Practical Finance for Software Engineering | Part 2: Understanding Growth

Revenue

The absolute amount of revenue r(n) is important, but only to help us understand a company’s market share and relative stage of maturity. A company earning $1m is very different from a company earning $100m in annual revenue. Beyond this use, the more important metric is often revenue growth.

MRR is a product and marketing focused metric that tracks the monthly recurring revenue customers have committed to spend in your business. ARR is simply the annualized version of MRR. In this manner, MRR and ARR are closer to bookings than any of the other GAAP metrics.

Growth and Valuations

Using Affirm’s S-1 filing as an example (p. 20), we can calculate the company’s Year-on-Year revenue growth by comparing FY20 ($510M) against FY19 ($264M) ≈ 93%. This is comparable to Afterpay’s revenue growth in the same period.

Fig. 1: Parsing Affirm’s S-1.
  1. Project its expected revenue growth using historical revenue growth.
  2. Find comparable public companies and look at their revenue growth rates.
  3. Using the comparables’ price-revenue ratios, estimate a range for our company’s price-revenue (P/R) ratio. Higher growth rates are correlated with higher P/R ratios (see Fig. 2 below.)
  4. Multiply your estimated ratio by revenue to arrive at a range estimate for our company’s valuation.
Fig. 2: Correlation between valuation multiples and growth rate. Data from SaaS Capital, plotted using Google Colab with seaborn.
  • revenue growth and product metrics e.g. MAU, DAU, checkouts per day
  • product metrics and infrastructure metrics e.g. number of virtual machines, size of data storage, recurring o11y fees
  • keep fixed costs f fixed
  • ensure that variable costs v(n) grow slower than r(n)

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