Understand the risks of funding your company with deferred revenue
SaaS businesses can harness a recurring subscription model to establish and maintain a stable revenue profile and fund their growth. SaaS companies often require annual agreements with upfront payments, resulting in more deferred revenue that management and investors like. Management teams frequently fail to recognize that their addiction to deferred revenue may also greatly increases their business risk.
Given the addictive nature of deferred revenue, it is critical that management appreciates its potential volatility. Cash is different than revenue. Because cash is collected up front, revenue is a lagging indicator of actual business performance. Small changes in subscriber growth rates may cause disproportionate changes in cash collections. Management needs to monitor situations in which initial growth rates track to expectations, but then growth rates change months into the plan.
At the end of every quarter, SaaS execs should update at a rolling forecast, always looking out at least 12 months, as well as updating a range of outcomes and “what must be true” regarding key metrics supporting those outcomes. Each forecast should include a sensitivity analysis and understand which variables contribute the greatest volatility to outcomes with a focus on forward-looking variables. From there, what-if scenarios should be supplemented with clear action plans and trigger points.
The complete post from Forbes here: