Why SaaS CFOs Are Essential

The topic of when, how, and why to hire your first CFO has come up not once, but three different times this week.

Once a business crosses $2 million in sales, there is a strong need for a CFO. But the problem is that most businesses can’t afford the cost of a full-time CFO.

Most of the founder CEOs who are unaccustomed to working with a CFO aren’t even clear on what a CFO actually does.

I think I’ll take this article to explain.

First, let’s start with a breakdown of the finance function.

The finance function has two core components.

The first is accounting and the second is financial planning and analysis (FP&A).

The accounting department is typically run by a controller who is a certified public accountant.

The purpose of the accounting department is to answer one simple question:

“What happened in the past?”

What were the sales last week, last month, or last year?

What were the expenses last quarter, this year-to-date, or two years ago?

Accountants think about finance down to the last penny.

If you tell an accountant that last month’s sales were either $301,000 or possibly $300,001, it will absolutely drive them crazy until they can figure out the exact number for sales.

Accountants serve two audiences. They serve the management team to report historical financial results. They also produce financial results for government income taxes.

Most SaaS businesses hire a bookkeeper. A bookkeeper works in the finance function and performs task-level work in the accounting area. Bookkeepers process bills, invoices, or payroll.

They also verify documents.

For example, a bookkeeper will perform bank statement reconciliation. Did all the deposits we think we put in the bank account actually show up in the bank account? This is an important verification function.

Bookkeepers are transactionally focused.

To oversimplify, controllers manage bookkeepers and others focused on accounting tasks like accounts receivables (billing customers), accounts payables (paying bills), and payroll (paying employees).

Controllers manage people and worry about financial controls, fraud, and accounting policies.

With all due respect to my controller colleagues, controllers are super uptight, very detail-oriented, and have personalities that believe in exact precision. This is what you want in a controller.

Controllers and bookkeepers spend all day in a general ledger system like QuickBooks. This is their core application.

The other part of the finance department is the financial planning and analysis (FP&A) function.

This is usually run by a director of finance or director of financial planning and analysis.

This function is staffed by one or more financial analysts.

The FP&A team tends to focus on running financial analyses that help the executive team make decisions.

Whereas accountants and controllers are focused on the past, financial analysts tend to focus on the future.

If a financial analyst analyzes historical data, it is typically to figure out the right decision to make in the future.

A CEO or VP of sales might work with a financial analyst to answer the following question:

“What if we raised our prices by 12%, we lost 7% of our customers, and our conversion rate fell from 15% to 13%? Would we have more sales than before or less? And how much more or less?”

Financial analysts routinely answer “what if” questions.

Whereas accountants spend all day in QuickBooks, financial analysts spend all day in Microsoft Excel.

Finance people build models in Excel. These models are mathematical simulations of a business.

What if we increase our marketing spend from 12% of revenues to 20% of revenues, and that increased lead flow from 1,000 per month to 1,500 per month? Assuming the same average contract value and conversion rate, would we make more money by doing this?

Do we have enough salespeople to handle these leads? If we hire five more salespeople, but they are only 30% productive in month one, 50% in month two, and 80% in month three, at what time would our investment in marketing payoff?

A good FP&A team or financial analyst can and does answer questions like these all day.

I homeschool one of my daughters in math. For years, I’ve told her you can run a business if you know how to add, subtract, multiply, and divide. If you can do all of this with percentages, you can run a Fortune 500 company.

Financial analysts deal in percentages all… the… time.

Our selling, general and administrative (a.k.a. “overhead”) is 22% of sales compared with 17% for our competitors. Why? Why isn’t it lower? What are we doing differently? Is it worth the difference?

The ratio of our customer lifetime value is two times (200%) our customer acquisition cost compared to two and a half times (250%) from last year. Why did this happen? What does it mean for our ability to invest in lead generation? Can we afford to profitably grow sales? Should we continue the expansion of new customer acquisition, or would we be better off improving customer churn and selling to the installed base?

These are the kinds of insights that a good FP&A team can provide you.

A CFO typically has two key direct reports:

1) Controller
2) Director of Finance

If a company is quite small, the more junior version of these two roles would be:

1) Accountant (instead of Controller)
2) Financial Analyst (instead of Director of Finance)

A CFO has skills beyond these two direct reports.

The CFO is responsible for four key areas (beyond the two primary direct reports): sales growth, profitability, cash flow, and capital management.

The CFO supports sales growth by ensuring there are sufficient budget dollars allocated to those activities that drive sales (e.g., products R&D, marketing lead generation, and sales team staffing).

The CFO is responsible for ensuring the company meets its profit or EBITDA (earnings before interest, taxes, depreciation, and amortization). Many companies have sales but not enough profits. The CFO’s job is to make sure there are profits.

Cash flow is a vital issue to reduce the capital requirements of a business.

Most founders know that the #1 way to go bankrupt is to not have enough sales. This is intuitive to most people.

What most founders do not know, but every CFO does know, is the #2 way to go bankrupt is to have too many sales.

This is very counterintuitive to most heads of sales and founders with a non-finance background.

This is due to timing.

If you land a $10 million contract with Walmart for enterprise software, but they pay you in six or 12 months, you can easily go bankrupt by incurring the expenses now needed to service a mega account.

CFOs spend a lot of time thinking about the timing differentials between when cash comes into the business versus when it goes out of the business.

Do you know why some SaaS businesses have annual contracts paid for in advance by customers?

Because of CFOs. That’s why.

Finally, CFOs are responsible for capital management. If you have a SaaS business growing annual recurring revenue (ARR) by 100% per year, that’s a great business. Typically, to sustain that growth rate at a small scale (sub $10 million), the company has a negative cash burn (they are losing money).

That loss must be covered by capital. Capital comes in two forms: debt and equity.

CFOs that have a lot of capital management experience have experience securing and negotiating debt facilities, term loans, and lines of credit. They may also have experience with raising equity financings through private placements.

More experienced CFOs have done an IPO or handled the financial aspects of making an acquisition/being acquired by another company.

CFOs will vary in their capital management experience. It depends on if their prior experience was operationally focused (e.g., accounting and financial analysis) or SaaS capital markets focused (e.g., banks, venture investors, investment bankers, IPO roadshows).

A SaaS company that’s growing organically with minimal outside capital needs will only need a CFO who is operationally focused.

If a company is growing extremely quickly (and thus at risk of bankruptcy) or looking to use financing strategically, they will want a CFO who has experience with outside capital markets.

Now that we’ve covered what a CFO does, let’s talk about a practical problem.

Generally speaking, after passing the $10M ARR mark, most SaaS companies should have a full-time or near full-time CFO. The faster they are growing, the earlier the need.

In the $2M to $10M ARR range, this gets tricky. The need for a CFO is there, but it’s often not financially workable to hire a good one full time. Fortunately, there are part-time or fractional CFOs available.

The great thing about the finance function is that 90% of finance skills are transferable across industries. $10 million is $10 million is $10 million.

However, there are some industry nuances mostly around the obscure accounting rules that apply to how various revenues and expenses should be characterized in financial statements.

You want to follow these industry-specific rules and conventions for two reasons.

First, you want to avoid a tax audit.

Second, you don’t want to artificially suppress your company’s financial performance because you miscategorized certain revenues and expenses. This will negatively impact your ability to raise capital, company valuation in equity markets, and the enterprise value at exit.

When I work with founder CEOs, I used to be appalled at how poorly developed the finance function is in companies under $10M ARR. Now, I’m still appalled but no longer surprised. In fact, when a $2M a year company has a CFO, I’m pleasantly surprised.

I’m not a CFO, but I have been working with good ones for 25 years. I’m acutely aware of what happens when the finance function is underdeveloped. It’s a major headache to intelligently scale a business. You never want to scale a business into bankruptcy.

I am thinking about hosting an educational webinar with one of the virtual CFOs that I work with to discuss what a well-run finance function looks like in a SaaS business. If I have enough interest, I’d be happy to organize a professional development opportunity. If this is something you’d be interested in, submit the form below to indicate your interest.