In the fast-paced SaaS world, the ability to know when you’re veering off track is essential. One wrong turn can have potentially devastating consequences for your business if not caught and corrected early. And, having the ability to spot and leverage new opportunities in the market quickly can help you significantly accelerate growth.
Looking at variance can help you do both, especially when you understand the different kinds of variance in financial reporting and what they can tell you about your business.
The simple definition of variance is the difference between the actual performance and the projected or forecasted performance. A variance can be either favorable or unfavorable, and both can provide key insights into your business.
In this article, we'll zoom in on the types of variances that are particularly relevant to SaaS businesses. But first, let’s provide a bit more context.
Why do SaaS companies need variance reports?
First, variance reports, which are documents companies create to identify and explain variances in the business, serve as an invaluable tool for interpreting your company’s overall financial health. They offer vital clues about areas requiring immediate attention.
Second, public SaaS companies are under legal mandates to provide detailed information on variances in their financial disclosures to auditors. Even private SaaS companies, while not legally bound, routinely share variance reports along with other SaaS-specific metrics with their board and investors.
Third, these reports aren't just bureaucratic formalities; they're the triggers for change, providing actionable insights that empower you to make data-driven decisions to propel your business forward.
Examples of variance in revenue & costs
Revenue variances
Revenue-related variances are central to determining what's impacting your SaaS business the most. They equip you with the understanding needed to properly report to the board and investors.
1. Sales volume variance
In SaaS, the role of sales volume, specifically new bookings, is crucial. This is because the SaaS industry is based on a subscription model where customers are paying on a recurring basis. So, one customer can turn out to be a significant revenue stream over time.
Sales volume, which includes the number of new bookings (i.e. new customers) you’re winning, is closely linked to your annual recurring revenue (ARR), a key metric for every SaaS company. Sales volume variances (also known as sales variances) can help you determine whether your sales strategies are effective.
2. Variance in customer base
Success in SaaS is highly dependent on the number of customers you have more so than the size of their contracts. The latter is important too, of course, but it’s vitally important to your business to pay attention to any variance in your customer base.
Variance in your customer base is the difference between your projected and actual customer base. This type of variance helps businesses understand whether their customer acquisition and retention strategies are working or not.
3. Price variance
Unlike other types of variance, price variance is rarely a surprise. After all, you know when you’re changing your prices and what the potential impact will be. The value in tracking price variance is that it can help explain other variances you find elsewhere in your variance reporting.
For example, imagine you’re a subscription-based streaming service, and your revenue tripled from one quarter to the next. You already expected a favorable price variance because you recently raised your price from $7.99 to $15.00 per month, almost doubling the revenue from each customer.
While your price variance doesn’t fully explain the total difference between actual and planned revenue, which was well more than double, it leaves you with far less to investigate in your variance analysis and explain in your reporting.
Cost variances
Cost variances offer insights into what your financials are telling you about spending in your business. The difference between planned and actual costs for hosting and marketing give you a comprehensive view of your operational efficiency and effectiveness in customer acquisition, respectively.
1. Hosting costs
Cloud hosting costs are a significant and often highly variable line item in the budget for SaaS companies. Cloud cost varies based on a number of factors. Usage is a primary driver that can significantly impact the actual cost of hosting and may help to explain a difference between the actual cost and the budgeted amount.
More customer usage means increased hosting costs. But it's crucial to interpret this variance carefully. While a decrease in hosting costs might seem like a good thing, if it's being driven by a usage variance, it could actually signal underlying issues that need investigation.
For example, if the total cost incurred for hosting went down, it could be indicative of a loss in customer engagement or even a loss of customers altogether. So, in this case, what seems favorable may actually be a red flag requiring immediate action.
2. Marketing costs
Marketing costs are also a significant expenditure for SaaS companies. They directly influence your Customer Acquisition Costs (CAC). While you can benchmark your CAC with other companies similar to yours, understanding what constitutes a "good" CAC is more nuanced.
A more insightful measure is the lifetime value LTV:CAC ratio, which compares the average revenue you generate from your customers with the cost to acquire them.
If your variance results are worse than expected for marketing costs, it could mean your CAC has increased without a corresponding increase in LTV, signaling inefficiency in your marketing strategies. Conversely, if your actual results are better than expected for marketing costs, where the actual amount you spend is less than projected to acquire customers, would be a reason to celebrate, but only if it doesn't lead to a decrease in the quality or quantity of customer acquisition.
Examples of variances in asset & liabilities
Asset variances
Asset variances can help you determine where your company stands financially and what steps may be needed for future growth or stability. Here are two types of asset variances relevant to SaaS:
1. Cash on hand
Cash on hand is one of the most straightforward yet crucial types of variance to monitor in a SaaS business. Many different factors can influence your cash on hand, from operational cash flow changes to strategic business decisions like mergers or acquisitions.
A favorable variance, where your cash reserves are higher than expected, could signal efficient operations or improved revenue-generating activities. But in the broader context, interpreting cash on hand variances with such a favorable outcome may require a deeper analysis.
For example, was the difference the result of the loss of an unexpected loss of staff? If so, the variance may in fact be pointing to a potential problem. In this case, while the variance appears to be favorable, the underlying reasons for it are not. However, if the variance is the result of new efficiencies in the business that created cost savings, then the variance is truly favorable in every sense of the word.
On the flip side, an unfavorable variance, where you have less cash than projected, could be a warning sign for potential liquidity issues.
2. Intellectual property
Intellectual property (IP) is another critical asset variance to consider for SaaS companies, which includes software code, patents, and trademarks. Variance drivers in IP valuation can include legal costs, R&D expenses, and the perceived market value of your IP. Essentially, an IP variance is the difference between the estimated value of your intellectual property and its current market valuation.
If the difference between the actual value of your IP is greater than you accounted for, it could suggest your IP is gaining market recognition, validating your investment in R&D or branding. On the other hand, if the actual value is lower than expected, it might indicate depreciation in the value of your IP, prompting you to question whether it's adequately protected or leveraged.
Liabilities variances
Understanding specific types of variance in liabilities, such as interest payable and bonds payable, provides a thorough view of your company's financial commitments.
1. Interest payable
Interest payable represents the amount of interest expense your SaaS company owes but hasn't yet paid. Influencing factors can include the interest rates on loans or credit lines, the company's borrowing activities, and repayment schedules.
A favorable variance in interest payable, where the amount owed is less than anticipated, could indicate prudent financial management or possibly better-than-expected terms on borrowed funds. However, this should be interpreted carefully; lower interest payments could mean you're not leveraging credit to make beneficial investments in your company. At the same time, an unfavorable variance might point to escalating borrowing costs or poor debt management.
2. Bonds payable
Bonds payable refer to long-term debt instruments issued by your company to raise capital. Variance in bonds payable can be influenced by market interest rates, your company's credit rating, and investor sentiment.
A favorable variance occurs when bonds payable are less than expected. This could signal that your company is effectively managing its long-term debt, thereby potentially increasing investor confidence. An unfavorable variance, on the other hand, could mean your company is struggling to manage its long-term liabilities, which may lead to heightened scrutiny from investors and analysts.
Variances in SaaS metrics
In SaaS, not all critical variances are purely financial; the business-specific metrics can offer deep insights, too. These metrics often include revenue, costs, and cash, but depending on your strategic goals, other KPIs may hold the spotlight. Think of them as a type of efficiency variance as they can reveal a lot about your operational efficiency.
For example, ARR and churn rate are two metrics tracked by virtually every company in the SaaS industry. By identifying the types of variance in SaaS metrics, you gain nuanced visibility into different aspects of your business.
The variance analysis is where insights are revealed
Variance analysis is the process of identifying and investigating variances to determine why they occurred and can offer deep insight into the financial and operational aspects of your business. The process itself is pretty straightforward. However, it can be very time-consuming without the right tools.
Many of the examples of the different types of variances we’ve provided here are somewhat simplistic. However, conducting a variance analysis for a line item or metric that has multiple potential drivers, is anything but simple. And, relying on spreadsheets for analyzing these kinds of variances can make it a daunting task.
Using a technology like Drivetrain makes even the most complex variance analysis simple, with advanced features such as automated data collection, real-time analytics, and customizable dashboards that allow for effortless interpretation of variance report results.
In SaaS, understanding the different types of variance you’re likely to encounter is essential for effective variance reporting. Embracing a comprehensive approach to variance reporting – one that includes the right SaaS metrics along with your financial metrics – can help you refine your strategies and act as a catalyst for sustainable growth.
If you have the time and technology to dig deeply into your variances, you’ll discover gold – the kind of insights that you can use to make sound, data-driven decisions to keep your business on track and move forward faster toward your goals.
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