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Finance 101 for sales teams
For all my homies with quotas
Do you have a quota? Do you like to hit gongs? Do you drive a BMW 3 Series or Audi A4?
If you answered “yes” to any of these questions, you’re in the right place.
This post is about the intersection of Sales and Finance. Today I’ll explain seven finance concepts from the perspective of how it impacts a sales rep.
What are the different types of revenue?
How’d you come up with my quota?
Why is gross margin so important?
How long does it take to make money on a customer?
How much does my customer contribute to the biz?
What does my account’s net retention tell me?
How do each of my deals contribute to company valuation?
CJ, here. Subscribe for free to receive new posts & support my work
1/ What are the different types of revenue?
If there’s one takeaway from the exhibit below, it’s that “Revenue” is an accounting view of the world and “ARR” is an operational view.
Revenue is accrued over time (read: spread out) and will often trail (read: be less than) the associated ARR value for the same period.
ARR is more like a balance as of a point in time, whereas revenue is more like a piece of that ARR you chunk off and allocate to that period
Bookings: When the deal closes & customer signs
Billings: When the accounting department actually "bills"' the customer for the "booking"
ARR (Annual Recurring Revenue): The current 12 month value of the contract
MRR (Monthly Recurring Revenue): ARR divided by 12
Revenue: Revenue is spread out to match the delivery of the product or service
Deferred Revenue: The ARR that’s not yet in Revenue
RPO (Remaining Performance Obligation): If anyone ever asks a sales person about RPO, run for the door. It’s the TCV (see below) that’s not revenue yet
TCV (Total Contract Value): All the ARR across all the years added up
Average ARR: All the ARR across all the years added up divided by number of years
2/ How’d you come up with my quota?
The typical sales “pod” is built around one quota carrying rep. A rep is an individual contributor, a mercenary carrying a bag and bringing in new deals
That rep has a manager, a system engineer and a business development rep. The rep’s manager may have a span of control of six to eight other reps, while the system engineers and SDRs pull single, double or triple duty, supporting multiple reps depending on what segment they cover (lower ratios for enterprise, higher ratios for SMB)
What’s less obvious is the other back office support (Finance, HR, Legal). Someone has to generate money to feed all these mouths
And, the business does kinda wanna make a profit at the end of the day
Rule of thumb: A rep’s quota should be 4x to 5x their On Target Earnings (OTE)
So $200K OTE = ~$1M Quota
Flipping that on it’s head, a rep’s contribution margin to the business should be around 80% if they achieve 100% of their plan
Companies at mega scale like AWS and Salesforce, which have literally hundreds of products for reps to sell, get their quota to OTE ratios above 10x!!!
Disclaimer: Opinions are my own. Not investment advice. Do your own research.
3/ Why is gross margin so important?
Gross Margin is
Revenue less Cost of Goods Sold
If you sell technology your cost of sale is probably cloud infrastructure (AWS, Azure, GCP) as well as Customer Support
If you actually build something (like Peloton) it’s whatever the raw materials that go into that good are
Here’s a snapshot of Gross Margin for some tech companies with varying infrastructure costs
Atlassian’s high gross margin leaves TONS of room for investment in Research and Development. They run an incredibly efficient ship
Twilio has 33% less (on a relative basis) to invest in the rest of the business after taking care of their existing customers
A higher gross margin means more cash left to do cool stuff with - like pay your people more, hire additional help, build a new product, buy a company etc.
4/ How long does it take to make $ on a customer?
Customer Acquisition Cost is what you spend in sales and marketing costs to go out and get a net new customer
CAC Payback Period is a derivative of Customer Acquisition Cost, and spits out the number of months it takes to breakeven on that new customer
CAC Payback Period shows how efficient your GTM machine is
In the example above, it takes you 8.8 months to break even on the customer
Generally speaking, you want this to trend lower - money today is better than money tomorrow
Lower CAC payback period = customers fund your growth.
Higher payback period = VCs fund your growth
5/ How much does my customer contribute to the biz?
Customer Lifetime Value (LTV) estimates the total amount of money you’ll get from a customer before they churn out
And LTV to CAC is a multiple of how many times over you make up your CAC over the course of a customer’s lifetime
In this example you get +5x from a customer compared to what you initially spend to land them
6/ What does my account’s net retention tell me?
Net Retention basically throws all your existing customer dynamics into a pot, mixes them up, and spits back out how much your business will grow or decline by, absent any net new customer activity
A Net Retention of 122% means you could stop selling to new customers and would still grow at 22% next year
Ways to change net retention:
You decrease churn (Gross Retention)
Your customer buys more products (Cross Sales)
Your customer buys more licenses (Product Penetration Pricing)
You drive more usage of a product they already bought (Volume Pricing)
7/ How do each of my deals contribute to company valuation?
Multiples are an output of the valuation process, not the valuation process itself
But it’s still fun to think about how each deal translates to an uplift in valuation
At a 20x forward ARR multiple, closing a $100K deal boosts company valuation by $2 million dollars (hypothetically!)
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