SaaS Financial Model - Liquidity
Revenue, whether one-time, monthly recurring (MRR), or annually recurring (ARR), is important part of the Software as a Service (SaaS) industry. However, revenue is just one half of the equation for success. The collection of the cash is the other half of this equation.
Cash is critically important to any business. Collections of cash and converting processes into liquid assets is the key to businesses survival.
Liquidity in the SaaS financial model is essential. So how can a SaaS business improve their liquidity?
Revenue vs. Collections
It is important to understand the accounting concepts when discussing revenue and receivables. When a product or service is purchased by a client, the revenue cycle has started.
The simplest part of the accounting entry to is to book Accounts Receivable (AR) and Revenue. As you can see in the entry, at the initial recording of the transaction no cash has changed hands yet. The cash doesn’t come into the business until collections of the receivable.
The company may have earned revenue on the sale, but the cash still needs to be collected. [NOTE: Revenue recognition is a little more complicated in SaaS financial model, see SaaS-Monthly Recurring Revenue for discussion on revenue recognition and methods].
Collect Secure Down Payments from Clients
For one-time projects or custom programming services, get a down payment before the start of a project. This will ensure that the customer’s money is funding operations as opposed to the business’s money.
In the construction industry a percent complete method of accounting is generally utilized. One aspect from that industry that translates well to the SaaS industry is the concept of job cost borrowing.
In a nutshell, job cost borrowing is where one job’s cash is funding another job. What this means is the business is funding the jobs until collections can happen. An important aspect to securing down payment is, if the contract allows, keep the down payment on the books and only apply to the last invoice. If done properly there will be little to no AR at the end of the project. This helps improve the overall SaaS liquidity.
Monitor accounts receivable on a weekly basis, and charge interest on invoices that are past due.
Keeping on top of accounts receivable is a necessary job.
The older a respective accounts receivable becomes, the less likely the company will collect. Staying in touch with customers is key to improving collections.
The longer the customer’s account is outstanding, the more frequently they should be contacted.
There should be interest triggers in older accounts receivable. If an account goes past a certain time frame, such as 45 days, then the company should start charging interest. This process can be automated in most accounting software. The interest can also be used as a motivator for collection calls on older accounts. If the company is not charging interest, then they are giving the customer an ‘interest free’ loan.
Understand the implication of days sales in accounts receivable.
The calculation of days sales in accounts receivable tells management how many days until they collect, on average, a sale. For the SaaS industry this average is anywhere between 52 – 63 days.
Between these two dates the company will have to pay vendors, staff, rent, etc. If the collection takes longer than average, then either the owners will have to infuse personal cash, or the company will have to pull on their respective operating line of credit.
Strive to reduce the days sales in accounts receivable to increase cash inflow.
Speed Up the Billing of Customers
Some businesses get caught up in the product or service and delay billing a customer. If the product is at a milestone point where it can be billed, whether it is progress billing or final billing, it should be billed.
If the process is manual, then require the job owner or manager to bill within a set number of days once a milestone has been reached.
The billing can be the first day after the previous weeks chargeable time has been entered. Have weekly meetings on work in process and why or why not has time or product costs been billed.
When the company speeds up the billing of customers, even by three days, they have accelerated the collection process which can significantly improve the company’s cash position.
Monitor Invoicing Procedures to Ensure Accuracy
Receiving an incorrect invoice can substantially delay payment from a customer. This will extend accounts receivable collections and hurt cash flow.
Implement a consistent process in verifying the accuracy of an invoice as it goes out. Verify the correct items are being billed, the customer name and address is accurate, and the individual or department are clearly indicated on the invoice.
This practice is quite popular in the professional services industries, especially among lawyers and accountants.
The practice is that a company grades all of their client’s from A – D.
‘A’ client’s are the ones who pay on time, are easy to work with, and their questions or changes are reasonable. The staff don’t have much of any time written off on these clients.
The ‘D’ clients are the opposite, they don’t pay on time, they don’t respond to questions or request timely, have unreasonable turn around time, and most likely their jobs have the most time written-off. These client’s need to be periodically removed.
Most of the time the older accounts receivables can be traced to these ‘D’ clients.
There is a saying in the public accounting world, ‘don’t work for free’. When you have ‘D’ clients, if they are with the company long enough, you will have written off so much time that you essentially were working for free on a project for them. Sometimes it’s time to move on.
Tips and Recommendations:
Convert receivables to cash quicker. Even improving your days AR outstanding by a couple of days can have a significant impact on the cash position. For increase liquidity in the company:
- Collect secure down payments from clients. This will ensure that the client’s money is funding operations and a company’s cash flow will not be affected.
- Monitor accounts receivable on a weekly basis, and charge interest on invoices that are past due.
- Speed up billing of customers (even three days earlier each month) in order to accelerate the collection process which can significantly improve the company’s cash position.
- Monitor invoicing procedures to help ensure correctness.
- Ditch the ‘D’ clients.
Companies work hard to provide the product or service. Make sure the cash is coming into company and focus on the ways to improve the liquidity.