We created a template that covers everything discussed in our how-to post. Filled with sample data for an imaginary startup so you can take the time to understand how cash flows through the business and eventually translates into progress towards milestones.
This template is an over-simplification designed to drive home the point that cash is the lifeblood of your startup. Fill it with your own information and add what you need so you can get a clear picture of what’s driving your business.
As early-stage investors, we have seen plenty of financial models, balance sheets, budgets, & forecasts. Surprisingly, considering the importance of cash for any company, it doesn’t seem like there is a consistent “best practice” for financial modeling at the early stages of building a company.
This post is for entrepreneurs who are just getting started. Maybe you have an idea, an MVP, or even one or two customers. If you already have significant revenue then the finance function of your business will look very different than what we present here, as it should. So with what appears to be an endless amount of advice for budding entrepreneurs, we wanted to create something that would help you cut through the noise and focus on the one thing that truly matters: cash.
We have seen pre-seed startups doing everything from 5-year models, discounted cash flow valuations, and complex scenario analysis. But for a business with little to no revenue, and maybe an MVP, do you really know what your finances will look like in 5 years? How confident are you in that model?
As investors, the most important things we look for in pre-seed financials are 1) where the cash is coming from, 2) where it’s going, and 3) how that translates into progress towards meaningful milestones. We believe that as an entrepreneur, those three things should resonate with you as well.
Where is the cash coming from?
The title tells you everything you need to know. The first section of your model should be all about what cash is coming into the business and where it’s coming from.
Cash sources could be revenue, investment, grants, loans, or any other substantial funding. Breaking out the sources of all your cash line by line helps provide a clear picture of what is really keeping the business alive. Is revenue your main source of cash? Investor capital? non-dilutive funding or grants?
A common pitfall we have seen is the desire to lump everything into “revenue”. From the accounting perspective, this may be correct in some cases. But it doesn’t provide the insights you need to properly manage your cash.
For example, a business with $500,000 in revenue being sourced by selling products to customers is much more sustainable than a business with $500,000 in “revenue”, with no customers.
Where is the cash going?
It’s important to get a grasp of where your spending is coming from. Creating a balance sheet and listing all your major expenses line by line can help give you the visibility that you need.
It’s important to use “fully loaded” costs here. For example, with employees, you must also pay the employer portion of CPP, EI, vacation pay, benefits, etc. What this means is that the software developer you hired with a monthly salary of $7,500 can end up costing more, depending on your local labor laws.
When it comes to expenses, don’t feel obligated to list every expense item. Some things like software subscriptions you can lump together to make it easier to read. Especially if the amounts are small. Once certain expenses get over a certain monthly threshold perhaps revisit breaking them out (i.e. paying $2,500 a month for HubSpot).
Understanding the end result: Your cash balance
On a monthly basis, you want to understand how much cash you are forecasting to have at the end of the month, as well as how much runway you have remaining. The math is simple: (cash in – cash out) + previous month’s balance. If you’re not yet profitable, you will notice your cash balance continues to decrease. For profitable businesses, this number will increase.
As the months go by, filling in the “actual” numbers for your cash-in and cash-out items on your balance sheet gives you a glimpse of how your cash balance will change in the future. For example:
Slow revenue growth may mean that cash-out is closer than anticipated. Perhaps you hold off on hiring that SDR and customer success rep to help extend runway.
In a tight labor market, the cost of great talent may have been higher than you planned. Again, this will reduce the time you have until cash-out.
A favorable scenario – perhaps revenue growth exceeded expectations and you want to know if you can hire the customer success rep 3 months sooner. How will this impact your cash?
Milestone Progress
Milestones are what define the progress your business is making. Proper milestone identification is a topic on its own. At a high level, it’s important to lay out your roadmap alongside your financial model.
Being able to see your milestones on the same page your budget allows you to ask some key questions:
Am I spending money on the right things, at the right time?
Will I run out of money before achieving all my milestones?
Do I have extra time to achieve milestones if things take longer than expected?
This also helps both you & investors understand how spending ties back to milestone attainment.
Best Practices
As your business grows, revenue tends to become more predictable. When that time comes, you can start to plan on longer time horizons, which increases the complexity of your modeling. Picture driving a bus, when going slow you don’t need to see too far ahead of you. But once you are traveling at 100km/h you need to see pretty far ahead. The same can be said with financial planning.
For a pre-seed company with little to no revenue, it’s almost impossible to predict where you will be in the next 24 months. Sure, it will look nice in the spreadsheet and give you some confidence, but will you be right? Unlikely. Will you need to make significant changes? Almost certainly.
Planning for the next 12-18 months is what most early-stage investors are looking for. Answer the question, “what gets us to a seed/series A round?” and then show that from a numbers perspective.
You don’t need multiple tabs, with tons of variables and complex calculations, and you certainly don’t need a discounted cash flow valuation.
In addition, you don’t need to plan 3-5 years out, not yet.
At the early stages of your business, all you need is a bulletproof understanding of where the cash is coming from, where it’s going, and how that translates into progress.
You have built your product, found some customers, and now it’s time to make a sale. Product pricing is often something overlooked in SaaS, but pricing can have the biggest impact on your overall business.
The state of SaaS pricing – Some Quick Facts
Before we dive in, lets take a quick look at the state of SaaS pricing in general:
39% of SaaS companies spend 10 hours or less on their pricing strategy per year.
80% of companies change their pricing at least once a year, with most changing it multiple times.
98% of Saas companies earned positive results from making core changes to their pricing strategy.
Let the first and last point really sink in – almost 100% of SaaS companies do better by making core changes to their pricing – but less than 39% spend more than 10 hours per year on their pricing strategy!
If you want to get the most out of your pricing strategy, it’s important to a) spend more time on it, and b) review it frequently. Reviewing your pricing strategy at least twice a year is a good start. It’s important to ensure you are optimizing your pricing, but also not annoying customers with constant changes.
Different Types of pricing models
There are 5 different pricing models common among Saas startups: Flat rate, Usage based, Prepaid, Hybrid and Event-based. Let’s take a look at each one:
Flat Rate Pricing
The Flat Rate model is the most common. It’s easy to set up, since you only need to define the recurring price and billing frequency.
Usage Based Pricing
Usage-based pricing aligns monetization with how customers actually consume your products and services. You’re probably familiar with how cloud service providers charge, or even how your monthly utility providers bill you – all based on how much of the service you consume.
Nearly 39% of SaaS startups bill based on usage – and that number is growing.
The Prepaid Model
The Prepaid pricing model gives the you revenue upfront, whether the customer uses the service or not. This provides more security for the merchant, since the consumer has already paid for the service, and it’s easier to use.
The prepaid model allows you to have a predictable revenue stream going forward and is about the closest thing you will get to billing customers for exactly what they use.
The Hybrid Pricing Model
The Hybrid model combines multiple billing models to create hybrid pricing to maximize revenue growth. For example, you can have a base rate plus a per transaction fee.
We are all farimlar with the 2.9% + $0.30 that payment providers charge us – this is a perfect example of two-part tariff pricing hybrid pricing.
Events-Based Billing
Last but not least, event-based billing is thought to be the next generation of billing for SaaS companies; and is all about linking value to price. In this model, a company only charges customers for specific actions taken, for example the number of videos watched, miles driven, messages sent, etc. This requires more work on the seller’s side, including advanced metered usage and billing.
Building blocks for your pricing model
There are several different building blocks that will determine which pricing model works best for your business. For example:
Business model
Your value proposition
The total cost of your product
Revenue optimization
The competitive landscape
SaaS companies can have different business models; some are more low-touch (self-service purchases, and a low learning curve), while others are more high-touch (direct sales approach, usually B2B SaaS. These different models will affect your pricing model. Low-touch businesses usually offer a free trial and a lower price point, while high-touch businesses can start at a higher price point.
Customers care more about the value they receive as opposed to the price they pay, so your overall value proposition is central to how you determine the actual product price.
Another building block for your pricing model is the total cost of your product. This includes any fixed costs, variable costs and your profit margin.
You can use optimization to seek your ultimate revenue and profit goals for different pricing segments and distributed levels of granularity. The goal is to have certain revenue and margin targets, which will influence your pricing strategy.
When deciding on a pricing model, it’s important to keep an eye on your competition. That doesn’t mean you should use competition-based pricing, which can be dangerous in the long run. Instead, differentiate yourself with value-based pricing.
Executing your pricing strategy through your billing ecosystem
It’s important to understand the difference between pricing and billing, and how the two can work together. Pricing is the monetization of your products, the market and customers’ perception for value. Billing is how you’re going to collect revenue. The engine of barter from your customers to your product.
Once you’ve decided on your preferred pricing strategy it’s time to find a billing ecosystem that lets you execute it. Make sure the billing system to choose has all capabilities that you might need for your pricing system, for example freemiums and trials, ease of setup and maintenance, billing frequencies, targeted promotions, integrations and efficient invoices.
Your billing suite should act as your Revenue Operations Generator
Your billing ecosystem should guide you and your customers through the funnel from beginning to end, starting at Customer Sign up and Consumption of product catalog, to Billing Dates, Line items generated, Invoice generated, Payments, and Dunning. All of these functions should support your ideal pricing strategy.
Summary
Don’t be like the 60% of SaaS companies that leave money on the table; take a value-based approach to your pricing strategy. Making your pricing and billing customer-centric will provide you a competitive edge in the bloated SaaS market. Fine tuning your pricing model and implementing a strong billing ecosystem is key to hyper-growth SaaS companies.
Remember to start with your pricing model – which makes the most sense for your business? And more importantly, which pricing model makes the most sense for your customers?
Thinking about the building blocks for your pricing strategy ensures that you don’t lose sight of the bigger picture.
The tools that make up your billing ecosystem are critical to successfully monetizing your product. Make sure your tools are aligned with 1) Your pricing strategy, and 2) Your overall goals for monetization.
Watch the full webinar presented by Chargify below for more details and Q&A
