Welcome Back to This Week’s Mailbag
This week we have the following CFOs answering your reader questions:
Daniel Kang, CFO @ Mercury
Rama Katkar, CFO @ Notion
Today we’ll tackle:
What belongs in gross margin with AI costs
How to talk about consumption based ARR
Dissecting a rising CAC Payback period
What metrics to include in your exec dashboard
Board communication during a hard pivot to AI
Let’s get into it!
Speaking of mailbag, remember when these bad Larry’s used to come in the mail? Fun fact, my friend Jim Cook, former CFO at Netflix came up with the red envelope idea!
Question #1:
Our gross margin calculation has become really contentious internally. Hosting is clear, but CS headcount, free trial infrastructure, and solutions engineering are gray areas... oh, and our massive Anthropic bill. Different definitions move the number 8-10 points. How do you set a defensible gross margin definition that holds up and avoid relitigating it every time the number moves the wrong way?
On the stand, defending my gross margin allocations
Dan from Mercury:
Do what'll be defensible as a public company from a GAAP perspective. There often is a lot of grey area for judgment where you should do the technical accounting work to support your conclusions on COGS vs. operating expense. GAAP at least provides a standard to help settle the debates, preferably with auditor sign-off. You don't want to restate financials for this when scrutinized by an auditor. And if there's valid rationale and support for classifying as an operating expenses, then great; just don't fool yourself on product economics.
For example, when calculating LTV, you should fully burden for variable costs regardless of whether COGS or operating expense. Also understand what's causing the debates — is it a pure academic argument? Concern about investor perception? Teams getting bonuses based on gross profit goals? Investors (who do their homework though not guaranteed) see through inflated gross margins.
Rama from Notion:
I would align on a strawman with your auditors and consistently report in this way. I wouldn’t be open to re-litigating when the number moves the “wrong” way. You can show an (internal only) pro forma for certain expenses if you really think that they are abnormally high one-time. But, the costs you mention above are typically ongoing variable costs…so you’re going to have to manage other opex with these in mind regardless of if folks like that answer!
Question #2:
We're usage-based and our "ARR" is really an annualized run-rate from the last 30 days. Investors keep pattern-matching us to SaaS benchmarks, and the number bounces with seasonality and ramp. How do you talk about run-rate revenue with SaaS-minded investors — is there a cleaner metric for consumption businesses?
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