SaaS Metrics: A Guide for Start-up Finance Leaders
Over the last two decades, SaaS finance has evolved a large set of industry-specific metrics, revenue assumptions, and leading indicators of success.
If you’re a new finance leader in the subscription field or just looking for a refresher, this guide will get you up to speed on the most important concepts and metrics for running a successful SaaS business.
What makes SaaS different from non-recurring revenue models?
Fundamentally, SaaS businesses run on recurring revenue rather than single purchases.
Instead of collecting revenue from a customer upfront in a single transaction, your B2B SaaS business will likely be paid monthly or annually. This creates the advantage of a much larger Lifetime Value (LTV) for each customer but can come at the expense of upfront cash to cover Customer Acquisition Costs (CAC). Churn, which is the loss of a recurring revenue payment from a customer, also becomes an important consideration for SaaS teams.
As early-stage companies start-up and grow, this unique cash dynamic can make founders and boards uneasy about the early progress their companies are making. To keep their companies on the right track, SaaS executives, investors, and CFOs have developed an extensive toolkit of KPI’s that provide a better view of the viability of a SaaS business.
How are SaaS companies evaluated?
If your software company is still in the startup stage, it’s likely that your cash out (“burn”) exceeds your collections from customers. Even in the growth and maturity stages, SaaS companies can push the accelerator on growth and create a short-term cash deficit as a result. So how do you ensure you’re moving in the right direction?
The primary categories that finance teams and venture capital investors should consider are new customer growth, unit economics, and revenue retention. The rest of this article will be dedicated to explaining the key metrics within each of these three categories, and sharing models and resources you can use to put them to work.
New customer growth measures the speed with which your company signs on new, paying customers. It’s measured in both dollars and logos, and comparative growth rates (quarter over quarter, year over year) are common and very similar to more traditional business models.
Unit economics covers the benchmarks which allow a SaaS business to scale efficiently. Fundamentally, if the cost to acquire a customer exceeds the total revenue that customer may generate, your company will not be able to scale properly. Adding customers will increase costs, so growing with poor unit economics can create a worse situation than not growing at all.
Companies with strong unit economics can continue to invest with confidence, even if short term cash flows take a hit and require additional outside investment. VCs look for signs of efficient scalability in their portfolio companies.
Revenue retention measures the stickiness of your customer base. In a recurring revenue business, keeping and expanding your existing customer base is just as important as signing on new customers. Churn, expansion, and contract length will drive performance in this category.
The SaaS Metrics
For benchmarks on all of the metrics below, check out the resources at the bottom of this article. We’ve collected a few of the best models and surveys to determine where you stand against your peers and competitors.
New Customer Growth
A note on revenue recognition: In SaaS, if you sign upfront contracts longer than a single month, you’ll come across the concept of deferred revenue. According to US GAAP, deferred revenue is simply revenue that your business has collected, but not yet “earned.” When you collect money for an entire year in January, you “earn” that revenue over the course of the year, and gradually write down the deferred revenue balance. Accounting systems usually handle this automatically. For more on SaaS revenue recognition, check out this article.
What are new logos?
Total number of new customers added over the period.
What is Monthly Recurring Revenue (MRR)?
If your business sells primarily monthly contracts, MRR is the amount of the subscription cost. If you sell annual subscriptions, MRR is the annual amount divided by 12.
What is Annual Recurring Revenue (ARR)?
ARR is equal to the revenue associated with an annual contract, or 12 x MRR.
What are Bookings?
The contract value recorded at signing, reflecting the total money expected to flow into the business from the contract. On an annual contract, the total annual contract price is recorded, even if the payment terms are monthly. On a monthly contract, only one month is recorded as a booking. In a growing company, bookings as a percentage of revenue may fall as recurring revenues develop. However, you will see spikes from upfront contracts.
What are Billings?
The total amount of cash collected from customers that period, including upfront contracts. Billings should grow over time as the business grows its revenue but may spike due to large upfront contracts.
What is Revenue?
The bookings associated with the current period. For an annual contract, only the current month’s portion of revenue is recognized within that month.
What is Average Contract Value (ACV)?
ACV is the average bookings associated with a contract of a given duration. Ideal ACV varies by market and customer size, but investors generally look for a rising ACV as companies shift from small business to enterprise customers.
What is the Average Contract Term?
The average length of contracts signed by customers in a given period. Longer contracts provide more revenue protection and often translate to lower churn numbers, but may create churn spikes as longer contracts come to the end of their terms.
What are average Months Upfront?
The average number of subscription months paid at the outset of a contract period. If your customers sign annual contracts, months upfront is equal to 12. For most companies, a mix of monthly, quarterly, annual, and longer-term contracts will factor into this metric.
What is my New business growth rate?
Logo: (number of new customers) / (number of existing customers)
Revenue: ( (revenue at the end of the period) - (revenue at the beginning) ) / (revenue at the beginning)
What is Cost of Goods Sold (COGS)?
COGS includes all costs associated with keeping the product running (but not building or selling it). Generally, COGS includes server costs, white-labeled 3rd party software, production-environment maintenance staff, and customer support and customer success staff. Sales, R&D, and G&A expenses are not included in the COGS calculation.
What is Gross Margin?
Gross Margin measures the portion of revenue left over after the costs to deliver a product to a customer have been accounted for. This number is important to investors because it funds the ongoing operations of the company before any profit can be made. Gross margin is often referred to as a percentage of revenue.
Gross Margin: (Revenue - COGS) / Revenue
What is Sales & Marketing Expense?
Any costs to your business pertaining to the sales or marketing of your product. They include salaries, advertising spend, CRM software like Salesforce, and often include new customer onboarding. These costs are used in the calculation of Customer Acquisition Cost (CAC).
What is Research & Development (R&D) Expense?
R&D expenses are uncapitalized costs pertaining to the development of your product. They include engineering headcount, engineering systems, and all costs associated with creating or improving the product experience.
What is General & Administrative (G&A) Expense?
G&A expenses include the cost of overhead or “back office” support functions such as administrative headcount, office supplies, and building utilities. G&A expenses incorporate any costs not accounted for by S&M or R&D expenses.
What are Earnings before interest, tax, depreciation, and amortization (EBITDA)?
EBITDA measures the profitability of the ongoing operations of the company, before taxes, depreciation on assets, or interest payments on debt are deducted. Investors use this metric because depreciation and amortization are non-cash expenses, and taxes and financing expenses are influenced by the capital structure and tax strategies of the business and do not reflect its operational success.
Calculation: (gross margin) - (S&M + R&D + G&A) = EBITDA
What is Customer Acquisition Cost (CAC)?
The total sales and marketing expenses required to acquire a new, paying customer. CAC is one of the most critical metrics on the list because it determines your company’s ability to scale profitably. If it costs too much to acquire a new customer, scaling the business will either be ineffective or potentially even detrimental to profits.
Calculation: (Total Sales & Marketing Costs) / (Net new customers added) = CAC
What is Customer Lifetime Value (LTV)?
Lifetime value measures the average total revenue received by your company over the life of a single customer. Several factors impact LTV, including ACV, churn rates, and expansion revenue. Investors and operators look to see LTV grow over time, as your business matures and adds product lines, reduces churn, and increases ACV.
Calculation: (ACV x Average customer lifespan) = LTV
What is LTV/CAC?
The ratio of LTV/CAC is probably the single most important metric used in determining whether your SaaS company is scaling efficiently, or ready to scale. Generally speaking, companies look for at least a 3:1 ratio, as the lifetime value of a customer needs to exceed their costs by enough of a margin to allow for profitable business operations, apart from just acquiring customers (like development and G&A).
Calculation: LTV / CAC
What is my Months to recover CAC (MTR)?
The amount of time it takes for the total revenue from a customer to exceed the costs of acquisition. Also a critical determinant of your company’s ability to scale, CAC recovery measures how long it takes for a customer to produce positive cash flow. Each customer initially produces a cash drag on a SaaS company. The duration of that period determines the future strength of the balance sheet, and how much external capital is needed to acquire enough customers to sustain the company independently.
Calculation: CAC / MRR = MTR
Renewals and Expansion
What are Renewals?
SaaS businesses have built-in renewal periods at the end of every contract. Sometimes, these contracts renew automatically (usually in the case of monthly contracts), but often customers have to actively choose to renew their subscription. This is especially the case for larger contract values. Renewals measures the number of customers and amount of revenue from those who continued their subscription within a period of time.
What is Retention Rate?
Investors look at the renewal rate (and its inverse, the churn rate) as a measure of product quality and revenue longevity. The higher the number, the healthier the customer base.
Logo calculation: (number of customers renewed) / (total customers up for renewal)
Revenue calculation: ($ revenue renewed) / (total $ revenue up for renewal)
What is Churn?
When a customer cancels their subscription or chooses not to renew, they “churn.” Churn is a normal part of running a SaaS business, but if left unmanaged it can ruin the efficiency of your company’s growth. Churn rate should shrink over time as product quality improves, contracts get longer, and use cases expand.
What is my Churn Rate?
Churn rate is the percentage of customers or revenue that end their subscriptions each month, regardless of the reason. We look at both logo and revenue churn, because churn rates are often much higher among smaller ACV customers, which makes less of an impact on the business than larger contracts churning.
Logo calculation: (number of customers churned) / (total customers)
Revenue calculation: ($ revenue churned) / (total revenue)
What is Expansion?
Expansion happens when a customer starts paying more money than they paid originally. This can result from a discount expiring on the first contract period, the adoption of a new product line, additional seats purchased within a period, or a variety of other levers. Expansion helps to offset churn, and expansion revenue often comes at a much lower cost than net new customer revenue, allowing your business to scale more efficiently.
What is my Expansion Rate?
Businesses measure expansion rate to forecast the growth of their installed base. In more mature markets, the expansion rate can outpace new customer growth as companies look to monetize a limited number of existing customers. The expansion rate is generally expected to increase over time.
Calculation: ($ expansion revenue over the period) / (total revenue at the beginning of the period)
What is Net Dollar Retention (NDR)?
NDR combines the measurements of new revenue, churn, and expansion to tell us how the revenue of a company will grow or shrink over time. If net dollar retention is 100% or greater, then churn is either zero or completely offset by expansion. If NDR is lower than 100%, then churn is creating a drag on growth by removing a percentage of the installed base each month.
NDR Calculation: (Starting MRR + expansion - downgrades - churn) / (Starting MRR) x 100