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What solvability tells your (potential) investors about your company

What solvability tells your (potential) investors about your company

There are a lot of reasons for an investor to get involved in a particular project. He could like the company, be astounded by the product, or be impressed by the management team. However, underlying all these reasons is the investor’s desire to grow their investment. To achieve this, investors investigate opportunities from a variety of angles, with a particular focus on the company’s solvability metrics.

Unlike liquidity metrics that focus on the company’s capacity to pay short-term commitments, solvability metrics take a longer view by showing the company’s ability to meet its long-term financial obligations. By tracking solvability metrics, the company is in a better position to take strategic financial decisions based on valid information.

Good solvability can also convince investors about the benefits of investing in a particular company. For example, inflation has a knock-on effect, increasing interest rates which makes capital more expensive and leads to the contraction in the amount of available capital. When this happens, investors prefer to invest in companies with good solvability to ensure their returns instead of a high-risk, high-return option.

Let’s take a look at some solvability metrics and what they mean for your company.

 

  1. Debt-to-equity ratio (D/E ratio)

The debt-to-equity ratio is used to evaluate a company’s financial leverage, reflecting the capacity of shareholders’ equity to cover all outstanding liabilities in the event of a business downturn. Higher leverage ratios usually indicate a company or stock with a higher risk for shareholders and (potential) investors as it indicates that company is financing a large amount of its growth through borrowing.

How to calculate your D/E ratio:

total liabilities / total shareholders’ equity

 

  1. Debt-to-assets ratio (D/A ratio)

By considering all the company’s liabilities, such as loans, bonds payable, and all assets, including intangible assets, the debt-to-asset ratio indicates the company’s financial stability. The higher the ratio, the higher the degree of leverage, which means the higher the risk of investing in the company.

To give an example, if a company has a ratio of 0.4, then 40% of its assets are financed by creditors and the other 60% by equity. This is a useful metric to see how much debt the company already has and whether the company can repay its existing debts.

How to calculate your D/E ratio:

total liabilities / total assets

 

  1. Interest coverage ratio (IC ratio)

The interest coverage ratio is used to determine how easily a company can pay the interest on its outstanding debt as being able to pay interest payments is a critical and ongoing concern for any business. Once a company struggles to meet its obligations, it may be forced to borrow further or draw on its cash reserve, which would be better used to invest in capital assets or for emergencies.

The IC ratio is often used by lenders, investors, and creditors to determine the risk of a company based on its current debt or for future loans or investments. Generally, a higher ratio is better.

How to calculate your D/E ratio:

earnings before interest and taxes (EBIT) / interest expense

 

Talk to the experts

It’s important to remember that it costs money to borrow capital, whether that’s in the form of investment or loans. The costs of this capital could be interest payments, in-kind agreements, strategic concessions, or a liability in another form. Contact CFOrent to ensure reliable calculation of your solvability ratios to generate the capital your company needs to grow.

Contact us for more information.

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The importance of SaaS metrics to attract investors and grow your company

The importance of SaaS metrics to attract investors and grow your company

SaaS (Software as a Service) is experiencing major growth, with the sector growing from $120.7 bn in 2020 to an estimated $171.9 bn in 2022 (Gartner, 20211). This has attracted new companies to the sector, each offering a new perspective as they attempt to attract new investors and find new customers in different markets.

Even with the increased market size, it can be challenging to stand out from the crowd. So, how can you ensure your company gets the investment it needs?

The simple answer is metrics. Reliable and consistent metrics are an important benchmark for potential investors. However, defining the right metrics and following them up correctly is easier said than done. Let’s take a look at four industry standard metrics your SaaS company needs to be monitoring.

 

  1. Monthly recurring revenue (MRR)

This measure of predictable revenue flow makes accurate financial predictions about your SaaS business, making it a key indicator of growth. You can also use MRR to monitor the momentum of your business, gain insights into your overall profitability and cashflow, and help set future goals.

How to calculate your MRR:

average revenue per customer per month x the total number of monthly users

MRR can also be used to calculate your MRR growth rate:

(current net MRR – last net MRR)/last net MRR

 

  1. Annual recurring revenue (ARR)

While MRR looks at your monthly recurring revenues, ARR takes a longer view and reflects your revenue throughout the year. It is particularly useful for companies with lower transaction volume but higher transaction values.

Companies of all sizes can use ARR to measure their positive momentum (new sales, renewals, and upgrades) and negative momentum (downgrades and lost customers). This clarifies the overall health of your company, showing performance in specific areas and generating insights into customer wants and needs, including suggestions for cross-selling and upselling.

 

  1. Customer acquisition cost (CAC)

CAC tells you how much it costs to acquire each new customer, lead, or subscriber. It enables you to evaluate your effectiveness at each phase of the customer acquisition journey, as you move from attracting visitors to converting them into users then subscribers. The insights generated from this evaluation allows you to optimize your investments to lower your CAC, which has a direct impact on your potential CLV (see next section).

 

  1. Customer lifetime value (CLV)

How valuable is each customer to your business over the entire period of your relationship? The answer is the CLV, which includes your customers’ revenue value, CAC, and expected lifetime as an active customer.

Finding ways to increase the CLV is a good way to stimulate growth as it costs less to retain an existing customer than to acquire a new one. Plus, the CLV enables you to identify the most valuable customer segments in your target market so you can optimize your strategy to maintain (or improve) profit margins.

 

Talk to the experts

How well does your company monitor and evaluate these important metrics? Contact CFOrent if you would like expert help to ensure reliable and consistent follow up of your SaaS metrics to improve your company’s financial strategy or attract new investors.

 

1 https://www.gartner.com/en/newsroom/press-releases/2021-08-02-gartner-says-four-trends-are-shaping-the-future-of-public-cloud

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How liquidity metrics can make the difference when it comes to growth

How liquidity metrics can make the difference when it comes to growth

Companies want to expand their operations, grow into new markets, and serve new customers without compromising their profitability. To achieve this, you need to balance you cash inflows and outflows. But how can you boost the financial health of your company to give it the best opportunity for growth?

Using metrics to measure your liquidity will help you to follow up your cash health and give you insights on how to improve it. Let’s take a look at some useful liquidity metrics and see the benefits they offer.

 

  1. Current ratio

Also known as working capital ratio

Including all current assets and liabilities, the current ratio measures your company’s ability to pay short-term liabilities or obligations (within a year). It shows investors how your company can maximize your current assets to meet your current liabilities. It is worth noting that the current ratio only gives a snapshot into your finances, so doesn’t give a complete reflection of your short-term liquidity or longer-term solvency.

A current ratio in line with or slightly above the industry average is considered acceptable, while a lower ratio may indicate a higher risk of distress or default. However, if the current ratio is significantly higher than the industry average, it indicates that management might not be using its assets efficiently.

How to calculate your current ratio:

current assets / current liabilities

 

  1. Quick ratio

Also known as the acid test

The quick ratio is an indicator of your company’s short-term liquidity position and measures your company’s ability to meet your short-term obligations with your most liquid assets, without selling stock or obtaining additional financing. The higher the ratio, the better the company’s liquidity and financial health.

As the quick ratio does not include inventory, which is difficult to turn into cash in the short term, it is considered more conservative than the current ratio.

How to calculate your quick ratio:

(current assets – inventory – prepaid expenses) / current liabilities

 

  1. Cash ratio

The cash ratio tells creditors and analysts the value of your company’s current assets that can be quickly converted into cash and what percentage of your company’s current liabilities these cash and near-cash assets can cover. It is useful for creditors when deciding how much money they might be willing to lend to your company.

The results can be a cash ratio of 1 (the company has the same amount of current liabilities and cash), less than 1 (the company has insufficient cash to pay all current liabilities), or more than 1 (the company will have cash over after paying all current liabilities).

How to calculate your cash ratio:

(cash + cash equivalents) / short-term liabilities

 

  1. Days sales outstanding (DSO)

Also known as days receivables or average collection period

How long does it take your company, on average, to collect payment for a sale? The answer is your DSO. Calculated on a monthly, quarterly, or annual basis, companies aim to receive payments quickly to keep their DSO as low as possible and ensure a smooth cashflow. Generally, a DSO of less than 45 days is considered low.

How to calculate your DSO:

(receivables/total sales) x days

 

  1. Days payables outstanding (DPO)

As the opposite of DSO, DPO monitors the average time taken (in days) for your company to pay your suppliers, vendors, or financiers. Measured on a quarterly or annual basis, DPO indicates how well your company’s cash outflows are managed.

There are pros and cons to having a higher DPO. On one hand, it enables you to hold onto funds for longer so you can maximize benefits, increase your working capital, and free cash flow. But on the other hand, it can also be a red flag, indicating an inability to pay bills on time.

How to calculate your DPO:

(accounts payable x days) x cost of goods sold

 

  1. Days sales of inventory (DSI)

Also known as days inventory outstanding

The DSI indicates the average time taken for your company to convert your inventory, including works in progress, into sales. In other words, it shows how long your company’s cash is tied up in inventory and how long the inventory will last. While the average DSI varies from industry to industry, a lower DSI is preferred as it indicates that it will take less time to clear inventory.

How to calculate your DSI:

(average stock / cost of goods sold) x 365

 

  1. Cash conversion cycle (CCC)

CCC measures the time lag between the purchase of your company’s inventory and the receipt of cash from accounts receivable. By looking at how long your company’s cash remains tied up in your operations you can see how efficiently your managers manage your working capital.

A longer CCC means it will take longer to generate cash, which can mean insolvency for small businesses. A shorter CCC is a sign of a healthy company as it can use the extra cash to make additional purchases or pay off outstanding debts.

How to calculate your CCC:

DIO + DSO – DPO

days inventory outstanding + days sales outstanding – days payables outstanding

 

Talk to the experts

Interested in finding out more about liquidity metrics and how they can help boost your company’s financial health? Contact CFOrent for expert help and insights on improving your cashflows.

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