Challenges of the SaaS model: Demonstrating profitability

As a technology entrepreneur, you’re no doubt familiar with the acronym SaaS, which stands for “Software as a Service,” a model that offers access to software by subscription rather than for purchase. While this concept is increasingly popular, it does present certain challenges. In this series of articles, our tech advisors look at the financial challenges inherent to this model and identify possible solutions.

The challenge

Demonstrating profitability is one of the biggest financial challenges for business managers who use the SaaS financing model.

This is largely due to the following factors:

First, intangible investments like these are generally not capitalizable, so they do not appear in the company’s assets—unlike the tangible investments a more traditional company would make in buildings, equipment, etc.)—and that has a major impact on the balance sheet.

Second, not being able to capitalize these investments means that development investments are recorded as expenses, which negatively affects the results.

Lastly, selling a subscription over a long period of time rather than a prepackaged solution means it will take longer to reach profitability.

Possible solutions

Financial statements will not be enough to demonstrate a business model’s profitability to an investor or banker. Here are some best practices to help overcome this challenge:

  • Prepare financial projections that cover a minimum of 3 years of operation and include annual and monthly data on the income statement, balance sheet, cash flow budget and details of the main assumptions.
  • Have a dashboard that indicates historic and prospective data on the following key ratios (metrics):
    1. Customer acquisition cost (“CAC”)
    2. Lifetime value per client (“LTV”)
    3. Monthly and annual recurring revenue (“MRR” and “ARR,” respectively)
    4. Churn rate (“Churn”)
    5. “CAC payback period”

Companies that wish to use this type of model have a number of key performance indicators they can look at to assess their situation. However, they have to know which ones are relevant to their business.

To get financing that takes into account your recurring revenue model, you can look to our team to guide you through each stage in the life cycle of your business.

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