to take a long, hard look at your infrastructure. You need to determine whether it’s properly configured for the near term, and cut out the excess that doesn’t serve your current customer pool.
It can be challenging to decide whether you want to keep your engineers focused on delivering features for your product roadmap or focused on cutting costs, so it’s important to get an understanding of the full scope of potential cloud cost reductions before you divert your precious resources to the effort.
If you’re a customer of Amazon Web Services, Aimably can help you understand your AWS costs and lower your spending where it’s applicable.
Aimably’s AWS Spend Transparency Software provides you with the clarity to see exactly where your money is going for your SaaS hosting, while our AWS Cost Reduction Assessment lets you see a wealth of potential options for saving costs and the impact of those actions. We’ll even show you the risks associated with saving those costs so that you know exactly what you’re doing before you even lift a finger!
Stop losing sleep over your SaaS finances - let Aimably take care of AWS costs so that you can focus on the rest of your company.
