17 financial metrics you need to understand if you work in SaaS
The only guide you will ever need to understand the most essential financial metrics for SaaS companies
Understanding financial metrics is essential for everyone working in SaaS to make informed decisions and drive growth in their companies. In this article, we'll dive into various financial metrics crucial for software companies. Understanding both how these financial metrics are defined and how to use them can be your super power.
Revenue Metrics
MRR (Monthly Recurring Revenue)
Definition: MRR, or Monthly Recurring Revenue, is the amount of revenue a company generates from its customers on a monthly basis for its recurring services or products. It’s a key metric that indicates the predictable, recurring income of a business.
How to calculate MRR: Calculate MRR by multiplying the total number of customers by the average revenue per customer .
Formula: MRR = Total Number of Customers * Average Revenue per Customer
Example: If a company has 1,000 customers who each pay $10 per month on average, the MRR would be $10,000.
How to use MRR: MRR is crucial for subscription-based companies like Netflix, Spotify, and Dropbox. They use it to measure the stability of their monthly revenue from subscribers.
ARR (Annual Recurring Revenue)
Definition: ARR, or Annual Recurring Revenue, is the amount of revenue a company expects to receive from its customers on an annual basis for recurring services or products. It provides an overview of a business's predictable, recurring income and helps measure long-term growth.
How to calculate ARR: Multiply Monthly Recurring Revenue (MRR) by 12 to calculate ARR.
Formula: ARR = Monthly Recurring Revenue (MRR) * 12
Example: If a company has an MRR of $10,000, its ARR would be $120,000 (10,000 * 12).
How to use ARR: ARR is essential for companies with subscription-based models, particularly those focusing on annual subscriptions. Companies offering annual subscriptions may find ARR more useful than MRR since it directly represents the expected revenue from their primary subscription model. Analyzing ARR allows such businesses to better understand their long-term financial health and guide investment decisions.
Recurring Revenue Growth Rate
Definition: Recurring Revenue Growth Rate measures the rate at which a company's recurring revenue increases over time. It helps assess the effectiveness of sales and marketing efforts in driving revenue growth.
How to calculate Recurring Revenue Growth Rate: Subtract the previous period's recurring revenue from the current period's recurring revenue. Then, divide the result by the previous period's recurring revenue and multiply by 100% to express it as a percentage.
Formula: Recurring Revenue Growth Rate = ((Current Period Recurring Revenue - Previous Period Recurring Revenue) / Previous Period Recurring Revenue) * 100%
Example: If a company's recurring revenue increased from $100,000 to $120,000 in a given period, the Recurring Revenue Growth Rate would be 20%.
How to use Recurring Revenue Growth Rate: Monitor your Recurring Revenue Growth Rate to evaluate the success of sales and marketing initiatives. A positive growth rate indicates that your efforts are driving revenue growth, while a negative rate suggests the need for improvements. By tracking this metric, you can optimize your strategies to ensure sustainable revenue growth.
ACV (Annual Contract Value)
Definition: ACV is the average annualized revenue per customer contract. It calculates the average revenue generated from a single customer's contract within a year.
How to calculate ACV: To calculate ACV, divide the total contract value by the contract duration in years.
Formula: ACV = Total Contract Value / Contract Duration in Years
Example: Suppose a customer signs a three-year contract worth $12,000. In that case, the ACV would be $4,000 (ACV = $12,000 / 3 years).
How to Use This Metric: Analyze ACV to better understand customer value and the financial impact of contract lengths. By monitoring ACV, businesses can optimize their pricing strategies and tailor contract terms to maximize customer value and overall revenue.
Churn Metrics
Logo Churn
Definition: Logo Churn represents the rate at which customers cancel or do not renew their subscriptions during a specific period. It measures the percentage of lost customers over time.
How to calculate Logo Churn: Determine the number of customers lost and divide it by the total number of customers at the beginning of the period.
Formula: Logo Churn = (Number of Customers Lost / Total Number of Customers at the Start of the Period) * 100%
Example: If a company starts with 1,000 customers and loses 50 during a given period, the Logo Churn would be 5% (Logo Churn = 50 / 1,000 * 100%).
How to use Logo Churn: Track Logo Churn to assess customer satisfaction, retention, and the impact of churn on overall revenue. High Logo Churn may indicate issues with the product, service, or customer experience. By monitoring Logo Churn, businesses can identify areas for improvement and allocate resources to retain customers more effectively.
Revenue Churn
Definition: Revenue Churn measures the lost revenue from customers who cancel or downgrade their subscriptions during a specific period. Unlike Logo Churn, which focuses on customer count, Revenue Churn emphasizes the financial impact of lost customers.
How to calculate Revenue Churn: Calculate the MRR (Monthly Recurring Revenue) or ARR (Annual Recurring Revenue) lost from canceled or downgraded subscriptions, and divide it by the total MRR or ARR at the beginning of the period.
Formula:
Revenue Churn (MRR) = (MRR Lost from Canceled or Downgraded Customers / Total MRR at the Start of the Period) * 100%
Revenue Churn (ARR) = (ARR Lost from Canceled or Downgraded Customers / Total ARR at the Start of the Period) * 100%
Example: If a company starts with $100,000 MRR and loses $5,000 MRR from canceled or downgraded subscriptions, its Revenue Churn (MRR) would be 5% (Revenue Churn = $5,000 / $100,000 * 100%).
How to use Revenue Churn: Monitor Revenue Churn to evaluate the financial impact of customer churn and assess overall revenue health. High Revenue Churn can erode profits and stunt growth. By tracking Revenue Churn, businesses can identify revenue-at-risk and implement strategies to retain or recover lost revenue, such as targeted retention campaigns or pricing optimization.
Revenue Churn vs. Logo Churn: While Logo Churn measures the percentage of lost customers, Revenue Churn focuses on the lost revenue. Analyzing both metrics helps businesses understand the interplay between customer count and revenue generation and create strategies to balance customer retention and revenue growth.
Retention Metrics
NRR (Net Revenue Retention)
Definition: NRR measures the percentage of recurring revenue retained from existing customers after accounting for upgrades, downgrades, and churn during a specific period. It reflects a company's ability to retain and expand revenue from its existing customer base.
How to calculate NRR: First, calculate the total recurring revenue from existing customers at the beginning of the period, including upgrades and downgrades. Then, subtract the revenue lost from churn. Finally, divide the result by the total recurring revenue at the beginning of the period.
Formula: NRR = ((Recurring Revenue at the Beginning of the Period + Upgrade Revenue - Downgrade Revenue - Churned Revenue) / Recurring Revenue at the Beginning of the Period) * 100%
Example: Suppose a company starts with $100,000 MRR, generates $10,000 from upgrades, loses $5,000 from downgrades, and incurs $7,000 churned revenue. Its NRR would be 98% ([($100,000 + $10,000 - $5,000 - $7,000) / $100,000] * 100%).
How to Use NRR: Monitor NRR to evaluate customer retention and revenue expansion strategies. An NRR above 100% indicates effective retention and expansion efforts, while below 100% suggests a need for improvements. By tracking NRR, businesses can identify opportunities to retain and grow revenue from their existing customer base.
GRR (Gross Revenue Retention)
Definition: GRR measures the percentage of recurring revenue retained from existing customers, excluding any expansion or upsells during a specific period. It focuses solely on revenue retention without considering growth.
How to calculate GRR: First, subtract the revenue lost from churn and downgrades from the total recurring revenue at the beginning of the period. Then, divide the result by the total recurring revenue at the beginning of the period.
Formula: GRR = ((Total Recurring Revenue at the Beginning of the Period - Churned Revenue - Downgrade Revenue) / Total Recurring Revenue at the Beginning of the Period) * 100%
Example: Suppose a company starts with $100,000 MRR, loses $7,000 from churn, and incurs $3,000 downgrades. Its GRR would be 90% ([($100,000 - $7,000 - $3,000) / $100,000] * 100%).
How to use GRR: GRR helps businesses assess their customer retention and revenue stability. A high GRR indicates effective customer retention strategies, while a low GRR suggests improvements in customer satisfaction or engagement. Track GRR alongside other retention metrics to identify trends and make data-driven decisions to increase customer lifetime value.
GRR vs. NRR: While GRR focuses solely on revenue retention without considering expansion or upsells, NRR accounts for upgrades and additional revenue generated from existing customers. GRR is useful to measure the effectiveness of retention efforts in isolation, while NRR is a more comprehensive measure of customer retention and revenue growth combined. Analyzing GRR and NRR together can help businesses understand the impact of both retention and expansion efforts on their overall recurring revenue.
Acquisition Cost & Lifetime Value Metrics
LTV (Customer Lifetime Value)
Definition: LTV calculates the average total revenue generated by a customer throughout their entire relationship with a company. It represents the long-term value that customers bring to a business.
How to calculate LTV: First, determine the company's average customer lifespan (in years, months, etc.). Next, calculate the average revenue generated per customer account during that time. Then, multiply the average revenue per customer by the average customer lifespan.
Formula: LTV = Average Revenue per Customer * Average Customer Lifespan
Example: Suppose a company generates an average revenue of $1,000 per customer per year, and its average customer stays for 3 years. The LTV would be $3,000 ($1,000 * 3).
How to use LTV: Monitor LTV to evaluate the effectiveness of retention strategies and the overall profitability of customer relationships. By knowing a customer's LTV, businesses can allocate appropriate resources to customer acquisition and retention, ensuring that their efforts align with each customer's long-term value.
CAC (Customer Acquisition Cost)
Definition: CAC calculates the average cost of acquiring a new customer, including all sales and marketing expenses associated with acquiring that customer.
How to calculate CAC: First, determine the total sales and marketing expenses during a specific period. Then, calculate the number of new customers acquired during that same period. Finally, divide the total expenses by the number of new customers acquired.
Formula: CAC = (Total Sales and Marketing Expenses / Number of New Customers Acquired)
Example: Suppose a company spends $10,000 on sales and marketing expenses in a month and acquires 100 new customers. Its CAC would be $100 ($10,000 / 100).
How to use CAC: CAC helps businesses evaluate the efficiency of their customer acquisition strategies. Monitor CAC to identify trends, optimize marketing and sales spend, and ensure sustainable growth. Compare CAC to Customer Lifetime Value (CLTV) to ensure that the cost of acquiring customers doesn't exceed the revenue they generate over their lifetime.
CAC Payback Time
Definition: CAC Payback Time calculates how long it takes for a company to recover the Customer Acquisition Cost (CAC) through the revenue generated by a customer. It helps assess the efficiency of customer acquisition efforts and the profitability of new customers.
How to calculate CAC Payback Time: First, determine the company's Gross Margin (%) - (explained below) for its product or service. Next, calculate the CAC Payback Time by dividing the Customer Acquisition Cost (CAC) by the Monthly Recurring Revenue (MRR) generated per customer and the Gross Margin (%).
Formula: CAC Payback Time (months) = CAC / (MRR * Gross Margin)
Example: Suppose a company spends $500 to acquire each new customer and generates $100 in Monthly Recurring Revenue (MRR) per customer, with a Gross Margin of 80%. Its CAC Payback Time would be 6.25 months ($500 / ($100 * 0.8)).
How to use CAC Payback Time: CAC Payback Time helps companies determine how long it takes for new customers to become profitable. Monitor this metric to optimize customer acquisition strategies, ensure efficient use of resources, and balance short- and long-term profitability. Aim for a lower CAC Payback Time, indicating that the company recovers its CAC faster and achieves profitability more quickly.
LTV to CAC Ratio
Definition: The LTV to CAC Ratio compares the Customer Lifetime Value (LTV) to the Customer Acquisition Cost (CAC), providing insight into the return on investment (ROI) for acquiring new customers.
How to calculate LTV to CAC Ratio: First, determine the company's Customer Lifetime Value (LTV) and Customer Acquisition Cost (CAC). Then, divide LTV by CAC.
Formula: LTV to CAC Ratio = LTV / CAC
Example: Suppose a company has an LTV of $1,200 and a CAC of $500. Its LTV to CAC Ratio would be 2.4 ($1,200 / $500).
How to Use This Metric: Monitor the LTV to CAC Ratio to assess the efficiency of customer acquisition strategies and profitability of customer relationships. A higher ratio suggests that the company generates more value from each new customer, while a lower ratio might indicate a need to optimize acquisition efforts or improve customer retention. Generally, aim for an LTV to CAC Ratio of 3 or higher, as this indicates that the revenue generated by a customer is significantly higher than the cost to acquire them.
Burn Metrics
Net Burn
Definition: Net Burn measures the net cash flow of a company after accounting for both its cash inflows (primarily from revenue) and cash outflows (from expenses). It is a crucial metric for startups and growing businesses to understand their financial health and runway.
How to calculate Net Burn: First, determine the cash inflows from revenue and other sources. Next, calculate the cash outflows from expenses, such as salaries, rent, and operating costs. Finally, subtract the total cash outflows from the cash inflows.
Formula: Net Burn = Cash Inflows - Cash Outflows
Example: Suppose a company generates $50,000 in monthly revenue and incurs $85,000 in expenses. Its Net Burn would be -$35,000 ($50,000 - $85,000).
How to use Net Burn: Net Burn helps companies understand their cash position and financial sustainability. Positive Net Burn indicates that a company is generating more cash than it spends, while negative Net Burn suggests higher spending than incoming cash. Monitor Net Burn to ensure sufficient cash reserves, make strategic decisions about fundraising, and optimize your business operations to achieve profitability.
Note: Burn Rate differs from Net Burn, which considers both cash inflows and outflows to calculate net cash flow. While Burn Rate focuses solely on expenses, Net Burn offers a more comprehensive view of a company's financial health. Analyzing both metrics together can provide valuable insights for managing cash flow and growth.
ARR to Burn Ratio
Definition: The ARR (Annual Recurring Revenue) to Burn Ratio measures the efficiency of a company's revenue generation compared to its cash burn. It helps determine whether a company can sustainably grow its revenue without depleting its cash reserves.
How to calculate ARR to Burn Ratio: Calculate the company's Annual Recurring Revenue (ARR) and divide it by the Burn Rate (monthly expenses).
Formula: ARR to Burn Ratio = (ARR / Burn Rate)
Example: Suppose a company has an ARR of $500,000 and a Burn Rate of $50,000 per month. Its ARR to Burn Ratio would be 10 ([$500,000 / $50,000] ).
How to use ARR to Burn Ratio: Monitor the ARR to Burn Ratio to assess financial sustainability and efficiency in revenue generation. A higher ratio indicates that the company generates more revenue with less cash burn, while a lower ratio suggests a need to optimize revenue growth or control expenses. Use this metric to inform fundraising and operational decisions and prioritize profitable growth strategies.
Profitability Metrics
COGS (Cost of Goods Sold)
Definition: In the context of software companies, COGS primarily represents the direct costs associated with creating, maintaining, and delivering their software products. These costs can include Customer Success, Support & DevOps salaries, licensing fees, hosting, and other expenses that are directly attributable to the maintenance and delivery of the software.
(Note: The salaries for R&D not working on “delivering” to the customer, meaning everyone working on new features & functionalities, are usually not counted towards COGS)
How to calculate COGS: First, determine the regular cost of inventory(the product), which may include support & delivery labor costs, hosting expenses, and 3rd party software licenses. Next, calculate the cost of additional expenses incurred during that period, such as expenses for freelancers, one time implementation costs or increased hosting fees.
Formula: (SaaS) COGS = Regular Cost of Inventory - Additional Inventory Cost
Example: Suppose a software company has an inventory cost of $500,000 (including labor, hosting, and licensing expenses) and incurs an additional $30,000 in freelance labor its COGS would be $530,000 ($500,000 + $30,000).
How to use COGS: Software companies should monitor COGS to evaluate development efficiency, cost management, and pricing strategies. By comparing COGS to revenue, businesses can determine their Gross Margin, which reveals how much profit they make after accounting for direct production costs. Tracking COGS over time can help identify trends, opportunities to reduce expenses, and potential areas for process improvements in software development and delivery.
Gross Margin
Definition: Gross Margin represents the percentage of revenue that a company retains after accounting for the direct costs of producing its goods or services (COGS). It indicates how efficiently a company generates profit from its core business operations.
How to calculate Gross Margin: First, determine the company's revenue during a specific period. Next, calculate the Cost of Goods Sold (COGS) for that period. Finally, subtract COGS from revenue and divide the result by revenue. Multiply by 100% to express it as a percentage.
Formula: Gross Margin = ((Revenue - COGS) / Revenue) * 100%
Example: Suppose a company generates $100,000 in revenue and has a COGS of $40,000. Its Gross Margin would be 60% (($100,000 - $40,000) / $100,000 * 100%).
How to use Gross Margin: Monitor Gross Margin to evaluate profitability, cost management, and pricing strategies. A higher Gross Margin generally indicates that a company can produce goods or services more efficiently and has more resources to invest in growth or cover other expenses. Analyze Gross Margin trends over time and compare them to industry benchmarks to identify potential areas for improvement or competitive advantages.
Profit Margin
Definition: Profit Margin calculates the percentage of revenue that a company keeps as profit after accounting for all expenses, including direct costs (COGS), operating costs, and other overhead expenses. It measures a company's overall profitability and efficiency in generating earnings.
How to calculate Profit Margin: First, determine the company's total revenue and all expenses during a specific period, including COGS and other operating expenses. Next, subtract the total expenses from revenue to calculate Net Income. Finally, divide Net Income by revenue and multiply by 100% to express it as a percentage.
Formula: Profit Margin = (Net Income / Revenue) * 100%
Example: Suppose a company generates $500,000 in revenue, has a COGS of $200,000, and incurs an additional $150,000 in operating expenses(Sales, Marketing, etc.). Its Profit Margin would be 20% (($500,000 - $200,000 - $150,000) / $500,000 * 100%).
How to use Profit Margin: Monitor Profit Margin to assess a company's overall profitability, efficiency, and financial health. Higher Profit Margins generally indicate that a business can effectively manage its costs and generate earnings. Analyze Profit Margin trends over time, compare to industry benchmarks, and identify areas to optimize expenses or increase revenue to improve profitability.
