While many of these mistakes or potential issue items are likely to be more prevalent in a business with a lean (or essentially non-existent) finance team, we’ve seen large businesses deal with many of these same challenges.
Here are the top 8 mistakes I see most frequently (along with some potential fixes if you are dealing with any of these issues within your own business!)
1. NOT UTILIZING A FUNCTIONAL P&L
If you are asking “what is a functional P&L?”, you likely do not have one (or one that likely has some vulnerabilities). A Functional P&L is simply a P&L where expenses are properly broken up by different business units.
Here’s a super basic overview of the key P&L areas we typically use:
- Cost of Goods Sold (COGS)
- Sales & Marketing Expenses (S&M)
- Research & Development Expenses (R&D)
- General & Administrative Expenses (G&A)
This INCLUDES headcount-related expenses. If you are utilizing Gusto or a similar payroll tool, your headcount expenses are likely coming into your P&L as one (or maybe two) line item(s). This may not seem like a major issue, but if you are calculating sales efficiency metrics like CAC, Months to Recover CAC, Magic Number, etc., these figures are going to be WRONG because you haven’t properly accounted for your headcount costs in Sales & Marketing.
2. NOT UTILIZING A PROPER SAAS CHART OF ACCOUNTS
This goes hand-in-hand with having a functional P&L. Quickbooks (and most bookkeeping tools) are not built for SaaS companies out of the box. You will need to modify their standard chart of accounts by adding various cost components like hosting costs, customer success costs, etc. Additionally, one of the biggest mistakes we see companies make is not carrying hosting costs within COGS. If you are looking for more actionable feedback on this topic, check out, “How to Setup Quickbooks’ Chart of Accounts so it Works for SaaS”
3. STAYING ON CASH-BASIS ACCOUNTING
Not familiar with cash-basis vs. accrual-basis accounting? Here’s a super quick summary on the difference between the two:
“The difference between cash and accrual accounting lies in the timing of when sales and purchases are recorded in your accounts. Cash accounting recognizes revenue and expenses only when money changes hands, but accrual accounting recognizes revenue when it’s earned, and expenses when they’re billed (but not paid).” (Read more on the difference between accounting methodologies from Bench’s great write-up)
So to summarize, if you are recognizing revenue on a cash-basis, you realize revenue when cash comes in the door.
In the very early days of starting your SaaS business, you can get away with cash-basis accounting. However, once you hit critical mass (a number we peg around $200k+ of ARR), we highly recommend using at least a modified accrual basis to recognize revenue on your books. Cash-basis accounting poses a lot of issues as your business scales, particularly around monitoring recurring revenue trends amongst your customer base and tracking revenue-driven metrics.
Secondly, you will really struggle to measure proper gross margins with the significant variance that cash-basis accounting brings to the table. Finally, if you are profitable, you may ultimately overstate revenue and overpay taxes (we’ve seen this happen way too many times!)
4. NOT UTILIZING A FINANCIAL MODEL TO MONITOR BUSINESS PERFORMANCE
Many companies view the concept of a financial model to simply be a “check-the-box” item to share with investors so they will give you more money. While that may be conceptually true, any company with an efficient finance function will be utilizing a financial model (in some way, shape or form) to monitor historical financial performance and project future financial performance.
The businesses that don’t undertake this exercise are typically leaving themselves exposed when it comes to building realistic sales projections, monitoring cash flow or properly planning for future hires.
5. CLASSIFYING ONE-TIME REVENUE AS RECURRING/SUBSCRIPTION REVENUE
This is a big no-no in any SaaS business. One-time revenue that gets marked as recurring revenue may increase your “aggregate” recurring revenue, but when that client doesn’t renew or the revenue trend is volatile month-to-month, you will only be hurting your net revenue retention profile and likely losing the trust of your investors or board members. Having different types of revenue broken out clearly and accurately is an absolute necessity at any stage.
6. BILLING CUSTOMERS MONTH-TO-MONTH ONLY
This one is a bit more situation-specific and may or may not apply to your business. If you have the ability to move your customers from monthly to quarterly, semi-annual or annual billing, this can be a total game-changer for your business.
The benefits are massive: improved net revenue retention (and less total renewable dollars for your CSMs to chase after), more near-term cash flow (which can be reinvested in S&M or other parts of the business) and less A/R collections work for you or your accountant. If you still need to offer monthly subscriptions, price them in a way that will make your annual subscription look more attractive (by attaching a discount to the annual subscription).
7. SETTING YOUR BUDGET EQUAL TO YOUR SALES PLAN
To clarify, the mistake here would be to set your budget revenue number equal to your sales plan assuming 100% quota attainment. This can be tricky to plot out and forecast, but assuming you are using a rep-based sales model (for an illustrative example), you can use historical quota attainment (what % of quota are your reps hitting each year on average) and sales rep turnover rate (how many reps are leaving/fired each year) to establish baseline performance.
Once this baseline is established, incremental sales reps (or sales support) hires can be scaled in over the plan period to build out more risk-weighted sales plans. While this is only an example and may not be completely applicable to your specific business, it is a helpful type of exercise to get the finance team aligned with the sales team.
8. NOT TRACKING CUSTOMER RETENTION TRENDS (OR TRACKING IT INEFFICIENTLY)
Depending on your customer base and the way you are tracking your financial/transactional data, this can be a cumbersome exercise. It’s important to clearly define the different buckets of churn and have an understanding of where your business stands with regards to each of these items:
- Customer (Logo) Churn: How many clients were lost within a given period.
- Gross Revenue Churn: How much money was lost within a given period from clients leaving.
- Net Revenue Churn: How much money was lost from clients leaving including any expansion or contraction from existing customers.
Businesses should focus a majority of their attention on Net Revenue Churn, as this gives the most information around current revenue retention trends and allows them to measure the impact that a CSM or post-sales team has at expanding existing customers over time.
Regardless of the size of your business and the depth of your finance team, these are problems that any SaaS company can be faced with. Taking steps towards a strategic finance function sooner rather than later will ultimately provide significant value.
While some of these issue areas can seem overwhelming and unsolvable, particularly if you have a lean finance team, there are plenty of incremental fixes and solutions to correct all of these items over time.
This blog was originally published by SaaSX and authored by William Cordes. Republished with permission.