Much has been written about the key metrics that cloud companies should track, and most SaaS entrepreneurs are well-schooled in calculating CAC (customer acquisition costs), MRR (monthly recurring revenue), and CLV (customer lifetime value). It is surprising, however, how few SaaS companies now present a traditional P&L (profit & loss statement) with basic financial data. At Emergence Capital, we have noted this trend, and we thought it might be helpful to point out a few of the key financial metrics that can help investors really understand the cash inflows and outflows.
Bookings
For most young SaaS companies, bookings are the most important financial metric to track. Bookings represent the dollar value of the contracts signed within a time period. We look at the absolute numbers as well as the growth rates to determine the health and prospects for a company. We have found, however, that there are a few critical nuances to consider when tracking bookings, and it is important to understand the following distinctions:
- ACV Bookings vs TCV Bookings: ACV (Annual Contract Value) counts the expected revenue within the first year, even though some contracts may be multi-year. In order to account for those multi-year contracts we have the TCV (Total Contract Value) metric. We look at both, but care primarily about ACV Bookings.
- Recurring Bookings vs Non-Recurring Bookings: Not all bookings are equal. In SaaS businesses, recurring revenue is the gold-standard. However, many companies charge small (and sometimes not that small) implementation, training and other professional services fees. SaaS-savvy investors typically focus on the recurring bookings, and they may discount the non-recurring component of bookings.
- New Bookings vs Renewal Bookings: When companies are just starting to sign contracts, this distinction is useless, but it is great to have the framework to account for both new and renewal bookings as renewals start to kick in. Given that churn for SaaS businesses is critical, understanding the renewal layer as a separate bucket is extremely helpful to assess the value customers are getting from your solution.
- Upsells: We like to see negative dollar churn in every cohort. What does that mean? Of course you might lose some customers along the way, but the best SaaS businesses deliver so much value to those customers that stick, that the ACVs increase over time and these upsells more than compensate for those customers that churn out. We are ok with companies that have some customer churn, but we are more excited with those that have negative dollar churn (see charts below). For example, we can tell something happened with Cohort A, as the company lost a bunch of those users the month after they signed up (wrong targeting?). We can also tell that cohort B was not a good one, as MRR declined over time, however, cohort C was a great one as upsells were off the charts. Spending time trying to understand the underlying drivers for these behaviors is critical.
Gross Margins
Most people think gross margins are pretty straight forward. Start with revenues, then deduct the costs of goods sold (COGS), and you get the gross margin. Sounds simple, right? You would be surprised to see how companies take radically different approaches to calculating what should be included in COGS. For example, in a freemium business, we believe the costs of supporting free users should be included in COGS, thus lowering gross margins. We like to see fully loaded COGS to reveal the real Gross Margins of a company.
Operating Expenses & Operating Income
The easiest way for us to rapidly calculate ratios and compare those ratios with our own indexes (ratios for companies that are doing great and ratios for those that are not doing great) is to bucket operating expense (OPEX) in 3 categories:
- Sales and Marketing
- Research and Development
- General and Administrative
After deducting these expenses from the gross margin, you will arrive at an Operating Income (Loss). This number will help investors figure out how much money you are projecting the company will need over the next year or so.
This is a sample financial summary that we would love to see in every pitch deck:
Putting together something like this is not only necessary for raising money, but it is also extremely helpful to track the key drivers and ratios as you grow your business. For example, in the table I shared, you can tell the company was efficient early on (spent $5.5M in S&M to get $6.4M in new ACV recurring bookings ⇒ $0.86 for every dollar of new ACV recurring bookings), then became a little bit less efficient as it scaled (spent $12.7M in S&M to get $11.5 in new ACV recurring bookings ⇒ $1.10 for every dollar of new ACV recurring bookings), and ultimately controlled the S&M efficiency (spent $16.6M in S&M to get $20.7M in new ACV recurring bookings ⇒ $0.80 for every dollar of new ACV recurring bookings). As you can see, with this data you can not only benchmark your business against other companies, but you can also track performance improvements over time.
While tracking these metrics is just one piece of the puzzle, we hope this analysis and template can help shortcut the process and save you some iterations at the time of raising capital.
