There is no one answer for how much money companies should keep in the bank. It varies from company to company and industry to industry. In addition, SaaS companies have a unique dynamic with their recurring revenue and the difference in current financing available.
If you’re reading this, your SaaS business is likely focused on growth. You won’t be providing dividends to shareholders but instead looking for the best ways to reinvest extra capital. Of course, you don’t want to overspend and expose your company to excess risk, either.
So how do you find the balance of pushing for growth and keeping the right amount of cash in your account?
Traditional Financial Wisdom
Common sense dictates that you should never run your business on an empty tank. Companies without sufficient cash reserves are at too high a risk to market factors and unforeseeable expenses.
For years, many finance experts have recommended businesses keep a minimum of three months of operating costs in their bank account.
This money gives your business some financial security if things go wrong. It’ll cover expenses if you miss sales objectives, pay for an unexpected expense, and even give you some time to pivot in unforeseeable market conditions.
However, traditional businesses have never had the level of reliability of their revenue that many SaaS businesses enjoy today.
Modern SaaS Wisdom
Due to the recurring nature of their revenue, SaaS companies receive different cash reserve recommendations.
With low churn and dependable expenses, SaaS companies can be a little more aggressive with their cash balance. Therefore, instead of looking at numerous operating costs, we recommend SaaS companies look at net cash burn.
If your operating expenses are $600,000/month and you have $500,000 in MRR, your net burn is $100,000/mo. Therefore, you’ll need $600,000-$1.8m (i.e., 6-18 months of net burn) in reserves (unless you have access to additional capital already).
Companies with higher churn should err on the side of caution and keep a larger balance because losing customers can increase the cash burn rate.
Why a minimum of six months burn?
Companies should never run the risk of running out of money. If this happens, you are insolvent, and drastic things result. To prevent this, you should always have enough money in the bank to get you to the point where:
A: You get to break even and are not reliant on further funding.
B: Enough time is available in your cash runway to allow you to raise equity or debt.
With this in mind, you should protect your company from things that can happen, like if you have a bad month or two. Bad months can increase your burn rate, which in turn reduces your cash runway. This is why we always recommend a minimum of six months in reserves.
Current Financing Available to SaaS Companies
The two sources of finance available to SaaS companies (equity and debt) have different dynamics you need to consider.
Equity has been the most prevalent source of capital in the SaaS startup world. Of course, not every situation can be handled with debt, but expect an equity raise to take at least 10 months.
Debt is a lot faster to raise than equity, and its use by SaaS companies is growing. So, if you are working on lining up debt, you can be comfortable with closer to 6 months of burn. Some debt providers are more efficient with your time than others.
Debt requires companies to have enough revenue to secure the debt facility, but equity relies primarily on speculative multiples of what the company could be worth in the future.
Make sure to consider your cash cycle and how it may affect your cash balance from month to month.
Companies with seasonal cash cycles (a high percentage of their cash-in comes from a few months a year) need to make sure they have more money in the bank at different times of the year. They need enough to get them through the low points of their cash cycle.
As mentioned above, raising capital can take time. So plan your use of funds in advance and adjust your fundraising accordingly. For example, if you are planning a significant development project, you may need to put a lot more cash in the bank than, say for general growth purposes.
When taking equity capital, make sure you get enough to achieve your goals, but not too much that it unnecessarily dilutes your shareholders. Similarly, with debt capital, make sure you aren’t taking money that will sit around in your bank account, costing you interest.
Follow these guidelines, and you should have enough time for your next raise and find the right funding options for your business.
Seeking a finance partner that can help? To explore your options, talk to us.