“If you can’t measure it, you can’t improve it” – Lord Kelvi.
These are startups that failed due to premature scaling. According to a survey, 70% of startups, including tech and Software As A Service (SaaS) companies, crumble in an attempt to scale too quickly. But what’s the right time to scale?
Instead of focusing on your gut feeling and what others tell you, let the numbers show you the mirror.
That’s where financial metrics or KPIs come into the picture.
Whether you’re a subscription-based SaaS company or a cloud-based SaaS platform offering robo advisor solutions, measuring the financial metrics could be the difference between success and failure.
When it comes to SaaS companies, it’s an uphill battle to identify the top financial metrics. With a digital product, upsells, subscription, recurring revenue, and more, traditional financial metrics are less likely to give an accurate financial performance overview.
The metrics you decide to track or monitor impact your business, showing you how to better the company. Keep in mind that while Google sheets and Excel come in handy, at some point, you will require more robust and comprehensive solutions like getlatka for SaaS reporting.
5 Financial SaaS Metrics
To simplify, we’ve outlined the top five metrics for your SaaS business. Use these to steer your ship through the rough sea.
1. Annual recurring revenue (ARR)
When it comes to a SaaS business, recurring revenue is the oxygen. As a metric, it’s the first thing a potential venture capitalist (VC) looks into, and problems here could lead to devaluation or even worse – VC walking away from the table without funding.
By definition, ARR is the total yearly revenue generated from the existing customers through their spending on your business. ARR is crucial as:
- It gives a clear picture of how your business is generating yearly revenue.
- It indicates that you’re good at both acquiring new customers and retaining the existing ones.
- It helps in accurately forecasting growth.
To effectively use ARR as a SaaS business metrics, you must have a term agreement with the customer for a minimum of one year, or a significant chunk of the term agreements should be above one year or more.
MRR = Monthly recurring revenue
With ARR, you can monitor the year-on-year progression, which comes in handy in long-term product planning and creating future road maps. Companies with well-managed recurring revenue have the potential to increase the valuation. This makes ARR the most significant driver for valuation.
Getting it right is the key to success.
What to include?
- Recurring subscription
- Downgraded and upgraded accounts
- Revenue lost from churn customers
What not to include?
- Non-recurring charges
- Account adjustments
- Set-up fees
How to increase ARR?
- Focus on increasing upsell
- Enhance customer retention
2. Customer renewal rate
It’s also known as customer retention rate or renewal rate. Unlike the retail sector, a SaaS business cannot thrive on a one-time purchase. If you can’t get your subscribers to continue, you’re probably far from achieving a market/product fit. You are wasting resources if new customers keep coming in, but there is a high churn. It’s more like trying to fill a leaky bucket without fixing the leaks. No matter how hard you try, there will not be any significant revenue growth.
Keeping your customers happy and ensuring subscribers renew every month is a cost-effective and efficient technique.
The acquisition of new customers costs five times more than retention.
Renewal rate gives the percentage of customers who renew their subscription in the given year. It’s a significant financial metrics due to numerous reasons including,
- It determines the health and profitability of your business.
- It indicates the overall customer satisfaction.
- It accurately predicts the income.
Usually, renewal rates are measured across weeks, months, and even years. And measuring the rate over different periods is valuable. For example, measuring the customer retention rate over the first month of each subscriber could indicate a problem with the on-boarding process.
How to improve the renewal rate?
- Segment and analyze customers
- Reduce payment failures
- Ensure high product adoption among customer
3. CAC payback period
You have to spend money to make it– this old adage holds even for SaaS businesses.
What’s important is the time in which you earn back the invested money. This is also known as break-even analysis.
This is where you need the customer acquisition cost (CAC) payback period.
It measures the month it takes to earn back the money spent on acquiring new customers. It’s an essential financial metric as:
- It helps you understand the cash flow required to run the business profitably.
- It indicates whether you need to cut down marketing costs or not.
- It highlights problems in the retention strategy.
Start tracking the payback period from the early startup days. Initially, these numbers will be skewed but will help keep an eye on metrics and motivate you to work towards achieving it.
The faster is always the merrier in the CAC payback period. Ideally, a SaaS business should have its CAC paid back within 12 months.
A shorter payback time gives your business two golden tickets:
- Smaller working capital requirement
- Faster growth
How to lower the CAC payback period?
- Monetize your customers
- Enhance sales or marketing funnel conversion rate
- Reduce your discretionary marketing costs
4. Average cost of service (ACS)
One of the most under-recognized SaaS business metrics is the average cost of service (ACS). This metric tells you how much it costs you to deliver the software, provide support, and upsell additional features to a single customer.
When used in isolation, the metrics may not give a holistic picture of the economies of scale.
But, when used with CAC and ARR, it provides powerful insights about the business, which helps in making key business decisions like:
- Whether the current pricing model is sustainable or not.
- How doubling or tripling the subscriber base affects the turnover?
- How much should the subscription base be increased to ensure profitability in the current pricing model?
- How an increase in subscriber base effects the per-unit cost?
What to include in COGS?
- Hosting cost
- Cost of third-party software used in delivering the product
- Cost of customer support/success excluding sales costs
- Employee cost for keeping the product in the production environment
- Any direct employee cost required for the final delivery of the product
What not to include in COGS?
- Sales commission
- Development cost of the product
- Allocated overhead charges
5. Cash burn rate and cash runaway
The fundamental rule of any business is never running out of capital or cash. But, it’s easier said than done. In the excitement to acquire more customers and scale up the business, most startups spend far more than they get from the investors.
No SaaS metrics can ever change a zero bank balance.
Therefore, keeping pace with spending cash is critical for business success and requires a balanced approach.
By definition, the cash burn rate is the rate at which your company uses cash or cash reserves at a given period usually, a month. It’s an essential metrics because:
- It helps in identifying the overall business lifespan.
- Venture capitalists and seed-stage investors provide funding based on the company’s cash burn rate.
A negative cash burn rate is desirable. It means you’re building up cash reserves instead of spending them. As they say, if you want to drive a faster car, you don’t always have to spend money on changing the engine; you probably need good brakes. Similarly, the key to better cash burn rate management is not raising more money. It’s cutting down the expenses.
After knowing the cash burn rate, you need to know the time for which this burn rate is sustainable.
That’s where you need to calculate the cash runaway.
Cash runaway gives the time in months for which your cash will last at your business’ current cash burn rate. When the cash runaway is zero, you’re both out of money and time. In short, your business hits bottom and bankruptcy calls!
To avoid running out of cash, consider using debtor finance to receive cash from invoices early. You can read what is debtor finance to learn more.
How to reduce the cash burn rate?
- Focus on increasing the revenue
- Reduce payroll expenses, direct costs, and unnecessary expenses
- Focus on ROI
- Focus on a growth rate you can manage
From the laundry list of SaaS metrics, incorporate these five financial metrics in your financial reporting to improve the business’s financial health.
While all these metrics are critical to your SaaS business success, don’t enter the vicious circle of comparing your numbers with the benchmark. Every SaaS company is different, and each has unique circumstances, resulting in different financial numbers. It doesn’t make sense to follow a prescribed benchmark blindly.
Focus on tracking and monitoring these metrics as these provide excellent insights on how your company is performing today and the steps you need to take to ensure future growth.