A huge advantage of SaaS startups - after they start generating revenue, is the metrics! SaaS metrics help operationally focused CEOs measure and improve their business, and they help VCs compare the performance of SaaS companies across verticals and stages.
Some of these metrics are 100% accounting focused - but many are ‘accounting adjacent’ - as in, they may use some metrics produced by an accounting system (or an awesome SaaS accountant like us). These metrics can help a company understand its financial performance, customer acquisition and retention, and overall growth.
What I learned about SaaS metrics - the hard way
At the second VC firm I worked for I had the pleasure of being a board observer where the grandfather of SaaS metrics investing was a board member, David Skok. David has founded multiple SaaS businesses with amazing exits, and at the time I got to know him was leading the charge in investing in subscription startups with Matrix Partners. It was pretty ridiculous to get to listen to him helping out this particular founder at the board level - business school, but practical and actionable.
When I became an exec at my first SaaS startup, I dutifully went and implemented metrics tracking, just as I learned when I was a VC. Well… turns out founders can delude themselves, and I was no exception. Sure, these metrics are really helpful, but if you are using cruddy data or making wild guesses at metrics like churn rate, you are going to end up in a bad place. And, you guessed it, we ended up growing but burning too much cash, and ended up exiting the startup for a lot less than we had hoped.
So it’s important to not only track these metrics, but to challenge the assumptions that go into them. And really use good financial/accounting metrics; don’t use made up numbers about what it will look like when you achieve scale.
Measure the business you have so you can grow into the business you want.
The biggest mistake founders (and many VCs) make when it comes to metrics
Many of the most popular SaaS metrics can be calculated using revenue - but most should be calculated using gross profit. If your gross profit margin is 80%, then your CAC payback takes 25% longer than you’d estimate if you used your revenue to calculate it.
The second most common mistake I see - repeatedly - is to use assumptions in calculations that are wildly optimistic. Churn rate - ok, so you are too small to have had any churns yet. But that doesn’t mean you can assume a 100% retention rate in your LTV calculations. Find a metric that is more reasonable for the type of customers you serve, and stress test your LTV using that. If you are still having a great LTV to CAC using a higher churn than you are actually experiencing, great!! That’s good news. But if you revert to a more industry standard churn, does your LTV fall apart? If not, then you are looking really solid.
Some key metrics to track for SaaS startups
Monthly Recurring Revenue (MRR): This is the predictable and recurring portion of a company’s revenue that is generated from subscription-based products or services. MRR is an important metric for SaaS startups because it provides a clear picture of the company’s revenue growth over time.
Annual Recurring Revenue (ARR): This SaaS metric is used to measure the predictable and recurring portion of their revenue that is generated from subscription-based products or services. It is calculated by multiplying the Monthly Recurring Revenue (MRR) by the number of months in a year (12).
Average Revenue per User (ARPU): This is the average amount of revenue that a customer generates over their lifetime. Tracking ARPU is important because it helps a company understand the value of its customer base and identify opportunities for increasing revenue.
Annual Contract Value (ACV): ACV is a financial metric used by SaaS companies to measure the average annual value of a customer contract. It is calculated by dividing the total value of a contract by the number of years in the contract. The size of contracts sold by a SaaS business matters, because the larger the contract size the larger the theoretical amount that the business can spend on selling and marketing to the prospective customer, all else being equal.
Lifetime Value (LTV): This is the total amount of gross profits that a customer generates over their lifetime. LTV is important because it helps a company understand the value of its customer base and how much it can afford to spend to acquire new customers. Sometimes it is calculated by the total amount of revenue a customer generates over time - this is an incorrect calculation.
Revenue Churn: Revenue churn is a SaaS metric that measures the amount of revenue that is lost due to customer churn or downgrades in a given period of time. It is calculated by dividing the total revenue lost due to churn or downgrades by the total revenue at the beginning of the period. Negative revenue churn indicates that customers are purchasing MORE services over time from the SaaS company, and is a sign of a strong product and customer base.
Bookings: Bookings are a financial metric used by SaaS companies to measure the total value of new customer contracts that have been signed during a given period of time. It is typically used to forecast future revenue, as it represents the expected revenue from new customer contracts.
Book to Bill Ratio: Book to bill is a financial ratio used by enterprise SaaS companies to measure the balance between new customer contracts (bookings) and revenue recognized in a given period of time. It is calculated by dividing the total value of new customer contracts signed during the period (bookings) by the total revenue recognized during the same period.
Customer Count: SaaS companies should track their paying customer count at the beginning of the month and end of the month. Some SaaS businesses may also track live or active customers, seats, customers by product or category. And new customer count should be tracked very closely as well, and netted against churn to produce net new customers.
Customer Churn Rate: This is the percentage of customers that stop using a company’s products or services over a given time period. Tracking churn is important because it helps a company understand the health of its customer base and identify any potential issues that may be causing customers to leave.
Lead Conversion Rate: This metric tracks the percentage of leads that convert into customers. High conversion rates may indicate effective sales and marketing strategies, whereas low rates could highlight areas for improvement in the sales funnel or product offering. It’s important to track these by campaigns, salesperson and time to understand why/what is driving any changes that you see.
Activation Rate: For freemium SaaS businesses models, this metric tracks the percent of free sign ups to paid customers. It is calculated by dividing the number of users who become paying customers by the number of new users who signed up for a free trial.
Gross Margin: This is the percentage of revenue that a company retains after deducting the direct costs of producing its products or services. Tracking gross margin is important because it helps a company understand the profitability of its products or services.
Capital Efficiency Ratio: The Capital Efficiency Ratio attempts to measure how well a SaaS startup is using its funding. This metric was adopted from a measure of capital efficiency used on more traditional, public, companies and has a few shortcomings. We prefer the Burn Multiple calculation over this one for measuring how effective a SaaS business has been in using its funding to drive growth.
Customer Acquisition Cost (CAC): This is the total cost of acquiring a new customer, including all marketing and sales expenses. Tracking CAC is important because it helps a company understand the efficiency of its customer acquisition efforts. CAC is very important to early-stage companies, because if you want to survive, you need customers. Acquiring customers costs money, and you need to determine how much it costs, and are your efforts profitable? Once you’ve calculated your CAC, you’ll need to compare it to your customer lifetime value (LTV) to make sure your customers are spending more on your product than you’re spending to get customers.
Net Dollar Retention (NDR): Net Dollar Retention measures revenue changes within an existing customer base, taking into account revenue expansions, churn, and revenue contractions. Fluctuations in NDR can reveal underlying product or service issues or growth potential, making it a vital insight into a startup’s overall health, scalability, and investment appeal.
Payback Period: A Payback Period is a metric used by SaaS companies to measure the length of time it takes for the gross profit generated by a new customer to cover the cost of acquiring that customer. It is calculated by dividing the customer acquisition cost (CAC) by the average gross profit per customer. The lower the number, the more efficient the company’s customer acquisition efforts are and the quicker the company will see a return on its investment in acquiring new customers.
SaaS Burn Multiple: A SaaS burn multiple is a valuable measure for assessing a firm’s financial stability and efficiency. It is calculated by dividing the net cash burn (excluding any financing activities) by the net new ARR for the same period. Lower numbers are better.
Rule of 40: The Rule of 40 is a back of the envelope type SaaS metric that investors use to gauge a subscription business’ growth vs. profitability. It is calculated by adding the company’s annual growth rate to its profit margin (both metrics expressed as percentage margins), with the goal being to have a number that adds to over 40.
Quick Ratio: This is a metric that measures a company’s ability to increase recurring revenue while dealing with customer losses. The Quick Ratio measures a company’s ability to grow its recurring revenue while managing churn. It is calculated by dividing the sum of new MRR and expansion MRR by the sum of churned MRR and contraction MRR. A result that is less than 1 means a company is shrinking faster than it is growing; 1 to 4 is an OK but slow growth rate and over 4 is likely a higher growth SaaS business.
Help with your SaaS Metrics from a leading Startup CPA
Our CPA firm is a leader in SaaS accounting, with a wealth of experience and some of the best startup clients on the planet. We have worked with hundreds of SaaS clients, many of whom have raised billions in venture capital funding. Our team is well-versed in the unique accounting and financial needs of SaaS companies, and we have the knowledge and tools to help our clients understand and manage their SaaS metrics effectively.
We understand how much pressure founders are under, and believe that metrics and solid accounting are what help operational focused founders overcome many of the numerous challenges that early-stage companies face, like the need to find an MVP, high customer acquisition costs, negative gross margins, etc. Our team is equipped to help our SaaS clients navigate these challenges and make informed, metric based, decisions that will help them achieve their goals.
In addition to our deep understanding of the SaaS industry, we are also up-to-date on the latest accounting and tax regulations, and we stay current with the most recent trends in the industry and are regularly interviewed by reporters on our views into startup statistics and trends. We are available to help with any SaaS metrics needs our clients may have, whether it be providing regular financial statements, forecasting, KPI tracking, or any other financial analysis that can help them make strategic decisions and grow their business.
Looking for a great CPA to support your journey? Contact us.