As we alluded to in our first blog post, SaaS Finance is hard. Unfortunately, things don’t get a whole lot easier when you try and build a forward-looking financial model. Thankfully, we are here to brighten up your day with a series of posts on EXACTLY that topic. We will hopefully be able to help you avoid working through your “spreadsheet from hell” or “google sheet also from hell” all together.
In this post, we will outline a few things to focus on before you get started. One of the biggest issues we see time and time again is around why models are being created and how they are being used. Let’s discuss further below.
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Defining scope is critical if a financial model is going to have purpose. Are you building this model to raise funding or are you building it simply to help you forecast the health and growth of your business? Is it a combination of both?
Based on what your motivations are, this could change the direction and impact we expect this financial model to have within the business. The model you use to run your business may be completely different from the more optimistic (aka likely more unrealistic) version that you may show to investors. If you can’t be true to yourself on a model that helps you manage your own business, it will be hard to do the same for investors. As a result, make sure you define who is going to be using this model and why they will be using it to ensure you avoid this kind of conundrum.
The second question I ask our prospective clients is fairly simple: what stage is your business at? The answer to this simple question will likely identify what type of financial model you need and how to build it. We’ve outlined this below (consider these buckets as general guidelines):
With little financial footprint and minimal (or non-existent) historical financials, the goal here is to paint a rosy, yet DEFENSIBLE picture for potential investors (don’t you dare build that never-ending “j-curve”/”up-and-to-the-right” without proper justification). For starters, a pricing model, a simple P&L model (with a simple cash flow mechanism to address cash flow concerns) and a broad overview of headcount (current and future) will likely get the job done.
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You have traction! You also have some semblance of financial statements! We can work with that! Historical data is incredibly helpful for the financial modeling process, as it helps us identify baselines, particularly on the expense side. At this stage, it is critical to show investors and other stakeholders in the business who are privy to these kinds of materials that the team can execute and expand scalably. In addition to the materials laid out in the Pre-Seed bucket, we recommend layering in a full three-statement model (e.g. add in a full balance sheet and cash flow statement), a full revenue build (yes, that scary revenue waterfall thingy, which we will cover later in the series) and a more enhanced view on headcount growth assumptions. You should also be able to coherently break-down when funding is needed and where it will be used across the business, particularly in regards to sales and marketing costs.
For later stage businesses, you should have a well-oiled machine of a financial model. In addition to a full three statement model, you should have a robust revenue build by product and revenue type, a very detailed headcount build and an effective forecast model that you can easily update/modify. Additionally, we recommend incorporating a full sales model (there are 2 basic approaches - a top-down: total new bookings goal -> deals per rep or bottoms-up: rep-by-rep view with rep attrition) and a CPM/lead model. Any business at this stage should have a standardized process around budgeting (e.g. annually) and forecasting/re-forecasting (quarterly, bi-annually [6+6 forecast’s]) to properly measure their business performance and create a good backdrop for additional FP&A reporting.
In our next installment, we’ll cover the elements and components we typically build into our client’s financial models, including many of the features we mentioned above.
If you are currently struggling with building a financial model of your own and are desperately looking for the help button, you’ve come to the right place. Feel free to drop us a line below to learn more about how we can help, including a free evaluation!