SOFTWARE FINANCE
FOR MORTALS
Introduction to Corporate Finance
AGENDA
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What is Finance?
Financial Statements Overview
Revenue Recognition
Recurring Revenue and Multi-Year Contracts
KPIs
ROI, IRR, NPV, Payback, and the Time Value of Money
WHAT IS FINANCE?
DEFINITION
• Per Wikipedia:
− “Finance is the science[citation needed] of funds management, or the
allocation of assets and liabilities over time under conditions of
certainty and uncertainty”
• Per ATpedia:
− Finance is the art of building a predictable, growth-oriented, and
sustainable organization, using a data-driven approach to inform
key business decisions
WHAT WE DO
• The Finance department holds fiduciary responsibility for
the organization. We…
Ensure we have the requisite resources to support growth
Set, measure, and evaluate our metrics of success
Forecast performance and solve issues months ahead of time
Help structure strong, profitable business agreements and
relationships that minimize risk
− Keep the business running! (pay the bills, collect our revenue,
account for gains and losses, etc.)
−
−
−
−
FINANCIAL STATEMENTS
OVERVIEW
THE THREE FINANCIAL STATEMENTS
• Income Statement – conveys the profitability of the
company over a period of time; begins with the revenue
line and after subtracting various expenses arrives at net
income
• Balance Sheet – snapshot of the company’s resources
(assets) and funding for those resources (liabilities and
stockholder’s equity) at a given point in time
• Cash Flow Statement – depicts the company’s actual
cash inflows and outflows over a period of time
INCOME STATEMENT WALKTHROUGH
Actuals
2013
Revenue
Maintenance Revenue
Subscription Revenue
Recurring Revenue
License Revenue
Billable Travel
Services Revenue
Total Revenue
% Recurring of Total
14,000
10,000
24,000
4,000
200
1,800
30,000
80%
Fully Loaded COGS
Recurring Revenue COGS
License Revenue COGS
Billable Travel COGS
Services Revenue COGS
Total Fully Loaded COGS
3,600
1,000
200
1,200
6,000
Gross Profit
Recurring Revenue
License Revenue
Billable Travel
Services Revenue
Total Gross Profit
Gross Margin
20,400
3,000
0
600
24,000
80%
Operating Expenses
Research & Development
Sales & Marketing
General & Administrative
Total Operating Expenses
% of Revenue
6,500
5,500
3,000
15,000
50%
Operating Income
9,000
Margin
Interest (Income) Expense
Other (Income) Expense
Vista Management Fees
Transaction Costs
Legal Fees
Restructuring Costs
Non-Recurring Expense
Income Tax (Credit) Expense
Amortization Expense
Net Income
Margin
EBITDA Adjustments:
Deferred Revenue Haircut
Indemnity Claims
Depreciation and Amortization
Office Move
Total Adjustments
EBITDA
Margin
30%
10
0
10
25
0
0
10
(10)
150
9,195
.00
Revenue generated by our products and services –
subject to recognition rules
Costs related to delivery of our products and services
Revenue – COGS…answers the question of “how
profitable are our products and services?”
Other everyday expenses (payroll, travel, benefits,
etc.)…subtracted from G.P. to get Operating Income
Operating Income less any non-core expenses – what our
reported income is for tax purposes
31%
0
0
50
0
50
9,050
30%
Operating Income plus any non-core expenses (such as
depreciation) captured in OpEx…our true metric that
answers how profitable we are as a business
BALANCE SHEET WALKTHROUGH
Balance Sheet
Assets
Cash and equivalents
Accounts receivable
Other current assets
Total Current Assets
2013
4,000
7,000
1,000
12,000
Long term assets
23,000
Total Assets
35,000
Expenses incurred, but not paid
Liabilities
Accounts payable
Deferred revenue
Other current liabilities
Current Portion of LT Debt
Total Current Liabilities
1,000
15,000
2,000
1,000
19,000
Revenue earned, but not collected
Long term Debt
Other Long term Liabilities
5,000
1,000
Shareholders Equity
10,000
Total Liabilities and Shareholders Equity
35,000
Assets owned by the business that can be
quickly (<1 year) converted to cash
Less-than-liquid assets (e.g. real estate, value
of patents, etc.)
Liabilities held by the business that are due in
the next year
Payments due for acquisition debt or long-term
leases
Equity invested in the business,
accumulated earnings (net income)
plus
CASH FLOW STATEMENT WALKTHROUGH
Cash flows related to our core, day-to-day
operations (collecting revenue, payroll, etc.)
Cash flow:
Changes inflow/(outflow)
Operating Activities
Investing Activities
Financing/Equity Activities
2013
1,500
Cash flows related to the purchase or sale of
assets
100
(100)
Net cash inflow(outflow)
1,500
Free Cash Flow
1,600
Cash flows related to payments or collections
from debt or equity holders
Another metric for profitability – looks at the
“true” cash generated or lost by the business
REVENUE RECOGNITION
REVENUE RECOGNITION BASICS
• Revenue is recognized as value is delivered
− Revenue recognition is independent of cash collections, which
may happen in different periods
• Recognition of revenue from three types of transactions:
1. Revenue from selling inventory are recognized at the date of
sale often interpreted as the date of delivery
2. Revenue from rendering services are recognized when services
are completed and/or billed
3. Revenue from permission to use company's assets (e.g.
interests for using money, rent for using fixed assets, and
royalties for using intangible assets) is recognized as time
passes or as assets are used
SOFTWARE BUSINESS MODEL
Mitratech has five main sources of revenue:
• License fees – fees customers pay to own the software
‒ Treated as a capital expenditure for most customers; high upfront costs
• Maintenance fees – annual fees customers pay to access software
upgrades, bug fixes and customer support
‒ Fee generally range between 18-22% of license revenue (discounted or
undiscounted)
‒ Contracts often automatically renew for one year periods
• Subscription fees – annual fees customers pay to use the software; does
not give perpetual ownership rights
‒ Inclusive of services given with maintenance fees in the license / maintenance
model
‒ Treated as an operating expenditure for most customers; low upfront cost
• Hosting fees – annual fees customers pay to have the vendor host the
software for them
‒ May include initial “set-up fees”
• Services fees – Fees customers pay to have the software implemented,
configured or customized
‒ Usually billed for on a “time and materials” basis (hourly)
PRACTICAL APPLICATION
Recognition of revenue from three
types of transactions:
1.
2.
3.
Revenue from selling inventory
are recognized at the date of
sale often interpreted as the
date of delivery
Revenue from rendering
services are recognized when
services are completed and/or
billed
Revenue from permission to
use company's assets (e.g.
interests for using money, rent
for using fixed assets, and
royalties for using intangible
assets) is recognized as time
passes or as assets are used
License revenue
Services revenue
Maintenance revenue
CSM revenue
Subscription revenue
Hosting revenue
VSOE
• Vendor-Specific Objective Evidence
− Accounting rule that allows us to recognize multiple revenue types
in a single deal
• Concept is to prove that each facet of a transaction (e.g.
license, services, and maintenance) are independent from
one another and provides value unique to the other pieces
− Prevents companies from artificially discounting and uplifting certain
products with the goal of boosting either one-time revenue hits or
recurring streams
• VSOE must be established on an annual basis by proving that
80% of license and services transactions fall within +/- 15% of
list price
− If out of compliance, significant accounting adjustments are
required, often resulting in a loss of revenue
− Additionally, very conservative revenue recognition rules must be
followed until VSOE is re-established
BOOKINGS MIX – EFFECT ON EBITDA
Current FY EBITDA Impact @ $10mm total bookings
Next FY EBITDA Impact
License
Services
Hosting
CSM /
Subs
$5.4mm
$2.7mm
$9.0mm
$1.7mm
$4.1mm
$4.3mm
"SaaS"
Due to the nature of recurring revenue and the differing margin profiles of our offerings, the bottomline impact of your bookings can be very different at different mix profiles
RECURRING REVENUE AND MULTIYEAR CONTRACTS
BENEFITS OF A STRONG RECURRING BASE
• Reduces a business’s reliance on new business
• Allows the business to better forecast future
performance and plan for success
• Brings potential for topline growth via regular price
increases
• Ensures cash flow, helping to maintain a steady,
predictable cash balance
LICENSE VS. SUBSCRIPTION EXAMPLE
License vs. Subscription Revenue Comparison
Year 2
Year 3
Year 4
Year 5
Year 1
Total
Client A
License Fees
$ 100,000 $
-- $
-- $
-- $
-- $ 100,000
Implementation
200,000
----- $ 200,000
Maintenance Fees
22,000
23,100
24,255
25,468
26,741 121,564
Total Revenue
$ 322,000 $ 23,100 $ 24,255 $ 25,468 $ 26,741 $ 421,564
Client B
Subscription Fees
Implementation
Total Revenue
$ 50,571 $ 53,100 $ 55,755 $ 58,543 $ 61,470 $ 279,439
200,000
----- 200,000
$ 250,571 $ 53,100 $ 55,755 $ 58,543 $ 61,470 $ 479,439
(B - A)
$ (71,429) $ 30,000 $ 31,500 $ 33,075 $ 34,729 $ 57,875
Subscription model generates less revenue in year 1, but the out-year
benefits far outweigh the year 1 loss
BENEFITS OF MULTI-YEAR CONTRACTS
• When paired with annual increases, provides 100%
certainty of revenue growth
• Builds strong relationships with clients, reducing attrition
• Provides a better long-term view of potential attrition
• Adds another compelling angle for potential clients
KPIs
WHAT IS A KPI?
• Key Performance Indicators are non-financial metrics
that inform how well an aspect of the business is running
and will run
• KPIs are useless without benchmarks – each must be
measured against a goal or a historical trend in order to
be relevant
• KPIs inform business decisions, forecasts, and are key
in tracking continuous improvement
SAMPLE KPIS
G&A
Employee Retention
Recruiting
Funnel
A/R Aging
Bad Debt %
Cash Balance
Sales
Pipeline
Product
Bookings
Bookings Split
(subs)
Sales Activities
Win Rate
Impressions
Leads
Generated
Leads
Accepted
LeadGenerated
Bookings
Conversion
Rates
Utilization
Bill Rate
Non-Billable
Hours
Backlog
Forecast
Accuracy
Case Backlog
Tickets
Closed per
Month
Case Aging
Avg. Time to
Close
NPS
Dev
Support Allocation
Defect
Backlog
Scoping
Accuracy
New Dev vs.
Sustaining
Sprint
Completion
Rate
PM
New Module
Pipeline
# of
Concepts
# of Stories
Scoping
Accuracy
New Dev vs.
Sustaining
Uptime
Tickets
Closed per
Month
Case Aging
Avg. Time to
Close
Marketing
Services
Support
Hosting
Ticket Backlog
ROI, IRR, NPV, PAYBACK, AND THE
TIME VALUE OF MONEY
PROJECT PROFITABILITY METRICS
• While there are infinite ways to value a project or
investment, there are 4 standard metrics that nearly any
business will look at:
− ROI: Return on Investment (Profit / Cost)
 Very simple, back-of-the-napkin calculation; useful in evaluating
short-term projects or comparing those with similar timeframes
− IRR: Internal Rate of Return (time-weighted annual rate of
return)
 Since this metric is time-weighted, it’s a better metric to use to
evaluate long-term projects or comparing those with different
timeframes
− NPV: Net Present Value (time-weighted dollar value of entire
project)
 Similar to IRR, but more useful when investment funds are limited
and the focus is more on total $ return
− Payback: Amount of time for a project to break even
 Most useful in “selling” to risk-averse businesses
TIME VALUE OF MONEY
• The idea that money available at the present time is
worth more than the same amount in the future due to its
potential earning capacity
− This core principle of finance holds that, provided money can
earn interest or be put to use on profitable projects/investments,
any amount of money is worth more the sooner it is received
• Major assumption is that “idle cash” does not exist and
that money can be immediately put to use to make X%
per year (discount rate)
PRESENT VALUE OF FUTURE CASHFLOWS
T=0
T+1
T+2
$10
$10
$10
Discount rate: 10%
PV of T=0: $10
PV of T+1: $10 / (1 + 10%) = $9.09
PV of T+2: $10 / ((1 + 10%)^2) = $8.26
Net Present Value: $27.35
• By employing the time value of money concept, we can
place a value on a forward-looking stream of cash
inflows and outflows, taking the opportunity cost of
investing at X% return into consideration
− Higher discount rates = lower PV of future cash inflows of equal
amounts
SENSITIVITY TABLES
• Oftentimes, Finance runs into less-than-concrete problems
with multiple variables that are not totally predictable – in
these cases, sensitivity tables are incredibly useful tools to
show how results change with assumptions
− Example – “James, how much product revenue will we generate
from new bookings next year?”
FY15 Revenue Sensitivity
FY15 Software Bookings
%
L
i
c
e
n
s
e
100.0%
90.0%
80.0%
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
$
9,000,000 $ 9,200,000 $ 9,400,000 $ 9,600,000 $ 9,800,000 $ 10,000,000 $ 10,200,000 $ 10,400,000 $ 10,600,000 $ 10,800,000 $ 11,000,000
$10.1 mm
$10.3 mm
$10.5 mm
$10.8 mm
$11.0 mm
$11.2 mm
$11.4 mm
$11.7 mm
$11.9 mm
$12.1 mm
$12.3 mm
$9.5 mm
$9.8 mm
$10.0 mm
$10.2 mm
$10.4 mm
$10.6 mm
$10.8 mm
$11.0 mm
$11.2 mm
$11.4 mm
$11.6 mm
$9.0 mm
$9.2 mm
$9.4 mm
$9.6 mm
$9.8 mm
$10.0 mm
$10.2 mm
$10.4 mm
$10.6 mm
$10.8 mm
$11.0 mm
$8.5 mm
$8.6 mm
$8.8 mm
$9.0 mm
$9.2 mm
$9.4 mm
$9.6 mm
$9.8 mm
$9.9 mm
$10.1 mm
$10.3 mm
$7.9 mm
$8.1 mm
$8.3 mm
$8.4 mm
$8.6 mm
$8.8 mm
$8.9 mm
$9.1 mm
$9.3 mm
$9.5 mm
$9.6 mm
$7.4 mm
$7.5 mm
$7.7 mm
$7.8 mm
$8.0 mm
$8.2 mm
$8.3 mm
$8.5 mm
$8.7 mm
$8.8 mm
$9.0 mm
$6.8 mm
$7.0 mm
$7.1 mm
$7.3 mm
$7.4 mm
$7.6 mm
$7.7 mm
$7.9 mm
$8.0 mm
$8.2 mm
$8.3 mm
$6.3 mm
$6.4 mm
$6.5 mm
$6.7 mm
$6.8 mm
$7.0 mm
$7.1 mm
$7.2 mm
$7.4 mm
$7.5 mm
$7.6 mm
$5.7 mm
$5.8 mm
$6.0 mm
$6.1 mm
$6.2 mm
$6.3 mm
$6.5 mm
$6.6 mm
$6.7 mm
$6.8 mm
$7.0 mm
$5.2 mm
$5.3 mm
$5.4 mm
$5.5 mm
$5.6 mm
$5.7 mm
$5.8 mm
$6.0 mm
$6.1 mm
$6.2 mm
$6.3 mm
$4.6 mm
$4.7 mm
$4.8 mm
$4.9 mm
$5.0 mm
$5.1 mm
$5.2 mm
$5.3 mm
$5.4 mm
$5.5 mm
$5.6 mm
• The table runs the bookings -> revenue model for every
possible combination of total software bookings and the
license percentage split, giving James a range to respond
back with