If you are a SaaS business, you must read this article to understand:
- What is SaaS Quick Ratio?
- Why is SaaS Quick Ratio Important for a SaaS Business?
- How to Calculate SaaS Quick Ratio?
There are a number of key metrics that SaaS companies use to track various critical aspects of a SaaS business. Some of these include Monthly Recurring Revenue (MRR), customer satisfaction, customer churn rates, etc.
Another key metric used to measure the growth efficiency of your SaaS business is the SaaS quick ratio.
In fact, investors who look for investment opportunities in young SaaS companies consider SaaS quick ratio as one of the important evaluation metrics.
Want to know how to evaluate the growth potential of a young SaaS company? Study a single metric carefully – the SaaS quick ratio. This is because SaaS Quick Ratio answers one of the critical questions ‘Can this SaaS company scale or grow profitably and sustainably?’
Quick Ratio is a term used in corporate finance and it is typical for you to confuse it with SaaS Quick Ratio.
The terms used might be the same, however, each of them measures two different aspects of your business.
Where accounting quick ratio, also known as the acid test ratio, measures the liquidity position of your company. That is, how quickly you can convert your current assets to pay for your short-term liabilities.
SaaS quick ratio, on the other hand, measures the growth efficiency of your SaaS business. In other words, how sustainability can your SaaS business grow, given the current net MRR and the customer churn.
What is SaaS Quick Ratio?
SaaS Quick Ratio is a key metric that measures the potentiality of your SaaS company to grow its recurring revenue given the customer downgrades and churn.
Basically, it helps you measure the revenue inflow in terms of new customers and expansion to existing customers against the revenue outflow in the form of customer churn and downgrades. This in turn lets you know the net revenue growth at a given point in time.
Thus, SaaS quick ratio is a measure of your SaaS company’s growth efficiency. Using the SaaS Quick Ratio, the investors can evaluate the growth potential of your SaaS business and how sustainable is such growth.
Thus, by taking into account both the new revenue from new and existing customers and lost revenue due to customer churn and downgrades, SaaS quick ratio can help investors know the extent of your business growth and its sustainability.
SaaS Quick Ratio Formula: How to Calculate the SaaS Quick Ratio?
The SaaS Quick Ratio formula takes into account the revenue inflows and outflows to come up with the net revenue growth.
SaaS Quick Ratio Formula = (MRR from new customers + MRR from expansion to existing customers)/ (MRR lost due to customer churn + MRR lost due to customer downgrades)
Let’s have a look at each of the components of the SaaS quick ratio formula.
1. MRR from New Customers or New MRR
This is the monthly recurring revenue that your SaaS company earns from new customers you acquire.
2. MRR from Expansion or Expansion MRR
Expansion MRR accounts for the monthly recurring revenue that your SaaS company earns via product or service upgrades undertaken by your existing customers.
3. MRR Lost du to Customer Churn or Churn MRR
This is nothing but the monthly recurring revenue lost as a result of current customers choosing to leave or give on your SaaS offerings.
4. MRR Lost due to Customer Downgrades or Contraction MRR
Contraction MRR accounts for the MRR lost due to product/service downgrades by the existing customers.
SaaS Quick Ratio Example
SaaS Quick Ratio is simple to calculate. All you need to keep handy are the SaaS quick ratio formula components as mentioned above. These can be collected from either your company’s payment processing software or CRM.
Let’s say your:
- New MRR = $200,000
- Expansion MRR = $300,000
- MRR Churn = $60,000
- MRR Contraction = $10,000
Accordingly, your SaaS Quick Ratio comes out to be as follows:
= ($200,000 + $300,000)/($60,000 + $10,000)
What does this SaaS quick ratio of 7.14 mean? Its means that the company is earning $7.14 in revenue for every $1 it is losing.
What’s a Good Quick Ratio for SaaS?
One of the typical questions that most SaaS companies like yours ask is “ What’s a good Quick Ratio for SaaS?” or “What’s the right SaaS quick ratio?”
Well, it’s no rocket science when we say the higher the SaaS quick ratio, the better. However, it in no way means that having a low SaaS quick ratio is alarming for your business. Typically, it totally depends on your SaaS company’s scale of operations.
Let’s have a look at various scenarios to better understand SaaS quick ratio benchmarks and the ideal SaaS quick ratio. Here, we will consider different possibilities for a SaaS company achieving the net MRR growth of $430,000
Let’s consider the example discussed above in Scenario #1. New MRR and Expansion MRR = $500,000. Similarly, Churn MRR + Contraction MRR = $70,000
Thus, SaaS Quick Ratio = 7.14 and the net MRR growth = $500,000 -$70,000 = $430,000
New MRR and Expansion MRR = $550,000. Similarly, Churn MRR + Contraction MRR = $120,000. Thus, SaaS Quick Ratio = 4.583 and the net MRR growth = $550,000 – $120,000 = $430,000
New MRR and Expansion MRR = $600,000. Similarly, Churn MRR + Contraction MRR = $170,000. Thus, SaaS Quick Ratio = 3.52 and the net MRR growth = $600,000 – $170,000 = $430,000.
New MRR and Expansion MRR = $700,000. Similarly, Churn MRR + Contraction MRR = $270,000. Thus, SaaS Quick Ratio = 2.592 and the net MRR growth = $700,000 – $270,000 = $430,000.
As you can see, this SaaS company maintains a net MMR growth of $430,000 in all four cases. However, the growth efficiency in scenario #1 is the best simply because the company is able to grow its revenue by the same amount and with lesser churns and downgrades. In other words, it is not only covering its lost revenue with ease but also adding to its revenue more as compared to other scenarios.
In the first case, for every $7.14 earned, it’s losing $1. However, in the other cases, it is earning less for the same $1 it is losing in the form of customer churn and downgrades. Also, no doubt the net revenue growth in the last three cases is also the same as the first scenario. However, the majority of the net revenue growth of the SaaS company would be utilized towards covering for the lost revenue.
Now given these scenarios, what is the ideal SaaS quick ratio a SaaS company should aim for.
What is the SaaS Quick Ratio Benchmark?
As said earlier, SaaS companies would always run after higher SaaS quick ratios. But, having a higher SaaS quick ratio may not necessarily mean that your SaaS business can grow sustainably.
SaaS quick ratio is a term that was given by the venture capitalist Mamoon Hamid. He is the co-founder of Social + Capital who also worked out that the SaaS quick ratio of 4 and more is what SaaS companies must aim for. According to him, investors should invest in young SaaS companies having a SaaS quick ratio of 4 04 more. And he used this metric to invest in companies like Slack, Yammer, and Box.
Much after this, SaaS quick ratio became one of the key metrics that venture capitalists started evaluating to understand the growth efficiency of SaaS companies.
However, there’s a caveat here. Using this SaaS quick ratio benchmark of 4 and above may be good for young or startup SaaS companies. This is because it is initially possible to earn and maintain the net revenue growth with lesser churns and downgrades. However, as the SaaS companies grow and mature, it is challenging to maintain the same revenue growth without losing customers or plan downgrades.
Thus, a SaaS quick ratio of 4 and above may be good for young SaaS companies. However, earning $4 for every $1 lost is difficult for growing companies for it is too high a benchmark to achieve. That’s why, where initial startups focus on maintaining a high quick ratio, the growth companies focus on reducing customer churns.
Further, just evaluating the SaaS quick ratio isn’t enough to know much about the growth potential of a SaaS company. You need to evaluate SaaS quick ratio together with other key metrics like MRR, customer satisfaction, churn rates, CAC, and Customer Lifetime Value (CLTV).
For instance, some companies may have a high CAC when compared to the industry average. Now, a higher net revenue growth figure might not look attractive as the company may be spending way too much on acquiring a single customer. Thus, SaaS metrics must be measured together to have a fair idea of the success of the SaaS business.
Why is SaaS Quick Ratio Important?
Let’s consider the four scenarios mentioned above to know why the SaaS Quick ratio matters. As we have already discussed, the SaaS quick ratio measures the growth potential of a SaaS business. If you go by the SaaS quick ratio formula, it measures the MRR gained from new customers and expansion to existing customers against the revenue lost due to customer churn and downgrades.
Now, a low quick ratio hints towards the difficulty a SaaS business finds in maintaining or sustaining its net MRR growth. This is because instead of putting the company on the path of growth, the net MRR growth is just enough to provide for its lost revenue.
However, a higher SaaS quick ratio is an indicator of the net MRR growth that not only provides for its lost revenue but also leaves it with enough that adds to the current revenue. Thus, a higher SaaS quick ratio is an indicator of the efficiency growth prospects of a SaaS company.
Accordingly in scenario #1, a high quick ratio of 7.14 indicates that the company earns $7.14 for every $1 it loses in revenue. Thus, it earns 7x the amount of revenue it loses to customer churn and contractions. This means the company adds enough to its revenue growth even after providing for the revenue lost.
However, the other three scenarios do not portray a higher growth efficiency of the SaaS company. This is because no doubt it is maintaining the same amount of net revenue growth. But, the major chunk of the net MRR growth goes into meeting the lost revenue.
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