I recently posted a LinkedIn poll asking what career path makes for the best SaaS founder. Out of the four options, only 8% of respondents voted for a founder with a finance background.
It’s incredibly common to be a founder in the software space who wasn’t a CFO or other finance professional in a past life. And a financial analyst is an expensive resource that most early-stage companies can’t afford until much later in the game. So, founders are on their own early on.
The sheer number of different ratios and metrics can be overwhelming for folks without financial backgrounds. It doesn’t help that there are tons and tons of articles out there about these different metrics — and many of them contradict each other.
Here’s how to fill in the blanks if you come from a background outside of finance.
The most important thing is that you have to understand the numbers
Even if you don’t know how to actually do the calculations, you need to understand the numbers and why they’re important. Ultimately, your grasp of the numbers is going to control the success — or failure — of the business.
The financial side isn’t just figuring out, “How fast can we get revenue?” It’s “How fast can we get revenue? Who should we hire? When should we hire them? What should we pay them? What does it cost to acquire and retain a customer? How much cash do we have and will we have?” The answers to these questions help you make informed decisions for your business.
Plus, your investors are going to expect financials. All these metrics exist for a reason, but if you’re not clear on their purpose and what they can tell you, you’re just checking a box to pass a list of numbers you don’t understand to the people who are writing you checks.
Here are some of the key concepts you should get a handle on when it comes to your company’s financials.
One of the most important aspects of this is understanding what your customer is willing to pay for your product and why. But it goes beyond that.
You want to understand the nuts and bolts that go into the cost side of product pricing. What is the cost of goods sold, and how do you calculate it?
How will you compensate your sales team for getting your product into customers’ hands? How will the commission structure impact your bottom line? How many qualified leads need to come in to give you enough pipeline to close deals? How many leads can one person on your business development team reasonably generate each month? Given that number, how many business development folks do you need to hire?
You’re basically working your way backward from your goals to build out the infrastructure you need to reach them. This sounds fairly straightforward, but it also raises the issue of cash flow and how you’re going to pay for all of it.
Cost of customer acquisition
The first thing you have to do is define the value of the customer. Is it a one-time value or lifetime value?
Lifetime value is ultimately going to give you the most instructive information in the long term. At a minimum, you want to make sure that you’re charging the customer what they cost you to acquire over their lifetime with your company.
There’s strategy involved in how you calculate this number. Are you going to include every sales and marketing expense? There’s also a certain amount of cleverness involved — you can take expenses in or out to make the equations work. You just need to make sure that you’re clear about what’s included in the equation when you share your financials with investors.
What you can put ‘below the line’
SaaS founders tend not to pay much attention to EBITDA, since acquirers and investors often base your valuation on your ARR run rate or growth rate. But ignoring EBITDA entirely is a mistake — it still factors into critical equations that investors care about.
One of the most important aspects to understand about EBITDA is what can go “below the line.” You can put nonstandard business operations costs, like attorney fees for fundraising, below the line, which makes your EBITDA stronger.
One of the most powerful, instructive numbers exercises you can do when you’re running a business is variance analysis on both P&L and cash. I did these while I was running Talent Rover, and I still use them at Place.
It’s the fastest, most effective way to understand where the issues are with your business because it’s basically telling you how you’re performing versus how you thought you were going to perform.
And it goes beyond “we spent too much money” or “we didn’t bring in enough money.” It can point out accounting mistakes, customers paying late, and so many other red flags that can help you understand why you’re in a different place than you forecasted.
One key to performing an effective variance analysis is setting up a transaction-based forecast that has real-time data and can be easily adapted when needed.
How to learn to understand the numbers
If these concepts are making your head spin, speak up.
Don’t be afraid to ask questions. Ask your team, your advisors, other founders, your investors. If it’s going to help you better understand your business’s financials, there’s nothing wrong with saying, “I don’t know what this means. Could you explain it?”
Of course, the way you ask the question is going to change depending on who you’re asking. If you’re asking an investor, for instance, communicate that you’re asking why they need something so that you can understand and make sure you calculate it correctly.
If someone explains a concept to you, and you still don’t really get it — get someone else to explain it, and someone else, and someone else, until you truly, consistently understand it.
You don’t have to do it all — in fact, you can’t
There are hundreds of different metrics and ratios that you can run on your business’s financials. You shouldn’t (and really, you can’t) run each one manually.
But you want enough ratios to explain the full customer cycle, from the initial sales conversation through when the customer decides to leave. Understanding that cycle from a cash flow and growth standpoint will help you make the right decisions for your business.
Don’t worry about being able to crunch the numbers yourself — you can leverage software like Place to tackle the math. But do get caught up and obsessed with what the numbers are trying to tell you.