All the fastest growing SaaS startups have this one thing in common: they’re tracking the metrics that matter the most.
To attain a clear picture of the health of your SaaS business, you must dive down below your standard financial statements and calculate metrics specific to your SaaS business.
There are these 6 primary metrics which are important for SaaS companies beyond the startup stage. Its preferable to look at these five metrics at least monthly but if you invoice monthly and have numbers that change weekly, you need to calculate them more frequently. Let’s have a look:
Net MRR/ARR growth rate
Net Monthly Recurring Revenue (MRR) Growth Rate measures the month-wise percentage increase in the net MRR. It’s one among the foremost and necessary SaaS metrics. Since MRR changes as new revenue is additional and customers churn (cancel) and as accounts expand or contract, the growth rate shows the net variation of those factors from month-to-month. The net growth rate provides a solid indicator of the pace with which your SaaS firm is growing.
Every SaaS company should measure their monthly recurring revenue (MRR) or annual recurring revenue (ARR). You should know your average MRR or ARR per customer and your recognized MRR as per the income statement.
Another point to consider is that there is a difference between bookings and recognized MRR. Bookings is a measure of signed software contracts and not a GAAP or IFRS term. You need to be consistent in measuring your subscriptions.
MRR/ARR acts as a building block and used in several other SaaS metric formulas. Based on your individual product lines, you should calculate MRR or ARR separately for each product. Averaging them together is not a great idea and will not provide the true picture.
Net MRR Calculation:
($) Existing MRR + ($) new business + ($) reactivation + ($) expansion – ($) churn – ($) contraction = ($) Net MRR
Net MRR Growth Rate calculation:
[ ($) Net MRR Month B – ($) Net MRR Month A] / ($) Net MRR Month A X 100 = (%) MRR Growth Rate
2) Average Cost of Service (ACS)
This metric (ACS) plays an important role in determining the health of your SaaS business. It takes into consideration total costs to serve the existing customers in delivering the software, providing support, offering additional features etc.
In other cases of being above or below ACS, you’ve got trouble. If the sales team is the closing deal and above ACS, that’s a red alert and the same in the case of selling below it. Depending on your CAC, customer profitability might never be reached, because high CAC and thin margins on ARR or MRR minus ACS mean a long payback period. Churn makes this even worse.
ACS can be calculated using the following components:
- R&D Amortization – The economic cost of your current release(s). If you don’t capitalize development, then the full cost of your R&D department.
- Technical Support – This covers the call center resolving inbound customer issues and queries.
- R&D Net of Cap – Include all the expenses in your development cost center except the software capitalization. It leaves you with the cost of software maintenance and supporting current releases and not any additional (new) development.
- Account Management – The sales team responsible for taking care of existing customers.
- Hosting – your hosting, server, and data center costs.
- Customer Success – This could be either 1) an ACS expense or 2) embedded in your Service department and counted in your service margins.
3) COST OF CUSTOMER ACQUISITION (CAC)
In simple terms, CAC can be defined as the total sales and marketing expenses associated with acquiring one new customer. This is measured on the basis of product and also various channels of acquisition.
Sales and marketing expenses majorly include salary, wages, taxes, fringe benefits, meals, travel and all those expenses on your P&L account that is added towards acquiring new customers. CAC is more powerful when compared to ARR from a customer.
You need to assist your controller or accountant to make sure that the expenses and headcount are coded to the department level on your general ledger. This is a vital step to make sure all the Saas metrics perform well and the true health of the business is disclosed correctly.
4) CAC PAYBACK PERIOD
CAC is termed as a critical metric as the acquisition of each customer comes along with a cost or say debt. In this case, the debt is CAC. Irrespective of the customer stays or churns, this debt stays with your business until it is paid off in full. You want to know the logic? Well, the money has been spent even if the customer churns. The money has to be paid back now.
CAC Payback Period is basically the number of months required to pay back the upfront customer acquisition costs after accounting for the variable expenses to service that customer. Simply put, CAC Payback Period equals CAC divided by the gross margin dollars generated by that customer.
A business can’t be profitable with that customer until the CAC has been paid off. MRR minus ACS equals to “Margin” which is the contribution margin to your business from that customer.
How to calculate CAC Payback Period?
($) CAC / [ ($) ARPA X (%) Gross Margin] = (#) Months to Recover CAC
5) CUSTOMER LIFETIME VALUE (LTV)
There are multiple ways and formulas to calculate LTV. One of them is the one below:
This formula reveals the lifetime margin (factors in ACS) of one customer after discounting for the time value of money (WACC) and churn but offset by customer subscription growth. In simpler terms, instead of valuing the cash flow of a business, the cash flows produced by one customer are valued.
Now, compare your LTV number to your CAC. Industry guidance suggests that your LTV should be three times your CAC. SaaS metrics are much more useful when used together to paint a definite picture.
If you practice these five metrics into your monthly financial reporting, overall financial discipline will begin to improve. You’ll develop a much better understanding of your business and will become capable of taking proactive measures to improve the health of your SaaS business.