Step-by-Step Expense Forecasting: A Guide For SaaS

To a certain extent, there’s a limit to what company executives can control. They can put in place an expert sales and marketing team. They can ensure the product or service is top notch and tailored perfectly towards the target demographic.

But at the end of the day, the market is going to have the final say on how that transitions to revenue and profits. Every industry goes through ups and downs, on both a market segment and macroeconomic level.

CEOs, CFOs and other senior executives can’t influence the wider economy, but what they can control is expenses. That’s why, when it comes to projecting the future financial performance of a company, expense forecasting is a powerful tool that’s worth taking the time to get right.

Having a clear and consistent projection on the company’s costs will allow a far better understanding of how the business can be expected to perform through all stages of the market cycle.

That makes for more accurate projections, and ultimately, better business decisions.

What Is an Expense Forecast?

An expense forecast is simply a projection of your future company costs. While the concept is fairly straightforward, the practicalities of actually putting together an accurate forecast are more complex than it can first appear.

That being said, building an accurate and usable forecast is critical for any type of business, but especially for SaaS startups. They’re so important, in fact, that we have a term for it: burn rate.

When you have a clear view of your burn rate, you have a clear view of the length of your cash runway. The goal is to line up expenses with natural revenue growth and funding roads so that you can reach your end goal: profitability. Expense forecasts can be used to find obvious (and not so obvious) areas where spend can be reduced and the length of your cash runway optimized to promote sustainable growth.

Why Is Expense Forecasting Important?

It goes without saying the economy has been rough these past few years. Things have been unpredictable, and we’ve seen huge market shifts. The unfortunate truth is that 90% of startups fail. So, understanding your burn rate is crucial.

Even successful startups have had to resort to mass layoffs. Though things seem to be slightly improving, there’s still a lot of hesitation. That being said, startups can still find success if they plan. That requires a clear view of your cash burn rate and how that relates to revenue growth rate and headcount.

How to Forecast Expenses

At its most basic, to make an expense forecast you can simply take last year’s costs, add a percentage increase (say, 4%) to that number, and you’re done.

There’s a bit more to it than that, though historical projections are a part of it.

First, recognize that it’s impossible to separate expenses from revenue growth and your budgeting process. In financial planning, it’s common to look at expenses as a percentage of revenue. That’s why, to forecast expenses, the first thing you’ll need to do is forecast revenue.

Of course, there are a couple different high-level approaches to revenue forecasting: the top-down approach, and the bottom-up approach.

The top-down approach is all about the leaders of the company creating (realistic) revenue targets, then communicating exactly how to achieve these goals to individual departments.

A bottom-up approach goes the other direction — department heads would create their own plans, justifying each expense in terms of how they’ll match the revenue goals set by leadership.

The first thing to do is determine how much you’re going to spend each month. Consider all costs. How much are you setting aside for marketing? What about hosting costs?

Since certain expenses may depend on your headcount, you also need to work your headcount models into your expense forecasting — for example, if you know each new employee will require a $1,500 laptop, you can put that on the list.

But you also need to break things down by department — depending on the overall business strategy, some departments might be planning major expansion in the upcoming months or years, while others business units could be cutting back or closing down completely.

In order for an expense forecast to be as accurate as possible, finance teams need to look at each of these individual components and project them out individually.

The last step is to review your forecasts. This can help you make future forecasts tighter, leading to less waste on variances. Do this at least once a month, using the insights to aid in creating new budgets.

So, that’s a general outline of how to forecast expenses. Let’s get a bit more granular by looking at how to forecast operating and payroll expenses.

How to Forecast Operating Expenses

Your operating expenses include day-to-day line items, which you’ll find on the income statement. For SaaS companies, they include salaries, marketing costs, and hosting costs. Operating expenses are divided into two types: fixed and variable.

Fixed expenses like rent and depreciation and amortization are easy enough to forecast, as they generally won’t change from month to month.

However, some expenses do change from month to month — these are your variable expenses, which are tied directly to how many sales you make. Variable expenses include your marketing costs, travel costs, and commissions. Notably for SaaS companies, they include your hosting costs, known as cost of revenue or SaaS cost of goods sold.

Once again, since variable expenses depend on sales, the first thing you’ll want to do is forecast revenue. Your SaaS revenue forecasting methods can (and should) be a lot more in-depth than simply estimating a “reasonable” growth rate. If you have a good amount of historical data, you might use a sales capacity model, which maps out the number of sales reps you’ll need to hit specific goals.

If you don’t have a lot of historical data, you could use the ARR snowball method, which builds off of short-term revenue trends. Of course, this method is more dependent on assumptions than the sales capacity model, so make sure you get those down pat.

So, you have your estimate of future revenue — how do you get your projection of variable expenses? The answer is calculating historical operating expenses as a percentage of revenue.

How to forecast payroll expenses

For SaaS startups, payroll is one of your biggest expenses. To forecast payroll, you’ll have to forecast headcount. And to forecast headcount, you’ll have to forecast revenue.

So, refer back to your revenue forecast and accompanying revenue targets. Then, perform a thorough assessment of your current workforce — names, departments, roles, salaries, benefits, and taxes.

What else is tied to your revenue targets? Well, your product development roadmap. You’ll need to consider what headcount you’ll need for each stage of your plan. What departments will you need them in? What roles will they have?

Based on your answers, you can forecast payroll for those future employees. Does the amount you’ll have to pay fit with your projected revenue growth, or will you need to secure more funding?

Since headcount is such a big expense, it’s one of the largest threats to your cash runway. That’s why, on top of understanding your accrued payroll obligations, scenario planning with headcount and payroll forecasting is so important. Scenario planning asks “what if?” questions. What if your revenue doesn’t grow at the rate you predict? What if you can’t get access to the funding you need? Would you be able to readjust hires and your product development timeline?

How to Forecast Your Expenses with Mosaic

For SaaS startups, forecasting business expenses is a necessary task. That being said, it’s not necessarily an easy task. Figuring out how expenses, revenue, and headcount projections all tie together can take many hours — especially if you’re relying on spreadsheets,  prone to human error and problems with version control.

The right software makes things much easier. By connecting directly to your ERP, Mosaic pulls expense data into your SaaS financial model. There’s no need to sift through hundreds of GL entries and punch them into Excel.

Instead, you have a clear, colorful view of these expenses sourced in real time within your expense dashboard. They’ll be automatically divided by type (operating expenses, cost of revenue, etc.) as well as department.

The idea is that, with clear visuals, you can track expenses and single out budget variances, which you can then communicate to department heads. These visuals also create a “common language” with department heads, who may not be used to trawling through financial statements.

In spite of its name, though, spend forecasting is about more than just predicting expenses – that would be a little boring. It’s also about understanding the context of those projected expenses, and that means financial metrics.

You’ll want to understand expenses as a percentage of revenue, and look at the efficiency of your marketing spend in driving revenue (here, you’ll use the CAC:LTV ratio). Mosaic’s dashboard helps you clearly view these metrics. You can make specific targets, then adjust your strategy based on how close you are to your goal – a key to driver-based planning.

A Complete View of Your Spend

By integrating with your own pre-existing systems – CRM, ERP, and HRIS – Mosaic gives you a complete view of your SaaS company’s situation, allowing you to balance headcount against revenue, cash flow against expenses, and your short- and long-term plans against the data in your financial dashboards.

All from a single, centralized platform that’s constantly updating in real-time.

For added flexibility and security, you can run scenarios on automatically generated revenue, headcount, balance sheet, and expense baselines.

Begin leveraging software that helps you ensure each expense is justified. This way, you won’t have to worry about outrunning your runway.

Want to learn more about how Mosaic improves your expense planning and analysis? Schedule your demo today.