Finding the Right Financial Metrics for Your SaaS Company
Software-based businesses have a head start: They're built with the right infrastructure and mindset to generate data-driven insights into the company's financial health.
If your business sells software as a service (SaaS), it is well-positioned to use software as a solution — particularly when it comes to strategic business intelligence.
SaaS businesses specialize in providing flexible and innovative approaches and leveraging the advantages of cloud computing, subscription-based models and other novel technologies to benefit their customer base. With a little extra muscle, SaaS companies can apply the same web of data-driven insights internally to create a clear picture of their own key performance indicators (KPIs).
Establishing a realistic baseline
Like many new industries, SaaS initially flourished by feasting on low-hanging fruit. According to Statista, the SaaS sector has experienced 7x growth over the past 10 years. High growth rates are necessary to stay ahead in competitive industries like SaaS. That ends up being very capital-intensive.
The savviest VC-funded SaaS startups are using their analytic acumen to optimize performance, beat industry benchmarks and attract investor dollars as they progress through the series funding alphabet. Here's a collection of common KPIs for your executive dashboard reports:
Customer acquisition costs (CAC): Acquiring new customers is essential to your company's growth. To calculate CAC, divide the total sales and marketing costs of a given period by the number of new customers acquired in that same period. A high CAC may indicate you need to tweak your marketing efforts, reduce your pricing or both.
Customer churn rate (CCR): A percentage that you calculate by dividing the number of canceled subscriptions per month by the number of total customers at the beginning of that month, CCR is another critical indicator. Basically, it's a reflection of customer satisfaction and loyalty. A high CCR suggests customers don't perceive the value of your product and/or think it's too expensive. As such, CCR can be a harsh but necessary reality check, especially in an economic downturn. A customer who cancels their subscription is telling you they consider your service expendable.
Monthly recurring revenue (MRR): This is the income you earn in each month from customer subscriptions. Analyzing the MRR trend over time provides a straightforward gauge of your company's growth — or lack thereof. An overall increase in MRR means you're continuing to acquire new customers or your existing customers are spending more with you now than before, both of which are key to ongoing growth. If MRR is decreasing, or even just remaining stagnant, something is amiss. It might be time to change your pricing and/or your marketing strategy to rekindle growth.
Customer lifetime value (CLV): How much money has a given customer spent on your service from the time they signed up until the present (or until they canceled their subscription?) That's their CLV. Analyzing your high-CLV customers can help you refine your acquisition efforts by targeting similar customers — which, in turn, can boost customer retention and reduce CCR. High-CLV customers also have more potential for upselling or cross-selling opportunities. Tracking CLV at the gross profit level (a.k.a. "gross margin-adjusted CLV") helps you predict how much profit will be generated within a customer's lifetime.
Cost of goods sold (COGS): There's still some variability among SaaS companies about what expenses should be considered COGS that are required to keep the product running, but we can take cues from industry leaders. Venture investors typically include the following: hosting, internal engineering (DevOps) wages, customer support or customer success (CS) wages, third-party services and third-party data built into your product. If you stop paying any of these costs, customers would be unable to continue using your product.
Gross margin: Subtract COGS from revenue to compute your gross profit, then divide that by revenue. The resulting percentage is your gross margin. That's one of the most important metrics for SaaS companies because that's what ultimately generates enterprise value at scale. A solid best-in-class benchmark to target is at least 80%.
CAC payback period: You'll never make it to profitability if CAC is higher than CLV — and don't forget to factor in COGS. We like to measure how many months it takes for gross-margin-adjusted CLV to cover initial CAC because the business doesn't start generating positive profit from each new subscription until after covering both CAC and COGS. Getting the gross-margin-adjusted CAC payback period to less than 12 months puts you in great shape. That's because you'll start to see positive profit trickle down to EBITDA from each new subscriber before they hit their first annual renewal date, and you can reinvest those profits into marketing to accelerate growth.
SaaS quick ratio: This determines growth efficiency of SaaS companies by comparing how many new revenue dollars are flowing into the company vs. lost revenue from customers who reduce spend or churn out during the same time period. Less than 1 means you're shrinking, not growing. SaaS industry leaders aim for 4 or higher, meaning they're adding $4 in new MRR for every $1 of revenue lost.
SaaS magic number: While the quick ratio above measures growth efficiency, the magic number here measures the efficiency of sales spend. Basically, the magic number is another way to think about CAC payback period from above. To calculate it, divide growth in revenue by sales and marketing spend in the same period. If the result is less than 0.75, your sales and marketing spend may not be effective enough at attracting new revenue dollars. But the magic number doesn't consider COGS, so it's less useful in a big-picture context.
Net burn: All startups need to keep a close eye on how much cash they're burning. That allows them to plan when they'll need to raise another round of investment to fund company operations until they're generating more cash than they're spending. Gross burn is just a total of all company spending. Net burn reduces that by the amount of cash the company is generating from sales. Your accrual-based income statement (a.k.a. profit and loss statement, or P&L) generally won't show you the full cash burn story, though. That's what the cash flow statement is for.
Some 'leading' indicators can actually be misleading indicators
The metrics above are evergreen indicators that are valuable to SaaS companies at every growth stage. All except for cash burn are derived from the P&L alone, though, so they're missing the other half of a business' financial story that lives on the balance sheet.
Don't get caught by surprise after misinterpreting your KPIs. Here are a few examples to watch out for:
Cashless profits: For SaaS startups that are still burning more cash than they're generating, it can feel like a windfall to receive a large annual license payment from a new subscriber. But that cash needs to last for the entire yearlong subscription term, so don't spend it all in one place! The MRR from that new sale will generate profit on the company's P&L each month of the annual license period. But because the company won't receive additional cash payments each month, we call those "cashless profits."
That means you can't rely on the P&L alone to calculate your burn rate. A good financial forecast model that considers deferred revenue and other balance sheet activity is necessary to have a full picture of how much actual cash the business will generate and burn each month into the future. That helps you protect your cash runway and budget future spending with confidence.
Lagging indicators vs. leading indicators: Another drawback to relying solely on your P&L is that it looks only at the past, and therefore doesn't provide insights into future growth or potential challenges. That's why the P&L is referred to as a "lagging indicator."
Leading indicators, in contrast, are forward-looking and can help SaaS businesses make proactive decisions, adjust strategies and identify opportunities. And many of those don't actually live in your accounting general ledger at all. Examples include your monthly active users (MAU), conversion rates, website traffic & impressions, and number of leads in your sales funnel. Monitoring these metrics in real time allows businesses to drive growth, enhance customer experience and position themselves for long-term success.A good SaaS financial forecast projects future revenues based on assumptions built around these leading indicators. Then, you and your CFO (and prospective future investors) can test how actual KPI trends measure up to your forecasted assumptions — to validate what’s working, identify and fix what isn’t, and reforecast with higher confidence and accuracy.
Make technology work for you
There's a reason you started a SaaS company in the first place: You realized the exploding technology sector had created all kinds of new business opportunities. Make sure your team knows how to manage your accounting and operational data at the right level of detail — and that your systems can report out the right KPIs to help you navigate a successful growth trajectory.
There's a lot here to focus on, so partnering with experienced outsourced professionals can lighten the load on your internal team and enable you to identify and then double down on what works best.
