I have seen plenty of startups that have begun invoicing without someone who can handle the accounting domain. That leads to several problems:

• Not knowing what your MRR/revenue is.

• Not knowing if you are being paid.

• Duplicating payments.

• Raising concerns on a DD that jeopardizes its objective.

Subscribe now

That’s why I am sharing this process.

First of all, you need to understand that there are many agents involved in the invoicing process. Some of them are:

• Accounting software or ERP. Here, my belief is that around Series A (just before of right after), there should be one in place. My favourite is NetSuite because it’s easier to integrate with all other cloud applications. My view is also to use NetSuite as a repository of accounting information, a consolidation tool in case of multiple legal entities, an analytical accounting tool, and a cash reconciliation master. Pretty much everything else I’d do on specific vertical tools that are much better and more efficient in solving needs.

• Billing engine: not to be confused with accounting software. You can use your accounting software to issue invoices, but if you have a SaaS and expect to have thousands of customers, accounting software won’t be ideal. You can use many tools, from Quipu to Chargebee. Most of the SaaS use Stripe from the beginning because their API is very well documented and easy for devs to work with. However, Stripe is an all-in-one platform, but it doesn’t allow you to integrate with other payment gateways or acquirers, which can be limiting as your needs evolve. My personal recommendation is to use Chargebee.

• Gateway: is a solution that makes the decision on what collection method to use for each case. It takes every invoice, and based on the preferences of the customer, uses one payment method or another. Some gateways are:

  • Stripe

  • Checkout.com

  • Adyen

  • GoCarldless

  • Paypal

  • Worldpay

  • Mollie

• Payment method. As the name suggests, this refers to how you'll collect payments from your customers. These are the main methods used, but you can see examples on the Adyen page. Beware that there are hundreds of payment methods, and in every country, there is one specific for it, at least. It’s good to emphasize the fact that you must enforce MIT (Merchant Initiated Transactions) rather than CIT (Customer Initiated Transactions) to have better control of your cash and minimize collection efforts. As long as you have control over who executes the payment, you reduce uncertainty and the need of working capital solutions:

  • SEPA Direct debit: ideal for B2B in the SEPA (single Euro Payment Area) region. It has the lowest cost. In the US, there’s something similar called ACH debit.

  • Credit card: the most used around the world. However, it can cost up to 4% of the transaction if the customer is using a virtual business credit card. It also has some threats: overlimits, expiration, and not all cards are accepted…

  • Transfer: it’s the safest and cheapest method once you have received the funds. However, being a CIT, it takes longer to collect and requires administrative work following up with your clients and reconciling. Some platforms, like Stripe, provide a virtual account number to receive wire transfers.

Here’s a simplified process based on Spanish accounting codes. While the specifics are local, the principles are broadly applicable. Also, I am considering Stripe as the billing and gateway for simplification.

STEP 1: Sales Invoice

I strongly recommend Stripe or whichever billing engine you useto issue all invoices, each registered in the specific client account (code 430). Example of journal entry into the accounting software for a fee of 100€ with a VAT of 21%:

STEP 2: Stripe issues a payout detail:

Please note that there must be a line entered for each customer

Stripe deducts its commission, and the remaining balance to disburse is 111€.

In case there is a chargeback, which applies to an invoice that Stripe has collected and paid out to the vendor already, the reverse process must be done:

Note that there will also be a chargeback fee, which will be deducted by Stripe from the next payout.

STEP 3: cash in the bank

Considerations:

• The debt from each invoice must be accounted for on each client account in the accounting system.

• It would be ideal that each collection would compensate each invoice, to have a correct balance composition. That will allow you to know exactly what the right amount is due for each client.

• The generic client account (430.00.000 for Spanish GAAP) must be clean, that is, have a 0€ balance by each period closing.

• Your dev team should use a unique identifier (e.g., nexus ID) to link Stripe customers to internal accounting records.

What pains have you encountered? Please add your questions below.

If you do a sensibility analysis of your business model, you will understand which is the most important metric in SaaS, it is churn, in its many forms. Here’s an illustrated example. Below you can see a 3-year plan only on the revenue side with the following assumptions:

• Starting client base: 500

• Starting ARPC: 1.000€ - Hence MRR 500k

• ARPC MoM increase: 1%

• CAC: 10k

• Total monthly acquisition expense: 100k

• Churn (customers): 1%

SENSIBILITY ANALYSIS

I’m concentrating the sensibility analysis on the revenue side. Assuming the costs remain the same (if you have a Gross Margin of 70-80% it’s not that critical).

Here’s a plot of how the ARR changes for a deviation of 10%, 50%, and 100% on each metric. I will only impact one revenue at a time to simplify the analysis. You can see highlighted in red the lowest ARR at the end of Year 3 from the three alternatives. Also, you need to take into consideration a critical fractile analysis, which would determine the probability each of those events has. It’s obvious it’s much easier to multiply churn by 3 than any of the other metrics, so churn getting out of hand can become much more damaging to your ARR. In the below scenario, remember starting ARR is 6M€ (500k * 12). Also, having an atomized client base can smooth out churn, along with the stickiness of your product.

At a 3,4% monthly churn, this model becomes flat. So from growing 40-50% YoY to remaining flat there is only 2,4 points in the churn percentage. This is scary. Look how fast the first column decreases compared to the others when the delta is higher.

If you ask me what KPI I’d like to control, it is precisely the amount of business your company loses each month due to lost customers. So here’s my definition:

Churn: the revenue rights your company loses over your former customers each month.

Let’s remember that SaaS is a very capital-intensive business that invests lots of money in developing a product/service and commercializes it. Then, each client generates gross margins that must pay off the investments and provide benefits. The beauty of SaaS is that these future profits can last for eternity if managed properly.

It doesn’t matter if your business can attract thousands of fresh customers every month if you are not able to retain them. I’d rather have low acquisition and poor retention, than the other way around.

Before we dive into churn, let’s define what is a customer and what is not. Here’s my definition, but you should come up with one that better suits your business behavior.

A customer is a person , an entity or a group of entities that are committed to use and pay recurringly for your product (Software). A customer needs to be fully activated/onboarded.

So what isn’t a customer?

There are times when a prospect is not fully committed to your service. A customer requires not only to sign on the dotted line, it also needs to believe the solution will help them. Make sure their organization is onboarded and ready to use the product regularly. And of course, a client needs to pay. But above all, a client is such when they believe the price they are paying is smaller than the value they are getting.

You may have customers that are paying but are not aware they are paying. That’s not a customer because their commitment has an expiry date and in SaaS, customers are committed indefinitely. If you have a customer who will not renew your subscription, it needs to be written off your CARR (Committed ARR).

CHURN PREVENTION STARTS WITH THE SALES PROCESS

Here’s how to fight churn:

1. Do not oversell. Make sure your client’s decision has been made in the best interest of the company.

2. Make sure your champion is entitled to make this decision and enforce it throughout their organization.

3. Make sure your customer can afford your solution, in time, money, and any other resources that play an important role.

4. Make sure your customer not only has the monetary means but is able to pay for your product. This is not trivial.

But once you have a customer that’s fully onboarded, that customer needs to stay. I will give you ideas on how to be proactive and reactive. Please beware that these ideas only work if you have a customer satisfaction mission. If you are a telco and treat your clients like a number, they won’t do you any good.

Subscribe now

PROACTIVITY

Be mindful at all times about customer satisfaction. It’s easy to say, and easy to do. You only need to believe that the core activity of your company is to satisfy your customers. As Howard Schultz did in Starbucks. Anyone in the company who is doing something that is not aligned with providing customer satisfaction and collecting from it should reassess their priorities.

One of my favorite teachers at IESE, Conor Neill, put it this way: “The best way to show that you care, is to care”. Being customer-centric must be embedded in the character of the company, not only displayed in ESG power points.

Every inquiry by a customer is a blessing, an opportunity to find out how to improve. Embrace it rather than criticize it. If someone in your organization is lazy in interacting with customers, you have a big problem. In my experience, I always hire people with an alignment on values and proactivity. People who like being told what to do, won’t be able to understand your customers.

Being a customer centric company does not guarantee the 0 churn Nirvana. Only a government can have such a strong lock-in with their “customers” that they cannot churn, but even they can see structural churn in the way of death or relocation. Churn is inevitable, so don’t panic and prepare for it. Here’s where Tom Cruise comes in, to help you detect what I call a Churner.

A Churner is a customer that is on a path to churn with the current scenario

Detecting a churner, even before they realize they are a churner is paramount. If you got this far reading, I assume you deeply despise churn and are willing to do everything in your power to prevent it. You don’t want to run your business like a gym that hopes its clients don’t show up but keep paying because of mysterious reasons. That is really hard, I haven’t even managed to create an automated system to point out churners, but if I had, it’d look something like this:

• Assemble your data team or get on it yourself.

• Analyse interactions with already churned customers to see what was the main reason. Have the main reason correctly registered in your CRM (Customer Relationship Management tool). It is fundamental not to fool yourself here. A reason for churn can be: the product is buggy, it has much more downtime, I need a feature you don’t provide, corporate takeover forcing another solution, it’s not compatible with my other tool, it’s not compliant, the company doesn’t have budget for it, the company cannot accept payment terms… But beware of the churn reasons, as there are some excuses that are not acceptable reasons because they won’t allow you to learn and act upon them. For example:

  • It’s expensive: what does that mean? expensive related to what? The customer needs to understand the total cost of ownership of your solution and compare it with not having it in place. Many companies do not realize the costs they incur and will incur in the future. Make a rundown of their procedures along with the client, having their validation every step of the way, and make them realize their improvement points. There are always things to improve. Tagging a churned account as “it’s expensive” doesn’t allow you to react, except lowering your price with no other reason, which is the last thing you want to do.

  • We are not using it. Why has the customer not been juicing out the benefits of your solution? Was it a poor onboarding? An internal change? A Customer Experience agent needs to know very well why are they not using the product.

  • We are changing to another product. Why? There must be a reason for a change, and that’s what you want to know in order to act strategically. Otherwise, you are just moving papers along, which is the opposite of SaaS.

Once you have a good system to analyze your WCGW, or Wocus (back in EY we identified What Could Go Wrongs), you need to implement the tools to detect them soon enough to save the client. Evaluate every churned account’s behavior for their last 6 months. Can you find a trend? At Factorial, we did it manually. These are some of the things we could see:

• Subpar engagement: if you see that the users who need to be performing actions are not doing so, it’s a red flag. You need to detect dependencies. I remember at Parkimeter we would close corporate clients, but the drivers of these companies were not aware they could use the parking facilities of our associates and therefore were not using the app. That meant that the app was irrelevant and the client could churn anytime. The opposite case was with Gymforless, when we launched the B2B product, companies implemented it and employees started to go to the gym with very good conditions. No People manager would dare to churn us and risk the wrath of their workforce. Another example we experienced was with Quipu. We closed a deal with La Caixa (one of the biggest banks in Spain), it was public and visible on their site, but the branches didn’t receive the proper incentives to push, so it didn’t have the reach we all hoped for. So engagement is important. If your client doesn’t engage, they can let you go anytime.

• Payment issues: companies face financial difficulties. Whenever there’s a collection issue, talk to your customer and see if you can help them with it. It can be a misunderstanding, a problem with the payment method, a cash situation, or a deliberate act by the customer. Detect it. For more information on credit management, see my previous post.

• Atrition: sometimes companies start well, but eventually phase off. You need to monitor if there’s a sudden change in engagement. Is the account losing users? Is the average transaction level dropping? Detect it and talk to your customer.

• And always, there’s nothing like a personal touch by your customer experience agent. This is someone who needs to know your customer’s fears inside out, an ally, a consiglieri, a friend. Find out what power struggles may happen inside your client that can put your subscription in danger. Again, if your ARPU (Average Revenue per Client/User) is too low, you cannot afford high touch, but you need to find a way to make that touch because what you really cannot afford is losing customers for preventable causes.

And again, there will always be churn, companies go out of business, cut costs… Assume it, and get working to resuscitate that account as soon as possible.

REACTIVITY

I get it, when you are in high growth mode, it’s impossible to do everything so you need to concentrate on the things that provide the highest value. What is going to impact your cash position the most? What will bring more revenue? What will bring more margins?

The one thing that positively impacts all of these is customer satisfaction. However, mistakes happen or the customer simply does not get the perception that they are getting more value than cost from you. Here are some tools to recover a client:

• Prove to the customer the value they are receiving: if you have done a proper customer discovery, you know how your client operates and thinks. What are their worries? What impacts their bonus? With all that knowledge, you should be able to construct a simplified P&L for them to make tangible the value they are getting. You must have this at all times to maintain the value perception in your customer’s head. Your friendly neighborhood CFO can provide you with a template.

• When everything is lost, you must know what the problem is and act upon it. However, you don’t have time, so you need an incentive for them to rebuild that fundamental trust you blew away. The obvious way to do it is to prove you believe in that relationship and put your skin in the game. That is, sacrificing your short-term P&L to show you are committed to making it work. This may come in many ways, and you should not overkill it not to spoil your customer:

  • Discount: like all these telecom companies that offer you the best deal when you are about to leave. In SaaS, remember that most of the revenues go to the bottom line, so having a customer without revenues or with fewer revenues for a limited time will have no marginal implications on your P&L. Remember you have lost your customer, so serving it for free or at a discount doesn’t change your P&L (revenue is already a sunk cost, it’s gone). On the cost side, the marginal costs associated with maintaining that discounted account are negligible.

  • Love: the opposite of the previous is not only not to discount, but to add more costs, putting more meat in the grill. That is a more powerful approach since it makes up for the less value provided in the past (perception), without undermining your service brand. It shows that you care. In life and business, you need to show that you care when you do. By giving love I mean putting an extra effort until the dissatisfaction is tackled, that means doing a special case with them, involving management if necessary, preparing a hand-holding schedule to make sure all goals are being met, asking the right questions to know when, where and how to act, and in short, treating the customer as if it were yourself. You need to fight every customer because you are not only “saving” that lost MRR, in case of churn, you would also be losing all the potential expansion from that account and losing the hidden value of WOM (Word of Mouth), the most powerful source of new customers that last.

• Appeal to their vanity. You may involve a customer that is in danger with a corporate benefit that can produce:

  • A learning aspect to their champion. You can show key individual(s) the way to personal and professional growth if they stick with you. Show them a path to continuous improvement and you’ll be transcendent to them. People should always stick to that which makes them better.

    

  • Visibility to individuals or the company itself: show them a new way to meet other acolytes of your service that makes the churner think they are wrong or just awake some empathy with like-minded professionals. They will be in a group activity where everyone but them is a fan, yet they can identify with their pains and their goals. That can be done by adding them to a social media campaign, a focus group, a special retreat, a mixture… Here, make sure you don’t bring many churners at once and all the other participants have a sky-high NPS, so the whole bunch doesn’t get spoiled. And don’t just buy their happiness with VIP tickets, create something meaningful yet entertaining.

  • Showing them a way to grow their business thanks to your relationship with you: you may present other clients that may be their potential partners (clients, suppliers, distributors, collaborators…).

    Text within this block will maintain its original spacing when published

    Don't treat your customers like idiots, respect them. Don't pretend, just do.

ALL CUSTOMERS?

No. There are some customers that will burn you to the ground. You cannot force a customer into a set of values that align with yours. If there is no match at the beginning of the talks, don’t waste your time as it will only create more trouble. As with everything, there is a Pareto in many dimensions. The most important issue here is to realize which customers will have an individual P&L that is negative, and fix it. You can have a negative P&L client only if you decide that it is a strategic account, that is, it will provide you with greater value in the future that cannot be measured at the moment. For anything else, it will be healthy not to waste your energy with customers whose mindset is to burn it all. Here are three examples.

• Back in 2006, I was at a small 100-employee company that had a contact center and the situation was critical (Angel Asistencia). A customer was insulting a phone operator, so I gave instructions to end every call that went that way, and if it persisted, they could transfer the call to me. No customer comes before employee morale and general education.

• Later on with that company, we developed an after-sales service for new home purchases. We had many real estate developers as clients. There were many issues involved with the number of tickets we received from each development, but of all the projects, the ones with the highest complaining volume were the ones with a special public promotor that offered subsidized housing. In theory, my logic assumed that people who paid less for a product would be more grateful. However, we discovered that people who jumped through all the bureaucracy hoops were not the ones who needed it the most, but they were people who had more willingness to bargain. That meant that people applied for those grants because they could, not necessarily because they needed to. These people, were also the worst customers to serve, as they were often unreasonable. The only person who came into our office physically in many years was from that client, and I could tell by the looks, that person was clearly not in need of any housing aid. In retrospect, I would have rather had this client sign with our competitors than with us.

• The other day, a friend told me she had to report an issue with the car and the insurance company refused to renew her contract. I’m not going to come into the ethics of that decision, or the lack of willingness from the company to determine if that incident was a one-off or a tell that showed the customer was about to apply for Cannonball or become the next installment of GTA. The company had the chance to churn a customer for a statistical reason and so they did.

So have clients that not only pay, but also that can be evangelists of the religion your company preaches.

LIVE AFTER DEATH

What happens when a customer churns? That is the moment when you start your resuscitation plan.

The history of your SaaS is recorded in the SaaS Masterfile, which I will cover in depth soon. A company that has become a customer has a place in your history books. It’s a line in the Masterfile that belongs to a cohort. Your goal as a SaaS manager is to maximize each cohort. That cohort can only be increased in 3 ways:

1. Expansion: gross expansion occurs when a customer pays more than the previous month. It applies to each customer and each cohort. (Actually, a customer can pay the same and expand MRR due to interest rate fluctuation on your consolidation currency, but you get the point).

2. Cross sale: in a future post, I will talk about the difference between a user, an entity, and a customer. One customer, which is one person or group that makes the purchasing decision, may bring in new units of the company, such as another subsidiary. That, in my humble opinion, belongs to the cohort where the customer was first acquired since the efforts in sales and marketing to obtain that decision maker were invested many cohorts ago.

3. Resuscitation: as we said, customers churn, in all companies. But remember that SaaS is a game for the long run. The lifetime of a customer does not have to be a straight line. Understand the reason for the churn, and even if the client has signed a 3-year commitment with your competitor, work your way back with them. They may come back or not, but they must have you in high regard on their top of mind. Recovering that customer will be easier than capturing a new one, although lengthy. Don’t punish them for leaving, show comprehension and be supportive. Recovering a client after a year is probably the best feeling in SaaS. Supplier-Customer relations look more like a friendship than a relationship. At some point in time, you may not hang out as much, but even then, you can consider them as a friend, the fact that a customer is not paying at the moment doesn’t mean they won’t ever again. Remember that it’s business, not personal, and they already have an account number waiting for them to be re-onboarded. Keep them in your newsletters, invite them to events, offer them ways to get back, have quarterly calls with them to see how they are doing, and provide them value by sharing what you are learning from working with other companies. Show, don’t tell. A client needs to want to get back to you on their own terms. They need to come up with the decision themselves. You just pave the road for them to return safely.

A company that has expanding past cohorts is a company with Net Revenue Retention (NRR or NDR for dollar) above 100%, and that is the sign of a healthy SaaS. NRR is obtained by dividing the value of all cohorts with at least 12-month seniority against the value it had 12 months ago. It can also be done for each cohort for a deeper analysis.

Any issues with churn? Reach out to me and let’s think about it!

LEAVE NO CUSTOMER BEHIND

In companies, a revenue or an expense is not the same as a collection or a payment. In SaaS, however, there is a high correlation, unless you go upmarket and your enterprise customers demand draconian payment terms. Of course, you can advise them to pay on the spot as they would pay their utility bill, but it’s not always possible. In the end, you want to increase your MRR because the marginal added costs to a new account are virtually zero.

In Spain, for instance, it is illegal to pay beyond 60 days, but not even the government abides.

In credit management, aka collections, aka accounts receivable management, aka morosidad (in Spanish), aka working capital optimization…, there are two variables to take into account:

• Is the payment cleared? Is the company ok with the payment?

• When is the payment going to be released?

Here you are, managing hundreds or hopefully thousands of subscriptions, and some payments start to fail. So either you have billing and collections automatized, or you send bills one by one and expect a transfer.

You must put a system in place that helps you prioritize where to invest your efforts with slow-paying customers, beyond the obvious one which is the size of the bill and their churn likelihood. I will share simple the system I designed and implemented at UKIO.

DEFCON stands for DEFense CONdition and it’s used by the US military, or at least it’s displayed in countless movies, to set up the necessary reaction to be prepared against a threat. It starts at DEFCON 5 when there’s minimal threat and it can go down to DEFCON 1, when there’s a clear imminent threat. In our case, a threat is lack of payment. How it works is you just assign a condition to every pending invoice or client as a whole. In SaaS, it makes more sense to do it for every customer because if they dispute one invoice, the whole subscription is in danger. In transactional business, where you compromise resources for every sale, credit scoring and prepayment is adviseable.

Here’s how we did it, but you can use it to better suit your business:

• DEFCON 5: Everything is in order. No complaints from the customer and no collection errors in place.

• DEFCON 4: There has been an incident with the account, but the payment always went through correctly. That may be a customer just raising a concern on how billing works, which doesn’t mean they disagree, but the company needs to be assertive and swift.

• DEFCON 3: There has been an incidence, but it’s solved. Usually, when there’s a collection failure, the system needs to do smart retries. These happen when you collect from a credit card and it runs over the limit, gets deactivated, or expires. That’s why the best collection method in Europe is SEPA Direct Debit, cheaper, more secure, and most effective.

• DEFCON 2: collection retries keep on failing and the company is trying to get a response from the customer without success. It’s paramount to know what’s behind that problem. Not because of the payment, but because the subscription may be in danger. Churn is your worst enemy, so you need to try a new approach to the company that is not invasive, but which provides answers. Is the customer happy and the issue has just been a misunderstanding? Is the frozen payment responding to a treasury maneuver by their evil CFO? Is the company having structural issues? Is this a dirty technique to negotiate prices? Is the company thinking of stopping paying for good? ALL HANDS on deck here!

• DEFCON 1: The client has expressed their unwillingness to pay and is most likely to churn. If it’s a treasury issue, be sure to find a payment alternative that fits your customer, doesn’t leave you hanging, and saves the relationship (and the subscription). Here is when you need to try everything to get the customer back and depending on the issue start putting restrictions on the use of the platform. Oh, and start talking to the lawyer. It’s wise to know for every market what is the minimum cost from which litigation is advisable, since you don’t wanna send the hounds of hell for a 100€ bill. Once it’s in the lawyer’s hands, stop licking your wounds and concentrate on the living customers.

What is the impact of collecting later?

There is a key metric in Finance called DSO (Days Sales Outstanding). It is the pending debt from clients (subtracting indirect taxes such as VAT) divided by the sales from the same period and multiplied by the number of days for that period, usually 365 days:

DSO = (Client's receivables outstanding / Sales) * 365 days

Let’s say you have receivables for the amount of 100.000€ (remember, without VAT) and your yearly sales (not ARR) are 1.200.000€. Your DSO is 30 days.

Now imagine you are not growing fast and you are handling your cash tight, without funding rounds, and near breakeven. If instead of having 30 days of average collection you had 0, you would effectively need 100.000€ less money to run the business. This is the impact of efficient collections on the balance sheet, but it also affects the P&L, since you would be paying interest on loans or losing interest on potential deposits you could set up. Let’s imagine a 5% interest rate, which would represent a 5.000€ improvement on your P&L at the end of the year.

A happy customer is one that pays.

Before diving into the reports, let’s recall what are the main characteristics of a report:

• True: the data that forms a report needs to be as accurate as possible. Finding the source of truth is not always easy. Here it’s especially relevant to make sure data entry and collection are reliable.

• Wholistic: a report needs to cover as many data points as possible, without losing focus, as long as it is representative of the health of the business.

• Relevance: as mentioned in the previous point, don’t waste energy on vanity metrics.

• Consensus: the data included in a report needs to be the same for everyone. It’s more important that the whole organization shares an imperfect set of data than not sharing and not knowing what the source of truth is. There are fewer things more frustrating than being in a meeting and wasting energy discussing the data rather than the decisions to make. So make sure all agents jump into a meeting with the information available beforehand and agreed upon. Without this, avoid the meeting and solve consensus on info.

• Availability: a business is not a political chamber. Share the information across the organization so everyone understands the business and knows how to improve it. It also helps to detect flaws. In a business, success is directly correlated with the ability to correct and improve. The bigger the business, the more people need to be involved in those improvements.

• Consistency: as mentioned earlier, there are things more important than having the correct data. If you have the right data, but change how to measure it, the indication you are viewing won’t make sense. In companies that are not mature, and which therefore experience a lot of changes, it’s key to analyze a set of metrics over time. If you change the way to evaluate those metrics, those will only fool you. Remember that there’s no perfect benchmark for your company, the closest proxy is your past because it measures your team, your market, your tech, and your moment…, and all of that is unique to you.

• Recurrent: it needs to happen recurrently to better analyze cycles and performance.

• Actionable: This is the most important. If you create a perfect report but it doesn’t lead to decision-making, you are wasting your time and your report recipient’s time. What makes the difference in a company is the implementation, and implementation is the way managers and employees act.

Having all that in mind, here are the three sets of reports we created at Factorial. I’ll provide an overview of them and dig deeper into them in future posts. Please let me know in the comment section which one you’d like to know more about.

1. Accounting reports: Profit & Loss Statement (PL), Balance Sheet (BS), and Cash Flow (CF).

2. SaaS report: the SaaS Masterfile

3. SAMBA: Sales & Marketing Business Analysis

1 - ACCOUNTING REPORTS

Accounting is the oldest set of reporting created by mankind, and to date is necessary, yet insufficient. Let’s review the three reasons why companies need Accounting:

1. Tax: It’s mandatory by tax collectors everywhere. To determine how much tax to collect, governments need to know how much you make. Don’t mess with the taxman!

2. Finance: to get financed, lenders also need to know how is the business going. These reports may vary depending on the sophistication and scope of the lender. If you go to a traditional bank they’ll require some information that you probably don’t use for your business. On the other hand, if you go to a VC to get funding, the analysis they’ll perform will be closer to what you’d do monthly.

3. Management: this is from my humble point of view, the most important reason. Accounting needs to serve the business. Here’s where most CFOs struggle. It’s not what you got taught in your Big4 days, it’s what the company needs to know.

So, when creating your internal reporting, you need to make sure you can “easily” produce reports to satisfy the needs of the three types of recipients.

Let me quickly describe the 3 basic accounting reports:

• Balance Sheet: this is the photo of where the company is at any given moment in time, within a closed period (won’t get into too much accounting here). The problem in SaaS is that a BS does not reflect the full value of a company, hence the big gap between a valuation and a BS. A BS is composed of 2 sides:

  • Assets: it’s what the company owns. Fixed Assets (mostly the Intellectual Property developed by your Product and Engineering team), Short Term Assets (mostly receivables and inventory for non-SaaS), and Cash. This is an oversimplification.

  • Liabilities and Equity: this is what the company owes. Liabilities are payments pending to suppliers, creditors, and lenders, while Equity is the theoretical liquidation value for the shareholders. Again, oversimplification.

• Profit & Loss (aka Income Statement): if a BS was a photo, the PL is the movie between 2 photos. For that reason, it is much more important. If a company has no cash, it’s dead and there’s nothing you can do about it, while if a company doesn’t have a way to eventually obtain a positive PL, it’ll most likely die (there are a few cases where a company can sustain long periods of losses and no external financing, but they are very rare. Governments would be a clear example of that). A company with a good PL will improve its BS as long as they don’t do financial mishaps, which is not allowed in SaaS. Here it’s very important to evaluate the changes in the PL month over month. Below you can see a quarterly PL from The Coca - Coca-Cola Company. As you see, it’s not actionable.

  

  . In my opinion, a good PL needs to have the following structure:

  • Revenues

  • COGS (Cost Of Goods Sold): all the costs incurred in the period that are directly related to the revenues. In a SaaS, those can include the Customer Experience team and its tools, the hosting, and the gateway costs (payment gateway, billing platform, and banking fees to collect from clients…). In summary, everything will rise proportionally as you get more clients and therefore more revenue (hopefully).

  • Gross Profit: this is the monetary value from subtracting the previous two points. Gross Margin will be the same figure put in relative terms, as a %.

  • Acquisition costs: here you can add any cost related to increasing your revenue. They may include but not be limited to marketing, performance marketing, sales, partners, social… Here I am implying you only acquire demand. If you were to also acquire Supply, those costs should also go in here.

  • Contribution margin: it’s what you get after subtracting all the acquisition costs from the Gross Profit. It’s called that because it contributes to paying the indirect costs of the company, which come below.

  • Indirect costs, with each subsection such as Product and Development/Engineering, People, Finance, and G&A (General and Administrative).

  • EBITDA: the difference between all of the previous subtotals. I like not to capitalize R&D before EBITDA not to fool myself. If you present the PL to a bank, you need your EBITDA to look more black, but if you wanna manage it as close to the cash, you take it out because you want to know how much are you investing each month.

  • Below EBITDA you can add everything else before taxes, like capitalization, amortization, interest expense, and extraordinary expenses (not accepted by auditors, but life happens).

• Cash Flow: as the most important axiom of finance puts it, Cash is King. Companies are ultimately valued for their ability to generate and distribute cash flows to their shareholders. It’s key to analyze a business model’s efficiency regarding its PL. Two different businesses with the same EBITDA may have different Net Incomes because the one with more Working Capital requirements will need to get financed and that will generate interest and may hinder the possibilities to get more financing. That’s why it is paramount to collect asap and pay as late as possible from a financial point of view, maybe not from a business point of view. Having that said, a SaaS is a business where the PL is very close to the CF since collections are mostly immediate (as long as you don’t go upmarket) and the most important expense is personnel, which also needs to be paid monthly.

  • Cash Balance: this is the cash position you have at any given moment. If you divide the cash balance by the burn rate, which is the cash you are burning monthly, you get your cash runway or RUNWAY. Bear in mind this is a theoretical runway based on the actual burn, which I prefer to calculate as an average for the last three months to reduce the impact of seasonality. However, the real runway is calculated based on the forecast of the business, as it’s highly likely the burn will vary over time. Let’s remember one of the beauties of SaaS is high gross margins, so the more you grow, the better the future cash flows will become, ceteris paribus.

In the general scheme of SaaS reporting, I give accounting reporting less than 10% of the value for the whole reporting package. Accounting is a good information source for other reports, but besides the Cash Flow, it’s not representative of your SaaS.

2. SaaS REPORTING: welcome to the SaaS Masterfile

Cash is the key to survival, but surviving is not the ultimate goal of your SaaS, isn’t it? Let’s analyze how your business is doing, that is, how your clients are behaving. There are multiple metrics you can use to determine if a customer is happy or not. The happiness of your client with your solution is strongly correlated with their loyalty if you don’t have any other defensibility. Nothing speaks happiness like recurrent payments. So let’s analyze how your customers are paying to understand the health of the business.

The SaaS Masterfile is a report that will be required by every VC (Venture Capital investor). If a VC doesn’t ask for that, don’t let them invest in your SaaS as you don’t want someone in your Cap Table who doesn’t understand how SaaS works, do you?

The Masterfile is a spreadsheet that contains a line per every single customer. Before getting dirty, let me differentiate the three types of customer levels:

1. User: it’s an identifiable person, usually by email, who is unique and belongs to one or several organizations. At factorial, a user is an employee. At Ukio, a user is a guest who has access to an apartment. At Salesforce, a user is a sales rep with a license.

2. Entity: an entity is the one that pays for the solution. Imagine you have a client that has different instances, once for every country. Let’s say your client is Nestle and they purchase your solution from 2 entities, Nestle Spain and Nestle France. You will need to provide two different invoices, one for each entity, but you only have one client.

3. Customer/client: A client is the one you acquire, the one that decides to use and pay for your solution. In the previous example, Nestle will be your client. This client will have different entities and probably different subscriptions, depending on your back-office configuration. To better understand your clients and your relationship with them, you need to analyze them by clients, not by subscription, by entity, or by users, which is what all the tools available in the market do. You need to do grandfathering between the subscriptions and the entities and be able to analyze them by client. Here’s why:

We agreed (if you got this far) that the Masterfile will have one line for each client. On that same line, you may add any variable you can later use to segment your data: client ID, name, lead providence, cohort (month), country, market, and product. At Factorial, we also used our approximation to the animal classification based on the famous article by Christopher Janz, but you can use any segmentation that you feel is useful. The animal size was based on the MRR a client had in the last month of the report, so this cell would change every month and we analyzed how the zoo composition was evolving to bigger animals and where to focus our efforts. Then, we would add a new column for every month where we would persist the MRR at the end of that month. It’s important to state that MRR is usually not the same as billing, MRR, or Monthly Recurring Revenue is the amount pretax in your currency that you would bill the client at the last minute of the month if they had a monthly plan. For that reason, the MRR will not match with the revenue from your PL report. You need to audit those differences to make sure you are doing them both correctly, but accept there will always be differences because of billing (an invoice can be issued on a different day with a different number of seats or even pricing plan, the billing cycle may be different and you are not doing revenue recognition to the cent…). By the way, a seat is a unit of billing, as it can be an employee, an event, a GB of data…

That created a set of data that can be analyzed. Here you can see, regardless of billing which can fool you, the evolution of a client. 5 things can happen to every client:

1. Nothing: MRR is the same as the previous month

2. Expansion: MRR is greater than that of the previous month. This is of course the desired outcome. It’s the most magical event in SaaS, but you need to understand why it is happening. If it’s because of the end of a discount, it’s not real expansion, don’t fool yourself. Also, make sure with your Customer Experience team that this behavior is expected. They have either changed the plan or expanded the number of seats or billable events, so make sure it doesn’t come as a surprise to the client.

3. Contraction: yellow light here, the customer is paying less. It may be a seasonal issue that has nothing to do with the relationship with the solution, but the CX manager for that account needs to get on top of that. It can be the first quantitative sign the company gets (from this data source) that a customer may be in danger of churn.

4. Churn: a churned client is one that had at least one active subscription in the previous month and currently does not. A client can have an MRR of 0€ but remain with an active subscription (personal belief) and therefore not be considered as churn. Again, you need to be honest when considering churn. You need to review every single month the casualties with the CX management.

   Churn is the most important metric in SaaS. Any SaaS with high churn will eventually die

5. Non-converted: to me, as I explained earlier, a client is an entity that is willing to pay and use your solution. As you know, SaaS has to be implemented, and that takes time and effort from both the provider and the client. If a company makes the decision, but the implementation fails for whatever reason, then, it never becomes a client. This happens more often than you think. So imagine you sign a big deal and after three months, the champion (your implementation lead inside your client) gets replaced by someone else who doesn’t think it’s the time for that implementation. You can consider that as churn or what I call a non-converted account. In my opinion, that never became a client so it should be removed from the Masterfile, while of course, it needs to be stored in a non-converted list.

   1. Here comes the big controversy. As you remove a line from the Masterfile, you are modifying the number of new customers and actual customers you reported last month. To me, that’s the best way to go as long as you are open about it. It’s not gonna be a huge difference (in which case you have a problem), but you need to disclose this criterion. Now let’s keep in mind this happens because you may have a contract signed on the last hour of the month and you create a subscription, but later on you realize it’s not a client.

Note: try not to share your Masterfile with anyone unless it’s strictly necessary. That contains very valuable information. If you have to share it, make sure it’s anonymized and only disclose names when a DD (Due Diligence) is in place with the proper legal protection (that you know may not be enough).

In a separate post, I’ll be sharing my learnings on cohort analysis, which is so important it is what motivated the logo of this publication (art created by Marcos Medina).

3. SAMBA: the most important report for sustainable growth.

Why Samba? Formerly the S&M report (Sales And Marketing), I learned from a friend that over at VW had a report called SAMBA, so I made it match. It comprises all the GTM (Go To Market) efforts of the company or group of companies. So regardless of the number of entities you operate, you want to know how much it costs for you to acquire a new customer, and how can you do it more or more efficiently.

Before getting deeper into it, let’s refresh the different stages of customer acquisition, which you should be able to obtain for optimal reporting:

• Contact: a person inside of a company. At this stage, you may not know anything about this person.

• Lead: It is a contact related to a company that you know how you have acquired. You still don’t know if it fits your ICP (Ideal Customer Profile) so you need to enrich this lead indirectly or actively via an SDR (Sales Development Representative).

• Deal: when you prove a genuine interest in the solution offered, a lead becomes a deal. A deal can also be in different situations: negotiating terms, resolving objections, pending demos to additional members…, but I’m keeping it simple.

• Client: a customer is a deal that agrees to use and pay for your solution. Jackpot!

The SAMBA feeds from these data sources: accounting (PL), the CRM, and the back office:

• From accounting, you need the investment made for each commercial effort. For that reason, you need your accounting software and processes to recognize each expense in the right analytical bucket. A bucket is the minimal and unique set of expenses you need to move a prospect across the sales funnel. For example, imagine you have a blog you use for capturing leads. All the expenses related to that blog would go into that bucket: the writer’s cost, the hosting, any tools or resources used… If a blog is used for many products/markets or whatever classification you deem necessary, you need to establish a way to split those costs with the use of an inductor. An inductor is a variable that reflects the effort. For instance, below you can find a case where a company incurs 4 different expenses for the blog in English language for a specific month. You see a total cost of 1.585€ that you distribute with an inductor. Then you obtain the cost of acquiring inbound leads for each market.

• From the CRM or marketing automation tool you will need to obtain the number of leads, deals, and new customers you obtain every month. Following the previous example, let’s say you acquired 45 leads for the US market. Then you will see that the cost per lead is 14€ (634€/45 leads). Now imagine you get 40 leads for the UK, then the lead cost for the UK will be 12€. That’s when you can start comparing. You do the same for deals and customers and you have made yourself a report that allows you to see where you are more efficient and where you are not, and then try different things. Now bear in mind that deals and customers need to have included all costs incurred in previous stages, don’t fool yourself. Also, it’s good not to go crazy with the inductors, as it’ll be impossible to get exact, you need to find a good balance that’s representative enough.

• From the Back Office, you need to at least have your ID. It may not seem relevant, but having a unique identifier for every single Client, lead, and deal…. is important. Remember that an email is not a valid ID.

In future posts, I’ll talk about specific metrics, but the ultimate metric on SaaS is Payback. Payback, besides a not-so-good movie, stands for the period that you need to recover the acquisition investment and it’s calculated by dividing the CAC (Cost of Acquisition per Customer) by the ARPU (Average Revenue per Customer). I say ARPU even though I’m not talking about users because in another life I was Italian, and we Italians cannot end a word without a vowel.

Please add your comments on what I have missed, what you disagree with, or what you’d like to read in a future post.

Subscribe now

SaaS - Software as a Service is a software licensing and delivery model in which software is licensed on a subscription basis and is centrally hosted (Wikipedia)

What sort of subscription services have boomed? The technological development we have experienced in the last 30 years has reduced the time to market for new businesses. New tech is more usable and affordable to a wider user segment. The cost of creating a website, setting up a logistic operation, developing new beauty and pharma products, and acquiring and processing data (despite GDPR), have become quite affordable. That has paved the way for being at a moment in time when starting a new service that solves an existing problem has never been easier. Think about the top apps used on your phone, did they exist 5-10 years ago? Do you think you’ll be using them 5-10 years from now?

Some of the industries that have been disrupted in recent years are:

• Streaming: TV, music, social media

• Food delivery and consumption habits

• Fitness consumptions habits

• Subscription boxes, from wine to selfcare

• Cloud services like storage and backup

• SaaS for businesses like Salesforce, Dropbox, Gmail, Factorial, Figma, Datadog, Zappier…

• E-learning platforms like Udemy or Coursera

• Subscription based gaming as opposed to cartridges or discs

• Telehealth services reducing the need for patient and doctor unnecessary transportation

• Mobile apps for everyday life like banking, messaging and photo/video management

Subscribe now

As of today, 8 of the 10 companies with a higher market capitalization in the world have SaaS in their offering (I’m leaving out Saudi Aramco and Eli Lilly). However, the irony is none of them started up as a pure SaaS company. See the chart below from source . Curious is also noting that pure SaaS companies like Salesforce are worth more than powerhouses like Nike or MacDonalds.

What makes it so attractive?

1. Recurrence, and therefore, predictability. Starting each month with guaranteed revenues reduces risk and allow for better planning and investing.

2. Gross margins. A pure SaaS can have a gross margin between 70-90%.

3. Homogeneization. Software allows for a standard solution to fit all customers (devs and product managers, please allow this generalization). No more compatibility issues.

4. Accessibility. Everyone in the world has access to the internet.

5. Easier sale. Customers can self-serve and pay. The marginal cost of serving an additional user is negligible. (Salespeople, please also allow the generalization;) ). If a customer doesn’t have to compromise and may unsubscribe on the next billing cycle, barriers to adoption decrease. However, a good SaaS will look for a higher customer compromise in terms of redefining workflows to include the solution, training to users, user penetration within the organization...

6. Quicker collection. Instant distribution allows for fast collection as if it were rent. That improves cash collection cycles and reduces the need to get paid in 30-60 days. Hence, WCR (Working Capital Requirements) decrease.

7. Affordability. When a product is being sold to a wider customer base, it can be offered cheaper to become profitable. A cheaper product that is recurrent doesn’t stand out as much when a company is undergoing a cost-cutting initiative (pretty much always). With this paragraph, I don’t imply low prices as an advantage, I only state that the unitary cost per customer decreases and that provides options.

8. Defensibility. A good SaaS is that which manages to get used more, either by one person or by more employees within an organization. Activation and usage are key, I’ll talk more about it in future posts.

9. Flexibility. Software can be sold and bundled in infinite number of value proposition packs that allow for higher market penetration and price skimming. Price skimming is charging a set of customers more when they might be willing to, that can be done from a time or a feature/usage perspective (ie premium plans).

10. Easier maintenance. The cloud allows for centralized management of all clients, which is much more convenient than on-premise solutions and the historical physical format updates (like CDs and Floppys. Yes, I’m old). All customers can easily use the last version without noticing upgrades (deploys).

11. Easier to integrate. The key to a new software is to get used (activated). Nothing speaks “activation” like integration with the current tech stack and processes. Integration is much easier with cloud-based solutions. Forget about big legacy tech implant consultants.

12. Centralization. This can be understood as an advantage and as a threat. It is safer for your data and uptime metrics to manage the service from a centralized source. Tell that to your Compliance manager or GDPR inspector to make them happy.

13. Unstealable. A Software solution that is not packed in an envelope is never finished, and that’s why it cannot be stolen. The content may be stolen, but not the code. Coding is being commoditized since many open libraries offer specific solutions for most items you may want to build. The key is to make it all work seamlessly and follow a product strategy that never sees the end of it. Code, without that product strategy, as good and flawless as it can be, will be obsolete on the next day. Look at the Netflix example, it arguably has the best product (not talking about the content) and they set the standard for other streaming platforms, who can try to copy, but they haven’t managed to become nearly as user friendly IMO.

On following post I’ll talk about business, metrics and SaaS trends. Please let me know on the comment section what would you like me to write about.

Share

Leave a comment