One of the most common terms that I come across at work today is “SaaS”, software-as-a-service. It’s particularly prevalent in webexpenses as we are a “SaaS” business. We all know the impact that cloud technology has had on the business world, our delivery model has been born from this technology and our licensing is based entirely on a subscription basis. The technology and delivery models are not the only profound changes, SaaS metrics are fundamentally impacting the role of the finance team.
To understand the changes let’s first look at the traditional GAAP (Generally Accepted Accounting Principles) model. This primarily relies on the business making the next sale, each month and year the business starts a clean slate, the team looks to build the revenues again from £0. Payments are generally collected at the point of purchase and in terms of financial reporting we look at retrospective revenue for the previous period. After sales support is a cost to the traditional model but a customer is often tied in for extended periods, based on their initial investment they are seeking a longer term return on investment. Forecasting and valuation are both estimated based on previous period performance, the finance function does a lot of looking back.
So how is SaaS different…
The start-up – SaaS start-ups are notoriously difficult. As the business is generating market interest, it will be incurring costs and it must do so before it can start generating sales. The challenge is then managing the “J Curve”. Any sales will be based on a deferred revenue basis so a company will only invoice and recognise on a monthly / quarterly basis. It will take 12 months from the point of delivery, before a company is able to recognise the associated first year revenue. Cash Flow can be a major headache, sources of finance are expensive and can be difficult to obtain.
The journey – In a SaaS business it’s key to acquire new customers, but it is also key to maintain these customers. The foundation of the business is built on monthly recurring revenue “MRR”. If a company can maintain the customer satisfaction and retain their clients they will quickly start to build a predictable revenue stream. The finance team are reporting from the end of the previous period and basing estimates of growth on a solid monthly base. Key to the team’s analysis is the customer lifetime value “LTV”, with high performing firms aiming for more than three times the cost to acquire a customer (CAC), in order to deliver profitability sooner. Minimising churn is key to a company’s success as this will allow accelerated growth, you can start to see a successful SaaS business now ascend the J curve. As cash flow becomes more dependable, good SasS firms will reinvest into future solutions, technologies and aftercare. Customer care is paramount though, the clients are tied into shorter contract and have the freedom to take their revenue stream elsewhere.
Valuations – Successful SaaS businesses are well sought after, investors are keen to buy into a predictable and expanding revenue stream. We have consistently seen acquisitions at over 8 times annual revenue, this far outstrips the traditional acquisition model. We have also seen a major transition from profit being the focus of investors through to revenue. In fact many SaaS businesses carry astronomical valuations but have turned very little profit. Rapidly expanding SaaS businesses generally look to continue the cycle, this means profits are reinvested into the future growth. As more clients come on board, the company should achieve economies of scale and reduce their cost to acquire a customer “CAC”. The aim is the perpetual cycle of bringing in more clients and adding to the an already happy-and-expanding base.
For the finance team it means understanding and managing a new set of metrics. It’s critical that the business has visibility of these but they can fluctuate on a regular basis. By competently managing these metrics it does though enable the finance team to be at the forefront of the strategic and commercial business decisions.
By Bernard Crumlish, Finance manager, webexpenses