Cashflow management - time to buckle up

At a recent meeting with a VC partner, we expanded on financial forecasting as an important tool to attract investors and to keep sane in volatile macroeconomic environment. Forecasting cash flow during recession could be particularly important exercise on the back of shrinking net income, increasing churn and just bad sentiment. Focusing on financial stability is a way to weather the storm and stand out from your peer competitors.

As the quote goes, " Balance sheets and income statements are fiction, cash flow is reality," now it's time to clock how much cash you have in the bank till it runs out. You can track this following below equations:

• Burn rate = (starting balance - ending balance) / # months

• Runaway = cash balance / ($) monthly burn rate

Example: cash balance of $200,000 with net burn rate of $20,000, your runaway is 10 months

Managing your cash flow in isolation will not be enough to get the whole picture. Forecasting sales revenue is also an essential element in the process. In SaaS model subscription period using historical data such as monthly recurring revenues (MRRs), new and existing sales, as well as cancellations (churn) can also help you dial in on your cash flow.

When Churn goes up, MRR goes down => Watchout

Digging deeper into the sales cycle. For B2B you may need to zoom in on your sales funnel by examining your lead sources, advertising, referrals and so on. How quickly did the lead move through the cycle? Where there any discounts or promotions that took place? Some forecasters go back 90 days.

source: OpenView (November 2022)

Sales and Marketing Metrics

The Boston based VC provides a good overview of financials by valuation. For a seed stage startup with 13 employee and ARR < $1M, Sales and Marketing expenses should be in the range of 21%-58%, ideally at 32% or less. Containing marketing costs to 32% of annual revenue is a generalized view to look at acquisition costs.

WIth Google Ads cost up more than 20% yr/yr this could be a challenge these days. Another ratio mentioned was the life-time value or (LTV). Good rule of thumb LTV should cover the cost of acquisition (CAC) no less than 3 times.

LTV > 3 x CAC, Months to recover CAC < 12 months

A basic forecast revenue model for a SaaS could look like this:

Starting with Average Revenue per User (ARPU) you can calculate the LTV. LTV = ARPU / % Churn Rate. In our simplistic table, ARPU is $20 while churn rate is 3.4% resulting in LTV of $580 and 29 months. As churn increases, the projected LTV decreases.

Operating Expenses and COGS

COGS

Finally, let's review the expenses as part of managing cash flow. Cost of Goods Sold (COGS) also referred to as cost of sales is attached to the direct cost of a SaaS company. Development costs are not included; only directly contributable cost.

Each business is unique and you should take under consideration costs such as software testing, cloud costs which tend to vary and increase lately.

Calculating COGS is fairly straightforward: COGS = Total Revenue - Gross Margin.

The difference between TR and COGS give us Gross Margin (the amount of money the company retains after direct costs.

From above table we understand that a VC will not invest in ARR of $10M, but Gross Margin less than 80%. This will suggest that you are keeping COGS at 20%. Tough to hit these days. As a good friend founder says "Flat is the new growth." The Rule of 40 is out the door.

In summary, with capital drying up or allocated elsewhere, businesses rightfully are on the defence, especially those most vulnerable - technology as the industry is largely cyclical (just compare Nasdaq 100 and Dow index). For now keeping a closer eye on spend and burn is one way to extend cash runway.