Getting to cash flow positive
Software-as-a-service (SaaS) companies that offer up services on a subscription-based platform face unique cash-flow challenges as a result of their business model. Because revenues are generated consistently over time through subscriptions, their path to profitability is sometimes slow. While the SaaS business model offers long-term revenue benefits to those who are resilient and persistent, companies must learn to navigate the challenges that come with balancing choppy cash flow in order to get to cash flow positive.
Cash flow gaps plague both early-stage and established SaaS companies. Because subscription revenue flows in steadily over extended periods, there is often high upfront cash outlay with minimal cash inflow in the first year (or two, or three). In the early stages, SaaS companies need to work toward becoming cash flow positive while remaining committed to providing a quality product for their customers. Here are five finance tips for SaaS companies to help them achieve a cash flow positive status sooner rather than later.
1. Know your CAC
One of the most important metrics for SaaS companies is the customer acquisition cost (CAC). Under traditional business models, customer acquisition costs are recouped rather quickly with one-time purchases. The downfall? No recurring revenue is built into cash-flow projections for the foreseeable future.
Under the SaaS model, subscriptions provide the recurring cash inflow that makes the business structure—and potential profits—so appealing. However, customer acquisition costs are not immediately covered in SaaS companies as they are with traditional businesses.
To reach cash-flow equilibrium, it is necessary to understand the total costs paid for acquiring a single customer subscription and work toward strategically reducing that expense. For most SaaS companies, CAC encompasses a number of factors, including:
• Marketing and advertising spend
• Sales personnel salaries/commissions
• Customer support and retention
• On-boarding costs
Each of these CAC components add up quickly, and without having an understanding of total outlay for acquiring a customer, SaaS businesses tend to stay cash-flow negative indefinitely.
So how do we lessen the blow of CAC? Start with improving the effectiveness of your company’s current sales and marketing efforts. This could mean evaluating total marketing spend in relation to return on investment or developing more captivating brand messaging to engage more prospects. SaaS companies can also work toward reducing CAC by moving more customers from free services to paid subscriptions (think “freemium” and upgrades), in a shorter amount of time. Decreasing the average time necessary to onboard a new customer, improving customer service for new and existing customers, and speeding up your conversion timeframe also help in reducing overall CAC.
2. Understand your LTV
The second most important metric for SaaS companies to understand and track is the lifetime value (LTV) of your customers. Examining your LTV will help you understand how and when you can get to cash flow positive as it allows for accurate modeling and comparison to CAC. LTV is simply the total amount of revenue a single customer generates over the lifetime of their account. Calculating LTV may seem a bit ominous, but let’s look at a simple example:
Your software service costs $150 per month for Customer A, and that customer plans to stay with you for 12 months, minimum. The LTV of Customer A is $150 x 12, or $1800.
But what exactly are you supposed to do with the LTV, aside from stare at it longingly while you worry over your current cash-flow position? Compare it to your CAC. The general rule of thumb for SaaS companies is that your LTV should be three times higher than your CAC to achieve cash flow positive and ongoing profitability. LTV is “easily” increased by raising prices on monthly subscriptions or offering add-ons, and your CAC can be reduced by focusing on the items listed above. The combination of ramping up LTV and lowering CAC as your SaaS company grows equates to profitability. Cha-ching!
3. Segment your customers
In addition to focusing on CAC and LTV, SaaS companies need to dive deeper and gain specific insight into their customer segments. Your SaaS business may offer different products in different markets, based on industry or size (for B2B companies) or geographic region or household demographics (for B2C companies). Whether you are serving the business market or the consumer market, you need to understand the CAC and the LTV for each of your customer segments.
Customer A mentioned above may be part of a small subset of your paying customers, while Customer B, who pays $50 per month for her subscription, represents a larger portion of your customer base or target market. To allow CAC and LTV to work for your business instead of against it, take the time to segment your customers based on their needs and their ability or willingness to pay each month. Then, focus your marketing and support efforts on the customer segments that provide the most bang for your buck.
4. Forecast cash flow accurately
Nearly all SaaS companies are cash-flow negative in the beginning when CAC is relatively high and subscription revenues are slowly trickling in. During these early stages, it is inevitable that SaaS businesses will experience a cash-flow trough. This makes it difficult to keep your eye on the long-term prize of steady monthly recurring revenues in the future. Worry not: a solution comes in the form of forecasting.
Knowing how long your SaaS business will be in a cash-flow trough may be uncomfortable, but it is necessary to your success. Forecasting based on initial CAC and average LTV for each of your customer segments provides a clear picture of how sustainable your business will be in the long term.
If the amount of capital on hand is not enough to cover the period of time your business sits in the red, you may face financial challenges that render your business incapable of continuing operations. However, you can often see the light at the end of the cash-flow tunnel based on accurate projections for sales and subsequent revenues, working capital to cover immediate cash-flow needs, and a strategic trajectory for growth. Armed with a precise forecast and a hefty dose of patience, any SaaS company can get through the valley that is a cash-flow trough. If you need help, check out our webinar on building a cash-flow forecast and download our template.
5. Perfect your sales process
Finally, it is essential to spend some time evaluating your sales process to ensure you have a profitable model. It should be no surprise that the ability to convert prospects to paid subscribers is the key to the success of your SaaS business. Without paying customers, you have no viable business!
If you are in the early stages of your company, you may want to test out different sales models and prospect funnels to determine the best fit for your target market and platform. Tweak the call to action on your landing page, promote your content through different distribution channels, or refresh your branding message to see what works and what falls short. Once you’ve determined what works best in terms of prospect to customer conversion, make sure your team is prepared to serve each client and upsell when appropriate. Having a durable sales process and efficient follow through help create and sustain a loyal customer base that improves your cash flow position over time.
Whether you business is just getting off the ground or has firmly planted roots, these five finance tips for SaaS companies should help your business establish and maintain a cash flow positive position. We’d love to hear more about strategies your company has implemented to overcome cash flow challenges. Leave us a comment in the box below.