Building a SaaS financial model: How to forecast revenue and expenses

Did you know that the global SaaS market is projected to reach a staggering $829.34 billion by 2031? This booming industry is attracting entrepreneurs and investors alike. However, navigating its financial landscape can be tricky.

In this article, we'll guide you through the process of building a SaaS financial model. We’ll equip you with the knowledge and tools to forecast your revenue and expenses accurately.

You'll also learn:

• Key SaaS metrics and their importance in financial modeling.
• Step-by-step instructions for forecasting revenue, including MRR, ARR, churn, and expansion revenue.
• How to project expenses, from COGS to operating costs and personnel expenses.
• Tips for building different scenarios to prepare for various outcomes.

Let’s start by explaining what a SaaS financial model is and why it’s so important.

What's a SaaS financial model?

A SaaS financial model is a tool that forecasts the financial performance of your SaaS business. It’s like a roadmap guiding your company's growth and helping you make smart decisions along the way.

Why is it so important?

A well-built SaaS financial model is crucial for strategic planning. It helps you understand your financial health. It also helps you predict future performance and make informed decisions about pricing and hiring.

How does it support strategic planning?

We’ll go into more detail later down the line, but here’s a quick breakdown:

• Revenue forecasting: Predicting future revenue is essential for any business. A SaaS financial model lets you examine recurring revenue. It also lets you have a closer look at new customer acquisition and churn rates to clearly see your top-line growth.
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• Expense planning: From development costs to marketing, SaaS modeling helps you project expenses. This approach ensures you can allocate resources effectively and stay on top of your spending.
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• Investor confidence: A financial model shows investors you're serious about managing your finances. It builds trust and demonstrates the viability of your business.

What makes SaaS financial models unique?

SaaS businesses often have unique characteristics, like recurring revenue and high customer acquisition costs. SaaS financial metrics like monthly recurring revenue (MRR), customer acquisition cost (CAC), and customer lifetime value (LTV) are key for understanding the health of your business.

Core components of financial forecasting for SaaS companies

Building a robust SaaS financial model requires a deep dive into several core components. Let's explore each one in detail:

Revenue forecasting

Revenue forecasting is the cornerstone of any SaaS financial model. It's how you predict your future income and plan for growth. It's a multifaceted process that goes beyond simply looking at your past sales figures.

To accurately forecast revenue for your SaaS business, you need to understand the nuances of recurring revenue, new customer acquisition, and churn rates.

Two key metrics form the foundation of revenue projection:

• MRR: This metric represents the recurring revenue generated from your subscriptions each month. Think of it as the pulse of your business, giving you a snapshot of your current financial health.
  
  MRR is influenced by various factors. These include new customer acquisition and expansion revenue from upgrades and add-ons. It also factors in contraction or churned revenue from downgrades and cancellations.
• ARR (annual recurring revenue): ARR is the annualized version of MRR. It gives you a broader view of your revenue trajectory over the year. It's a crucial metric for long-term planning and provides a more stable picture of your revenue performance.
  
  To create a complete revenue forecast, you need to go beyond MRR and ARR. You must also consider the different components that contribute to your overall revenue. Let’s take a closer look at what those are:
• New customer acquisition: This component involves estimating the number of new customers you expect to get each month.
  
  This estimation should be based on several of factors. Think marketing spend, the effectiveness of your sales channels, and the overall market demand for your product.
• Expansion revenue: This component comes from customers upgrading their subscriptions or buying add-ons. It's an important source of revenue growth for SaaS businesses. It allows you to increase revenue from your customer base without incurring the costs of acquiring new customers.
  
  Accurately forecasting expansion revenue requires analyzing historical data on upselling and cross-selling. It also means understanding the potential for new product offerings or pricing tiers you might introduce to your offering.
• Contraction revenue: This element reflects downgrades or lost revenue from existing customers. While it's not something you want to see, it's important to factor in contraction revenue to create a realistic forecast.
  
  This process involves analyzing historical data on downgrades. It also involves understanding the factors that might lead customers to reduce their spending.
• Churned revenue: This is the revenue lost due to customers canceling their subscriptions. Churn is an inevitable part of any SaaS business, but it's crucial to keep it under control.
  
  Forecasting churned revenue requires analyzing historical churn rates. Then, it requires identifying trends or patterns that might indicate future churn.

By factoring in these elements, your SaaS financial model can accurately capture the dynamics of your revenue streams. As a result, it can provide a reliable forecast for your future income.

Customer churn and acquisition

Acquiring and retaining customers is the lifeblood of any SaaS business. Your financial model needs to reflect the costs of these activities to accurately portray the financial health of your company.

Estimating customer acquisition

Customer acquisition involves attracting and converting potential customers into paying subscribers. It's a critical process for any SaaS business, and it often requires a substantial investment in marketing and sales efforts.

To estimate customer acquisition in your model, you need to understand your marketing channels. This process involves tracking key metrics such as:

• CAC: The CAC is the average cost of acquiring a new customer. It's calculated by dividing your total sales and marketing expenses by the number of new customers acquired during a period.
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• Marketing spend by channel: Analyze how much you're spending on each marketing channel. Consider paid advertising, content marketing, social media, and email marketing.
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• Conversion rates: Track the conversion rates of each marketing channel. Doing so will help you know which channels are most effective at generating leads and converting them into paying customers.

Churn rate and customer retention

Churn is the unavoidable loss of customers over time. It's a critical metric for SaaS businesses because it directly impacts your recurring revenue. To accurately forecast your revenue, you need to understand your churn rate and its potential impact on your future income.

You should be tracking the following metrics:

• Monthly churn rate: Percentage of customers who cancel subscriptions each month
• Annual churn rate: Percentage of customers who cancel subscriptions each year
• Customer lifetime: Average length of time a customer remains subscribed

By analyzing these metrics, you can spot trends and patterns in customer churn and take steps to improve customer retention. Reducing churn is crucial for SaaS businesses. Why? Because it's often more cost-effective to keep existing customers than to get new ones.

Customer lifetime value (LTV)

LTV is a crucial metric that estimates the revenue you can expect from a single customer during their association with your business. It's a key indicator of your company's long-term profitability. It also helps you make informed decisions about customer acquisition and retention.

LTV takes into account several factors, including:

• Average revenue per user (ARPU): ARPU is the average revenue generated from each customer during a specific period.
• Gross margin: Gross margin is the revenue that remains after deducting the direct costs of providing your service.
• Customer churn rate: The churn rate is the rate of customers who cancel their subscriptions during a specific period.

How to calculate LTV:

LTV = (ARPU * gross margin) / customer churn rate

LTV provides valuable insights into the long-term value of your customers and helps you answer questions such as:

• How much should I spend to acquire a new customer?
• What's the break-even point for my customer acquisition costs?
• How can I improve customer retention to increase LTV?

Customer acquisition cost (CAC)

CAC is the average cost of acquiring a new customer. It's a key metric for understanding the efficiency of your sales and marketing efforts. It's also important to ensure that your customer acquisition costs are sustainable.

CAC is calculated by dividing your total sales and marketing expenses by the number of new customers acquired during a period. The formula looks like this:

CAC = Total Sales and Marketing Expenses / Number of New Customers Acquired

This metric helps you answer questions such as:

• Are my marketing campaigns cost-effective?
• Which channels are most efficient at acquiring new customers?
• How can I reduce my CAC without sacrificing growth?

CAC payback period

The CAC payback period is the time it takes to recoup your CAC from a user's revenue. It's an important metric for understanding your cash flow and profitability.

A shorter payback period means you're recovering your investment faster. A quicker return on investment allows you to reinvest in growth and achieve profitability sooner.

The CAC payback period is influenced by several factors, including your ARPU, gross margin, and churn rate. By optimizing these factors, you can shorten your payback period.

Operating expenses and overhead

Operating expenses are the costs of running your SaaS business, excluding the direct costs of providing your service (COGS). These expenses can be categorized into:

• Research and development (R&D): These are costs associated with developing and improving your product. Think salaries for engineers and designers, software licenses, and testing tools.
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• Sales and marketing: These are expenses related to acquiring new customers and promoting your product. They include salaries for sales reps and marketing staff, ads costs, and public relations expenses.
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• General and administrative: These are the costs of running the business. They include salaries for administrative staff, rent, utilities, and office supplies. Professional services like legal and accounting also fall under this category.

Tips for forecasting expenses:

• Understand fixed vs. variable costs: Fixed costs remain constant regardless of your revenue, such as rent and salaries. Variable costs fluctuate with your sales, such as customer support costs and sales commissions.
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• Use historical data and industry benchmarks: Analyze your past expenses to spot trends and patterns. Compare your expenses to industry benchmarks to see how you stack up against your competitors.
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• Consider the impact of growth: As your business grows, your expenses will likely increase. Factor in the costs of hiring new employees, expanding your office space, and investing in new infrastructure.

Five steps to building a revenue forecast

Forecasting revenue accurately is essential for any SaaS business. It's the foundation of your SaaS financial model and guides your strategic planning. Instead of using a SaaS financial model template, we’ll help you build your own.

Here's a step-by-step guide to help you build a reliable revenue forecast:

Step 1: Set up your baseline MRR and growth projections

Start by establishing your baseline monthly recurring revenue. This is the bedrock of your revenue forecast in your SaaS financial model.

If you have historical data, use your most recent MRR as your starting point. For businesses without a historical MRR, set an initial target based on your pricing plans. Remember to also include your anticipated level of customer acquisition.

Next, define realistic monthly growth rates. Base your projections on an analysis of the market, your company's performance, and your planned sales strategies.

Consider factors like the competitive landscape, seasonality, and overall economic trends. These elements can greatly impact your growth trajectory.

Step 2: Project new MRR and expansion revenue

Now, it's time to project new MRR. This process involves estimating the MRR generated from new customer acquisitions. Factor in your projected customer acquisition rate and the average deal size you expect to close. Also, include the different pricing plans you offer.

Don't forget about expansion MRR. This metric is the revenue generated from your existing customer base.

Project how much MRR you expect to gain from upsells, cross-sells, or plan upgrades. Analyze historical data on expansion revenue to understand past trends. You should also consider your product roadmap and pricing strategies for the future.

Step 3: Account for churn and contraction

As you know, churn is the loss of customers who cancel their subscriptions. Contraction refers to the loss of MRR due to customers downgrading their plans.

To accurately estimate churn, analyze your historical churn rates and identify any trends or patterns. Consider factors that influence future churn. Think customer satisfaction, competition, and pricing changes.

Similarly, analyze historical data on downgrades to estimate contraction MRR. Consider factors like changes in customer needs or pricing adjustments. These factors might lead to future contraction.

Step 4: Incorporate pricing changes and seasonal trends

Your SaaS financial model should be dynamic and reflect any planned changes in your business strategy. If you anticipate changing your pricing, adjust your revenue projections accordingly.

Consider the impact of price increases or decreases on your customer base and overall revenue. Will a price increase lead to higher churn? Will a price decrease attract more customers?

Also, account for any seasonality your business might experience. If your SaaS product has peak and off-peak seasons, analyze historical data. Doing so will help you spot patterns and adjust your revenue projections accordingly.

Step 5: Build a conservative, base, and optimistic forecast

In SaaS modeling, it's key to prepare for diverse outcomes by building many scenarios. Create a conservative forecast that assumes lower growth rates and higher churn. Doing so will help you to always be ready and ensure you have a buffer in case things don't go as planned.

Then, create a base forecast that represents your most likely scenario. This forecast should be based on your realistic assessment of the market and your company's capabilities.

Finally, build an optimistic forecast that assumes higher growth rates and lower churn. This best-case-scenario forecast will help you understand your upside potential. It’ll also help you set more ambitious goals.

How to forecast expenses in your SaaS financial model

Forecasting expenses is just as important as forecasting revenue in your SaaS financial model. It helps you understand your cost structure, manage your cash flow, and achieve profitability. Here's a breakdown of how to forecast expenses effectively:

Calculate direct costs and gross margin

Direct costs are the expenses directly related to providing your SaaS product. They are also known as the Cost of Goods Sold (COGS). These costs include things like server costs, hosting fees, and customer support expenses. They also include any direct labor costs associated with delivering your service.

To project your gross margin, subtract your direct costs from your revenue. Gross margin is a key indicator of your profitability. It shows how much revenue is left after covering the direct costs of providing your service.

Estimate operating expenses by category

Operating expenses are the costs of running your business, excluding COGS. These expenses (some of which we’ve explained) can be categorized into:

• R&D: As stated before, these are costs associated with developing your product. This category includes salaries for engineers and designers, software licenses, and testing tools.
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• Sales and marketing: As we said before, these are expenses related to acquiring new customers and promoting your product. They include salaries for sales reps and marketing staff and public relations expenses.
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• General and administrative (G&A): These include the cost of salaries for admin staff, rent, utilities, supplies, and legal and accounting services.

When forecasting operating expenses, consider how these costs change as your business scales. Will you need to hire more sales and marketing staff as you acquire more customers? Will your R&D expenses increase as you develop new features?

Project future hiring needs and payroll expenses

Personnel costs are often a significant portion of SaaS companies' operating expenses. To forecast your expenses, you need to project your future hiring needs and the associated payroll expenses.

Consider your growth stage and team expansion plans. Will you need to hire more engineers, customer support representatives, or sales professionals? Factor in salaries, benefits, payroll taxes, and other related expenses.

Account for software, tools, and overhead

Don't forget about the costs of the software and tools you use to run your business. These costs include your SaaS subscriptions for CRM, marketing automation, and customer support.

Also, factor in your overhead costs, such as office rent, utilities, and equipment expenses. These costs can add up, so it's important to include them in your SaaS financial model.

By forecasting your expenses, you can gain a clear understanding of your cost structure. As a result, you can make better decisions about pricing, hiring, and resource allocation. Remember to regularly review and update your SaaS financial model as your business scales.

How Orb can help you manage your SaaS financial forecasting

We've explained how to build a SaaS financial model, a powerful tool for projecting your company's financial future. However, managing the intricacies of SaaS financials can be complex and time-consuming.

That's where Orb comes in.

Orb is a done-for-you billing platform. It simplifies your billing operations and empowers you to make better decisions about your SaaS financials. Orb provides you with the insights and tools you need to navigate your company's growth trajectory.

Orb simplifies your billing and financial management. The result? It frees you to focus on building on your core product competencies and delighting your customers.

Here's how Orb can elevate your SaaS financial forecasting:

• Get a clearer picture of your revenue: Orb provides detailed usage tracking and billing data. We give you a granular view of your revenue streams and product usage. This feature helps you understand where your revenue is coming from and find growth opportunities.
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• Use complex pricing models: Orb makes it easy to implement and manage various pricing models, no matter the granularity. Think usage-based pricing, tiered subscriptions, and prepaid credits. Orb lets you experiment with pricing strategies and optimize your revenue generation.
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• Automate your billing workflow: Orb automates your invoicing process, minimizing errors. Orb helps ensure accurate and timely billing, keeping users happy and reducing revenue leakage.
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• Integrate with your financial stack: Orb integrates with data warehouses and accounting software. We help with data consistency across your financial systems. Orb simplifies your financial operations and reduces the risk of errors.
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• Gain control over your financial data: Orb provides access to your billing and usage data through an interface and a custom SQL editor. We give you the flexibility to analyze your data and gain insights into your financial performance.

Ready to unlock the full potential of your SaaS business? Take Orb for a spin with our 30-day free trial and discover how it can simplify your billing and financial management. Check out our pricing options to find a plan that fits your needs and budget.