There are many reasons you might want to create a financial forecast, most of which boil down to either 1) helping you manage the business and understand its dynamics better, or 2) telling the story of the company to others (whether the internal team, senior management, the board, investors, or prospective investors).
Here we'll show you how to forecast revenue (and associated key metrics) for a subscription SaaS business.
If you'd like to follow along in Excel, here's the file we'll be walking through (though you'll still be able to follow along without it):
We'll start first by forecasting our number of active subscribers. To do this, we forecast two key components: The number of new subscribers in a given month, and the number of canceled subscriptions (or "churn").
To begin with a simple illustration, we'll assume that we win 10 new subscribers per month. We'll also assume that these subscriptions are cancellable any time, and that 10% of existing subscribers choose to cancel each month.
The beginning # of active subscribers in any period equals the ending number from the prior month. We refer to this method of forecasting as a "screw".
A basic subscriber forecast.
As a quick aside, there are many other ways to go about forecasting churn, like analyzing cohort behavior over time, to potentially get to a more accurate projection. Our view is that it's only worth getting into that level of detail once the company has reached a certain level of maturity, likely in the range of several thousand subscribers. Before then though, the simpler monthly churn rate is the approach we most often recommend because it's easier to calculate, easier to forecast, and it prevents you from getting bogged down in unnecessary detail and drawing conclusions from too sparse of data.
So now we have a simple framework for forecasting our number of active subscribers for any period. Next we add in our assumption on revenue per month, and multiply that by our # of active subscribers to get total revenue per month.
We'll add in a calculation for ARR (Annual Recurring Revenue) here as well by simply multiplying monthly revenue by 12.
Monthly Subscription Revenue = [ Ending # of Active Subscribers ] * [ Avg Revenue / Subscriber ]
We've now accomplished our goal of forecasting subscription revenue for our SaaS business.
Next, let's say we charge some consulting fees to implement our product any time we get a new subscriber, and let's say we charge $5k. You can see that logic added in below, and we've also totaled up these two revenue lines (Subscription Revenue and Implementation Revenue) to get Total Revenue.
Note that our ARR calculation here does not include the new non-recurring services revenue.
We could also get a bit more sophisticated about how we forecast our number of new customers each month instead of simply hard-coding our new customer count at 10 per month. Let's say our primary customer acquisition method is converting visitors from our website. For any set of website visitors, some of them contact us to become a lead, and then some of those leads convert into paying customers.
For starting baseline assumptions, let's say we get 1,000 website visitors per month, 2% of those convert into leads, 20% of our leads convert into paying customers, and our marketing efforts drive an increase in website visitors by 1,000 per month.
A slightly more sophisticated sales funnel forecast.
We could then go further to calculate direct costs to get to gross profit, calculate customer LTV, tie new website visitors to marketing spend, and so on, but we'll save those steps for future articles.
Want to be more sophisticated about your forecasting? We're the makers of Modeloptic, a powerful and intuitive financial reporting & projections platform. We'd love to hear from you at firstname.lastname@example.org.