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Quick Guide to SaaS Expense Forecasting


Quick Guide to SaaS Expense Forecasting

How long will your money last? It's a crucial question for finance leaders in any business. It's not just about knowing your current financial situation, but also projecting into the future based on your plans.


While company leaders can't control everything, such as market fluctuations and economic changes, they can influence expenses. This is why expense forecasting is valuable for CEOs, CFOs, and other executives when predicting a company's future financial performance.


What Is an Expense Forecast?


An expense forecast is a prediction of your future business costs. While the idea is simple, creating an accurate forecast is more complicated than it seems.


It's crucial to have an accurate and useful forecast for any business, especially for SaaS startups. This is so important that there's a term for it: burn rate.


Knowing your burn rate gives you a clear understanding of how long your money will last. The aim is to align expenses with natural revenue growth and funding, ensuring you can achieve profitability. Expense forecasts help identify areas where spending can be cut, optimizing your cash runway for sustainable growth.


Importance of Expense Forecasting


The economy has been tough lately, with unpredictable changes and significant market shifts. Sadly, a whopping 90% of startups don't make it. Knowing your burn rate is essential.


Even successful startups have had to lay off many employees. While things are getting a bit better, there's still uncertainty. However, startups can succeed with careful planning. This means understanding your cash burn rate in relation to revenue growth and the number of employees.


Is Budgeting Different from Forecasting?


Financial forecasting is a way to predict future business outcomes by considering expert opinions and existing data. It involves looking at various factors, not just direct ones affecting your business, but also broader influences like social and political factors in the economy.


Unlike budgeting, which is typically short-term, financial forecasting covers both short and long periods, taking more time to create. Companies often need to make multiple forecasts to get the most accurate predictions for their business conditions.


Budgeting, on the other hand, is the strategic planning of a company's finances in crucial areas. This involves creating a budget that outlines projected cash flow, estimated revenue, and daily operational expenses for a specific period. Budgeting is essential for understanding the viability of your ideas.


Before creating a financial budget, it might be difficult to visualize your revenue plans and business expenses. However, a detailed financial outline helps you see what is achievable and allows for necessary adjustments. Since revenue and expenses are not entirely predictable, budgets are typically short-term, often on an annual basis.


How to Forecast Expenses


To create an expense forecast, start by taking last year's costs, add a percentage increase and you're done. However, it's essential to consider historical projections and understand the connection between expenses, revenue growth, and budgeting.


Begin by forecasting revenue, with either of these approaches:

  • Top-down Approach – leaders setting realistic revenue targets for departments.

  • Bottom-up Approach – department heads create plans aligned with leadership goals.


Next, determine monthly spending by considering all costs, such as marketing and hosting expenses. Factor in headcount models, considering costs associated with each new employee. Break down expenses by department based on business strategy—some may be expanding, while others may be cutting back.


For accuracy, analyze each component individually. Periodically review forecasts to enhance accuracy and minimize variances. Repeat this process monthly and use insights to create new budgets. This outlines the general process of forecasting expenses, with a focus on operating and payroll expenses.


Forecasting Operational Expenses


Your day-to-day operating expenses, found in the income statement, cover regular items for SaaS companies, such as salaries, marketing, and hosting.


These expenses fall into two categories:

  1. Fixed – Fixed expenses, like rent and depreciation, remain stable each month.

  2. Variable – Variable expenses, like marketing and travel, fluctuate based on sales.


For SaaS, hosting costs, termed as cost of revenue or SaaS cost of goods sold, are also variable.


To predict variable expenses, start by forecasting revenue. For accurate projections, use methods like the sales capacity model, which determines the needed sales reps based on historical data, or the ARR snowball method, which relies on short-term revenue trends. When historical data is limited, be thorough with assumptions.


Once you estimate future revenue, calculate variable expenses by determining historical operating expenses as a percentage of revenue.


Forecasting Payroll Expenses


For SaaS startups, payroll stands out as a major cost. To predict payroll, you must first predict the number of employees you'll have. This involves forecasting revenue. Look back at your revenue forecast and related targets. Then, thoroughly review your current workforce, including names, departments, roles, salaries, benefits, and taxes.


Consider what else is connected to your revenue targets, such as your product development plan. Determine the headcount needed for each stage of the plan and the required departments and roles.


Use this information to estimate the payroll for future hires. Check if the projected payroll aligns with your expected revenue growth or if you need additional funding.


Since employee costs are a significant expense, they pose a considerable threat to your available funds. This is why scenario planning, which involves asking "what if?" questions, is crucial. Explore scenarios like what happens if your revenue doesn't grow as predicted or if you can't secure the necessary funding. Be prepared to adjust hires and your product development timeline if needed.


Conclusion


Understanding how long your money will last is a critical concern for finance leaders, especially in the unpredictable economic landscape. While external factors like market fluctuations are beyond control, expenses can be influenced through effective forecasting.


Expense forecasting is particularly valuable for CEOs, CFOs, and executives, providing a clear projection of costs to enhance predictions and decision-making. The concept of burn rate, crucial for startups, involves aligning expenses with revenue growth and funding to ensure sustainability. Overall, the strategic understanding and prediction of expenses are pivotal for businesses to navigate financial challenges and secure sustainable growth.


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