The most effective business owners run their companies based on specific metrics; and nowhere is this more pertinent than with SaaS metrics.
But which metrics are integral to your success? And which should you best avoid?
Choose the wrong metrics, and you may steer your business off a cliff. Spread your focus across too many, and you may lose sight of the essential information. Or what if you zero in on too few? You could develop a colossal blind spot that eventually swings back around to knock you off your feet like that devilishly arcing boomerang.
Based on our experience, top performing SaaS businesses track and manage just eight performance indicators.
1) Revenue Growth Rate
Revenue Growth Rate = (Increase in MRR) / (Last month’s MRR)
Yes, revenue growth. Not just revenue. Revenue growth is the simplest and purest marker of the growth potential of a business, which is of fundamental importance to any SaaS company. In Saas, fixed costs are disproportionately high when compared to variable costs, so each additional revenue-generating client will help cover the fixed costs of running your business.
2) Gross Margin
Gross Margin = (Revenue) – (Total direct costs of your product or service)*
A high gross margin is essential for two reasons: First, the higher your gross margin, the more potential you have for a high net margin. Second, a high gross margin gives you more room to invest in sales and marketing, and so realize a higher Revenue Growth Rate – performance metric number one!
*For a SaaS business, this includes server costs, hosting costs, software licenses, customer support and revenue shares (if applicable).
3) MRR Churn
MRR Churn = (Change in MRR (month-on-month)) / (Last month’s MRR)
It is hard to overstate the importance of keeping churn as low as possible. Simply put, if you have a 5 Percent monthly churn, this means one year from now, you will have lost 46 Percent of your MRR. So, you will need to attract a further 46 Percent of you current MRR in new clients, just to stay at your current MRR.
4) Customer Acquisition Costs
CAC = (Total sales and marketing spend acquiring new customers) / (Total number of new customers)
Your gut may tell you lower is better; this is only partially true. The objective here is to optimize for the right group of customers. So, get your CAC as low as possible without compromising on the quality of customer. If your CAC goes down, but your churn goes up as a result of targeting the wrong prospects, you are still heading in the wrong direction.
5) Payback Period
Payback = (CAC) / (Gross margin per year, per client)
The customer acquisition payback period measures how long it takes you to earn back your acquisition cost. A shorter payback period is better for these two reasons:
1) Less chance of customer churn during the payback period; in which case you would lose money on that client;
2) Higher ROI on your marketing spend; you free up customer acquisition capital faster to reinvest in growth functions such as marketing and sales.
6) Operating Cash Flow
OCF = (Sum of all cash received from clients) – (Total operating expenses)
This figure tells you how much cash you are generating or spending. As we all know, cash is king. No matter how brilliant your solution, no matter how effective your lead funnel; if you run out of cash, you’re out of business. Operating cash flow does not include capital raised through investment; it solely focuses on how much cash your operating activities generate or burn – this is your ‘live or die’ number.
7) Quick Ratio
QR = (New MRR + Expansion MRR) / (Churned MRR + Contraction MRR)
In SaaS, the Quick Ratio offers insight into your ability to grow recurring revenue reliably in the face of churn. Or, to put it another way, it measures the growth of MRR versus lapsed revenue. As a rule of thumb, the higher the Quick Ratio, the better – but even if your ratio is high, keeping churn to a minimum is key.
8) Churn Risk (Enterprise SaaS)
This is where we run out of equations; there is no ‘hard-and-fast’ rule. Just your assessment of the likelihood – and impact – of any client leaving.
This is especially relevant in the context of a concentrated client base, as with any enterprise SaaS supplier. Be sure to keep a close eye on when your big customers’ contracts expire, and what their renewal options and periods are. Then assess how likely they are to renew; or leave.
Why LTV Is Not a Good SaaS Metric
Most business owners focus on LTV, and there is some merit in that. However, we also see many shortcomings in LTV that lead us to believe it is overvalued – particularly for younger SaaS businesses.
Let’s start with the obvious drawbacks.
Firstly, younger SaaS companies do not yet have enough relevant data about customer lifetime value to make an informed judgment. If you’ve been operating for three years, and a range of your clients from the first year are still your customer – how can you accurately assess their LTV?
Secondly, LTV doesn’t account for variation in lifetime value and churn patterns. If your customer LTV is USD 500, it could be that 50 Percent of them are actually USD 600, while 50 Percent is USD 400. But it could also be that 90 Percent of your newly acquired customers have an LTV close to 0, while 10 Percent has an LTV of USD 5,000.
Evidently, the above scenarios have massive implications as to how you should invest your time; as well as where to invest in churn prevention strategies. Moreover, LTV fails to account for churn mitigation expense. With the right approach, you may retain a customer longer; however, these efforts, costs, and benefits are harder to account for in LTV.
Finally, LTV only looks at the total revenue a customer brings in, ignoring the time-value of money. Simply put, a Dollar made today is worth more than a Dollar earned a year from now – so, be sure to keep that fact in mind.
As a SaaS business owner, a dashboard displaying these eight SaaS metrics is an essential tool to get actionable snapshots of performance in time-limited situations. When all metrics are in line with your targets, you know you are on the right track. When one or more SaaS metrics are lagging, you know it’s time to investigate; and you can have confidence you will find the cause.
Frequently reviewing your dashboard is your best way to stay in control. It allows you to focus on expanding your business, while continually optimizing underlying processes.
Want to know more?
ABEL Finance helps SaaS business owners set up and interpret custom dashboards. As your Virtual CFO, we specialize in helping you understand and improve the financial performance of your business.
To discuss how we can improve your numbers today, schedule a free call here.