Founders and executives of SaaS businesses know all too well how important it is to track Key Performance Indicators (KPIs) that measure the performance of their business. What gets measured gets managed. By tracking several metrics on an ongoing basis, leaders can understand how to improve performance.
However, many of the performance metrics commonly used in traditional businesses aren’t a great fit for SaaS businesses. Many SaaS businesses are VC-backed, generating significant losses in order to build scale. That can mean the business has negative cash flow: something that would send investors running in a more traditional business.
Because of this, SaaS businesses should use a different set of metrics to quantify their progress toward the business’s goals. But what should these metrics be? There are countless KPIs to choose from. Many businesses even make up their own.
Aligning on a set of meaningful metrics is important in enabling leaders not only to understand business performance but to be able to explain this performance externally. The best approach is to select a set of metrics that are both universally understood and are a good fit for your business.
For SaaS businesses, eight metrics are commonly used. Your business doesn’t have to adopt all of these, but consider them a good starting point for building out systems that accurately track performance and growth.
Here are eight of the most important financial metrics for SaaS businesses:
Let’s explore each of them in a little more detail.
Looking for a deeper dive? Check out our Ultimate Guide to SaaS Business Accounting for a comprehensive overview of how to manage the finance and accounting infrastructure of your SaaS business.
What is it? Customer Acquisition Cost, commonly shortened to CAC, is the sum of the costs your business incurs to acquire a new customer. This calculation includes all costs related to sales and marketing, such as:
To calculate CAC, sum all of your sales and marketing costs in an accounting period and divide this number by the number of new customers you acquired during the period.
Why is it important? CAC is an indicator of how easy your business’s products and services are to sell. If CAC is too high, a business will struggle to be profitable and will face challenges as it scales. Successful SaaS businesses lower CAC over time by improving the performance of their sales and marketing teams.
What is it? In addition to the CAC itself, SaaS businesses should also measure the time it takes to recoup these costs through gross margin. For example, let’s say it costs your business $1,000 to acquire a new customer and the customer pays $100 a month for your product. Assuming your gross margin is 75%, you would make $75 in gross profit each month, giving a CAC payback period of just over 13 months.
Why is it important? CAC payback is another indicator of how successful your business is in selling its products and services. The optimal CAC payback period is between 12 - 15 months: any less and your business is underinvesting in growth, any more and your business will struggle to scale.
What is it? Many SaaS businesses receive regular payments from their customers, often on a monthly or annual basis. Recurring revenue is typically expressed either as Monthly Recurring Revenue (MRR) or Annual Recurring Revenue (ARR) and is a dollar value that the business expects to continue to receive on an ongoing basis.
Why is it important? Recurring revenues are considered to be a relatively predictable revenue base. Many investors apply multiples to a business’s recurring revenue to calculate a valuation for the company.
What is it? Regardless of how good your product is, some percentage of your customer base will gradually leave your SaaS business. Logo churn rate calculates the number of unique customers that churn each period. For example, if your business had 1,000 unique customers at the start of an accounting period, and during that period, 75 left, it would have a logo churn rate of 7.5%.
Why is it important? Churn rate is a good indicator of whether your business has product/market fit. If it’s too high, your business will be forced to invest heavily in acquiring new customers in order to grow. Conversely, if churn is low, it’s a sign your product is extremely valuable to customers. Reviewing the types of customers being retained and lost can also help to inform your firm’s marketing strategy on an ongoing basis.
What is it? Revenue churn rate is similar to logo churn rate but focuses on the amount of revenue lost when a customer leaves. It is calculated by taking the dollar value of revenue lost when customers leave in an accounting period and dividing this by the business’s total revenue in the period.
Why is it important? Revenue churn rate recognizes that not all customers are equally important to the business. The impact of losing five large enterprise customers is far greater than losing five small customers. This would not be captured in logo churn rate but is captured in revenue churn rate.
What is it? Many SaaS businesses raise external capital to invest in growth, often running their business at a significant loss. The business’s burn rate is its negative cash flow each accounting period. For example, if a business had monthly revenues of $1,000,000, but costs of $2,500,000, it would have a burn rate of $1,500,000.
Why is it important? Burn rate is an indicator of how fast your business is spending the money it has raised from investors. If burn rate is excessive, your business will quickly run out of cash and have to raise additional capital, but if burn rate is too low, it’s a sign your business is failing to adequately allocate capital to achieve growth.
What is it? Cash runway refers to the amount of time your business has left before it exhausts its supply of cash and must raise more money. To calculate cash runway, take your business’s monthly burn rate and divide it by the amount of cash your business has in the bank.
Why is it important? Cash runway is a vital metric. In any business, cash is king. If your business runs out of cash, it will cease to function. Tracking cash runway enables founders to determine when they must raise the business’s next round of capital.
What is it? The rule of 40 combines two key metrics: a company’s revenue growth rate and its profit margin. When these numbers added together total 40 or above, your business is considered to be a strong performer. For example, a business with a 35% growth rate and a 7.5% profit margin would be above this threshold.
Why is it important? Many SaaS businesses focus on either rapid growth or profitability, since focusing on both at once is difficult. The rule of 40 strikes a balance between the two metrics, helping investors and executives understand the relationship between growth and profitability.
Effectively tracking these metrics requires that SaaS businesses build mature financial infrastructure that enables leaders to understand how well their business is performing. For businesses that have traditionally taken a hands-off approach to accounting and finance, that might feel like a challenge, but it’s vital to the success of your business.
At G-Squared Partners, we’re proud to serve dozens of high-growth startups through our outsourced CFO and accounting services. Our executive team has a demonstrated track record of leading SaaS businesses to financial success and has the skills required to help your business build the financial systems required for future growth.
To learn more about how G-Squared Partners can support your SaaS business, contact an advisor today.