Note: this was originally published at https://alexoppenheimer.substack.com/
Generally accepted accounting principles were designed to create a single standard for comparing any and all businesses using the same terms and metrics. This is a very powerful tool, but it is a clear exchange for breadth over specificity. As a result, the economic reality of a business will likely differ from what the accounting metrics represent. By looking at a subset of business models, we can improve specificity – terms like ARR and GMV are both examples of this. While these terms have their own challenges with definitions, I think most agree what they represent: ARR is annualized recurring revenue for SaaS companies, and GMV is gross merchandise/marketplace value for marketplace companies.
One of my favorite examples of this is CAC – customer acquisition cost. It’s relevant for both SaaS businesses and marketplaces. Average CAC is the cost to acquire a single customer and Total CAC is the full spend for a cohort of customers. So what is the difference between CAC and Sales & Marketing expense? The truth is that Total CAC and S&M over a given period of time might be the same. That being said, the usually differ by a time offset that depends on sales cycle length.
The critical distinction is sales cycle length. Sales cycle is how long it takes for a customer to go from first contact to closing a deal. We measure sales cycle by segment and can use simple reports in Salesforce or another CRM tool to figure out how long it takes on average for customers to move through the sales funnel. Generally sales opportunities begin as leads, some of those convert to qualified for sales and then some of those convert to closed-won. The Sales Funnel shows the volume and conversion at each step in the process and is usually in the hands of the CRO or sales operations team. The two lengths of time that we care about in finance are: top of funnel to sales qualification (i.e. marketing cycle length) and then sales qualification to closed-won (i.e. sales cycle length).
There is a large variance in sales cycle lengths from business to business. For example, consumer software might have a
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