Managing Cash Flow in a SaaS Startup

In a conventional startup, cash is received upfront for one-off product sales — but SaaS startups don’t run on conventional business models.

SaaS startups have unique cash flow dynamics, as cash from customers is typically collected in small, recurring monthly payments. In their early days, SaaS startups tend to spend heavily on customer acquisition, creating a delay between spending the cash to obtain a customer and collecting the revenue over time. However, once a SaaS startup has moved beyond its growth phase, cash flow dynamics can represent an advantage.

Some of the strategies that SaaS startups implement to help manage cash flow in their growth stages and beyond include a mix of revenue—and customer-centric strategies combined with financial and operational strategies. Demonstrating strong cash flow management is key to successful fundraising periods and to ensuring long-term growth.

The SaaS Cash Flow Challenge: Understanding Your Unique Dynamics

In a SaaS startup, there’s a complicated relationship between bookings, billings, collections and revenue. This is largely due to the gap in time between a sale, when the customer actually pays for the service, and when your startup is able to recognize the revenue. This can have a significant impact on cash flow and working capital.

Significant growth should be the priority in the early stages of your SaaS startup. However, high growth can negatively impact your cash flow despite strong revenue earnings due to the timing mismatch between cash outflows and inflows. This is often referred to as negative operating cash flow, and it highlights the importance of managing expenses carefully while revenue is still catching up. It’s important for young startups to spend heavily to acquire customers, while revenue comes in gradually over time, not immediately. SaaS startups have to invest in sales and marketing costs to win new customers, and it may take several months to recoup these customer acquisition costs (CAC) through subscriptions and recurring revenue.

Building Your SaaS Cash Flow Statement

A good cash flow statement for SaaS startups should include operations, investments and financing, yet the interpretation differs from that of a conventional startup due to the recurring revenue that subscription-based entities rely on.

• Operations: These are the cash inflows and outflows from subscriptions, and they indicate how effectively cash is generated from day-to-day activities.
• Investing: This details where cash used for or generated from investors is being spent.
• Financing: This details the cash flow between the startup, its owners and creditors. In SaaS startups, financing cash flow is especially important during early growth stages, as it reflects how much capital is raised through equity or debt to extend runway and support expansion.

A SaaS cash flow statement involves various intricacies, including deferred revenue. A high amount of deferred revenue reflects a high influx of cash, which can signal healthy growth.

Various key metrics should be tracked on a SaaS startup’s cash flow statement, with one of the most important being the CAC payback period. This is the amount of time it takes to break even on the money spent to acquire a customer. The faster the CAC payback period, the better. However, SaaS startups should aim for 12 months or less.

Operating Cash Flow Components

The operating activities that drive cash flow in a SaaS startup are a mix of cash generation, cash consumption and financial activities. Cash generation activities include earning revenue from acquired customers and working to lower churn and retain existing clients. Tracking these activities helps measure free cash flow, which indicates the amount of cash your startup has available after covering operating expenses. Cash consumption activities involve sales and marketing costs and overhead expenses. Financial activities involve investment in the startup and the timing of payments.

Working Capital Considerations for SaaS

Specific working capital considerations separate a SaaS startup from other, more traditional business models. Rather than tying up revenue in inventory or physical assets, SaaS startups are more driven by a recurring revenue model. Deferred revenue, for instance, can create a cash flow advantage by offering a non-dilutive source of capital that can be reinvested into the startup.

Other working capital elements include managing accounts receivable for enterprise contracts and working to optimize prepaid expenses and annual software licenses.

SaaS Cash Flow Forecasting Methods

Good cash flow forecasting is key for accounting for the recurring revenue and growth trajectory of SaaS startups. Some strategies for building robust models include:

• Building cohort-based models that reflect customer behavior based on different types of consumers. Assessing how different customer segments behave over time can help better anticipate risks and create more accurate financial forecasts.
• Create scenario plans for growth rates and funding timelines. This is best done by building a baseline forecast, then identifying key variables that can be modeled and adjusted to understand the impact on cash flow.
• Build a 13-week rolling forecast. This key short-term tool provides a weekly, detailed view of inflows and outflows, allowing leaders to identify and react to projected shortages or surpluses.

Optimizing Customer Collections and Billing

Your startup’s billing operations can represent a strategic cash flow driver if you work to systematically optimize payment collection in your SaaS startup. SaaS startups should strive to design billing strategies that maximize upfront cash collection, work to implement dunning processes that minimize failed payments and structure contracts to incentivize annual prepayments versus monthly payments.

Annual vs Monthly Billing Strategies

Should your SaaS startup strive for annual or monthly payments? If you’re looking for a surge in cash flow, annual contracts are the way to go. Annual contracts deliver a large, upfront payment that startups can invest back into their business immediately, versus monthly contracts, which offer smaller, yet more frequent payments.

Consider offering incentives for annual payments to encourage purchase. Discounted pricing and value-added incentives are strategies to entice consumers to purchase for the year.

Reducing Payment Failures and Churn

Churn and payment delays can have an impact on your SaaS startup’s cash position, making it crucial to minimize each. Some strategies for doing so include:

• Implementing robust payment systems that streamline payment collections.
• Create triggers that can warn startup leaders of at-risk accounts.
• Design win-back campaigns for consumers who have left that can help deliver immediate cash flow to your startup.

Managing SaaS Operating Expenses for Cash Efficiency

Though you’ll have to spend money to make money in your SaaS startup, it’s important to control the burn rate and maintain growth momentum. This can be done through strategic expense management to maintain capital efficiency and ensure long-term financial stability.

Start by optimizing your largest SaaS expense categories of payroll, infrastructure and sales costs. Automate various processes to reduce labor and improve efficiency. You might also be able to negotiate vendor contracts so the terms are more favorable for your startup.

You should also strive to implement variable costs that can scale with revenue. Do this by tracking expenses and identifying which ones fluctuate with sales. You may then be able to shift from fixed costs to variable ones by outsourcing non-core functions or using advanced programs to automate certain tasks.

Key SaaS Metrics That Drive Cash Flow Decisions

Your startup should be tracking several metrics that can help influence cash flow decisions. These metrics go beyond the basics and include:

• CAC payback period
• Cash flow coverage ratio
• Net dollar retention
• Expansion revenue opportunities
• Billing efficiency
• Collection effectiveness ratios

Together, these indicators provide a clear picture of your startup’s overall financial health and its ability to sustain growth.

Funding Strategies and Cash Flow Planning

To optimize dilution and maintain growth momentum, align fundraising timing with your cash flow projections. This can help you determine the ideal amount to raise based on your forecasts and allow you to raise the right amount of money at the right time to support long-term goals.

It’s best practice to plan for 18—to 24-month runways between funding rounds, which offers the ideal balance between hitting growth milestones and avoiding equity dilution. If you need to bridge any cash flow gaps in the meantime, some alternative financing options include merchant cash advances, revenue-based financing and venture debt.

Venture Debt and Revenue-Based Financing

Revenue-based financing (RBF) and venture debt are two alternative financing options for startups to bridge gaps between financing rounds. With RBF, your startup receives capital from investors in exchange for future revenues. Venture debt functions more as a loan, allowing a startup to extend its cash runway without giving up equity.

Planning Your Next Funding Round

Fundraising processes should be based on cash flow projections and market conditions. Fundraising timelines should account for six-month processes, and startups should create milestone-based budgets that demonstrate capital efficiency. Cash flow scenarios can also help with investor due diligence.

Technology and Tools for SaaS Cash Flow Management

Implementing a robust financial infrastructure can help provide real-time cash visibility for your startup. It can also help automate forecasting and financial modeling. Just be sure to select programs that are designed for SaaS startups. Advanced features such as automation, AI and the ability to integrate with other programs are a bonus.

Master SaaS Cash Flow with Strategic Financial Leadership

Good financial leadership can help your startup master the management of its cash flow. However, as your SaaS startup grows and finances become more complex, you might look for a reliable partner to help with financial management. That’s where Graphite Financial can help. As a full-service financial partner with deep SaaS expertise, we can serve as a key extension of your business to proactively optimize your cash flow and streamline cash management.

Contact Graphite today for more information and to schedule a free consultation.

Frequently Asked Questions

How much cash runway should a SaaS startup maintain?

SaaS startups should strive to maintain a cash runway of 18 to 24 months. This buffer allows startups the time and space to achieve key growth milestones, navigate any market fluctuations and raise additional capital. While an 18 to 24-month buffer is generally considered the best practice, this can vary based on your startup’s stage and the current economy.

What’s the ideal CAC payback period for healthy cash flow?

An ideal customer acquisition cost (CAC) payback period for healthy cash flow is 12 months or less. High-performing SaaS startups may achieve a CAC payback period of five to seven months. The shorter the CAC payback period, the faster a startup is able to recover costs, facilitate growth, and, generally speaking, manage its cash flow. A CAC payback period of more than 12 months tends to signal problems with profitability and cash management.

How do you calculate cash flow for a SaaS startup?

Calculating net cash flow involves subtracting total cash outflows from total cash inflows. The formula is as follows:

• Net Cash Flow + Total Cash Inflows — Total Cash Outflows

To accurately determine cash flow, you’ll need to gather financial data, including income statements, balance sheets and other relevant reports for the period you want to analyze. Following this method provides a clear guide to cash flow for making informed financial decisions.

Should SaaS startups prioritize growth or cash flow efficiency?

Whether to prioritize growth or cash flow efficiency largely depends on the current state of the startup. For instance, early-stage startups should prioritize growth over cash flow efficiency to help prove product-market fit and scalability. Conversely, more established startups should shift their focus to cash flow efficiency after they’ve solidified their place in the market. More mature startups should aim to abide by the Rule of 40, which states that the combined value of a startup’s revenue growth rate and its profit margin should be 40 percent or greater.

What percentage of customers should be on annual contracts?

The ideal percentage largely depends on the type of customer your SaaS startup is targeting and the state of your startup. Smaller startups are often better suited for monthly payment plans, while larger startups tend to favor annual contracts. Annual contracts offer upfront cash for your startup and can help secure revenue for the year. They also tend to help with retention.

How do you forecast cash flow with unpredictable sales cycles?

Forecasting cash flow with unpredictable sales is best achieved using a rolling forecast so projections can be regularly updated. Implementing scenario planning to gauge best-case, worst-case and the most likely outcomes can also help your startup better prepare for various internal and external factors.

When should a SaaS startup become cash flow positive?

SaaS startups should become cash flow positive after achieving sustainable growth and can fund their own ongoing operations. While this timeline can vary based on the startup, its business model and other factors, achieving a positive cash flow usually occurs within 2 to 3 years.

What are the warning signs of cash flow problems in SaaS?

Some red flags that could be indicative of actual cash flow problems include late customer payments, shrinking cash reserves, increasing debt, problems paying vendors or employees, high overhead and poor financial forecasting.

How do deferred revenue and cash flow relate in SaaS businesses?

Deferred revenue is cash received from customers for services that have yet to be delivered. It can boost a SaaS startup’s cash flow immediately, but revenue is not officially earned until the service has been provided over the life of the contract or subscription. Deferred revenue follows accrual accounting principles and can help demonstrate a startup’s long-term earnings with greater accuracy.