Growth - even hyper-growth - doesn’t mean squat if it’s not moving somewhere profitable. And according to Xero’s CFO, high-growth businesses need a reality check.
A common jibe throughout the accounting software firm’s growth journey has been “Yeah, but where’s the profit?”
So it was probably with more than a hint of satisfaction that the company announced it was EBITDA positive in its latest set of results. The company still posted a £14.6m after-tax loss, but even that was a marked improvement on £35m loss in FY17.
Xero’s chief operating and financial officer Sankar Narayan talks about the company’s finances as a journey. “We remain committed to managing our business to cash flow break-even within our current cash balance,” Narayan told AccountingWEB, “without drawing down on our debt facility, excluding capital outlays for M&A such as Xero’s recent acquisition of Hubdoc announced in August.”
Xero continues to grow rapidly. And according to Narayan, the pursuit of profits won’t come at the expense of growth. “We have a strong focus on both topline and bottomline performance.
“Strong growth and operating disciplines ensure the activities to drive topline growth really move the needle. Xero’s cash flow margins over the past three years improved from -70% to -9% while revenues have grown 49% pa.”
In a recent piece in Forbes, Narayan noted that the business landscape is “rich with the carcasses of bright ideas that attracted a lot of funding but didn’t translate to viable businesses”.
The economics of high growth businesses often require reinvesting receipts to push further growth and expansion. That’s fine, said Narayan, but there’s two things high growth businesses need to determine: are you growing towards a profitable model, and when are you going to run out of cash?
“Profits are not necessary for strong valuation in the rapid growth phase of a business, but a credible and demonstrable future profit model is essential,” Narayan wrote. “Belief can only take a business so far before questions are asked about the long-term viability.”
Speaking to AccountingWEB, Narayan added that the CFO “needs to keep a close watch on the operating performance of the business ensuring the lead indicators are in line with the targeted course of the company and flagging course corrections where required.
“Your cash flows and cash position are very important in a rapidly growing business. As long as the business’s growth plans are value-enhancing with strong future returns, it makes rational sense to invest in the company to drive value growth.”
A business’s profits can be impacted in the short term, as many investing type activities with benefits well beyond one year are fully expensed. These would include customer acquisition costs (which are high in a SaaS business like Xero).
“Economic value added through metrics like LTV are more meaningful in the rapid growth stage,” Narayan added, echoing the philosophy of Anup Singh, the former CFO of Anaplan.
Anaplan is another cloud software enterprise, and it achieved unicorn status (a $1bn valuation) through rapid growth. While he was at the helm, Singh’s key focus is on recurring revenue and subscribers. Singh constantly monitors how many customers terminate their agreements - and also how many customers are decrease the size of their agreements with Anaplan (what’s termed as ‘shrinkage’).
The churn rate is intricately tied to the company’s net expansion rate. The big aim is to grow each customer’s spend and have it outpace lost revenue from churn and shrinkage. “It’s the so-called ‘land and expand’ strategy,” said Singh. “Land the initial deal, then service it.”
That’s where lifetime value comes in. Narayan’s focus is similar: “From a performance perspective, my primary focus is on revenue and subscriber growth. Other key metrics that I watch are Lifetime Values, gross margins and cost of acquisition.”
But, he added, “Your cash flows and cash position are very important in a rapidly growing business. As long as the business’s growth plans are value enhancing with strong future returns, it makes rational sense to invest in the company to drive value growth.”
About Francois Badenhorst
I'm AccountingWEB's business editor. Feel free to get in touch with comments, tips, scoops or irreverent banter.