Ratios are an essential tool in business, from traditional enterprises to software as a service (SaaS) companies.

Analyzing and accessing the financial and operational condition of a company helps expose weaknesses and strengths.

Through these analytics, essential decisions can be made regarding improvements or changes. Financial ratios, such as a quick ratio, are a fast and easy way to evaluate performance.

What is SaaS Quick Ratio?

In the accounting world, the quick ratio is a liquidity ratio that measures a company’s ability to use near cash or quick assets to pay for liabilities immediately. In the software as a service (SaaS) world, the Quick Ratio is a little different.

Saas Quick Ratio is a way to glance at the health of a SaaS startup’s growth efficiency quickly and efficiently.

The SaaS Quick Ratio was unveiled at the SaaStr Convention in 2015 by Mamoon Hamid of Social Capital VC. Since then, it has become an investor’s standard metric they ask for regarding financial numbers.

The SaaS Quick Ratio is defined as the ratio of revenue growth vs. revenue shrinkage.

In essence, the quick ratio is about taking the growth and dividing it by the loss.

Understanding the Metrics

  • New MRR: Monthly recurring revenue (MRR), also known as bookings, is revenue earned from subscriptions in a month. New MRR is the newly acquired revenue during the given period of time that is being evaluated.
  • Expansion MRR: expansion usually happens when an existing customer upgrades or when the number of users increases. The higher the expansion rate, the better.
  • Churned MRR: Revenue lost due to subscription cancellations is the churn during the month that is being evaluated. The lower the churn rate, the better.
  • Contraction MRR: contraction usually happens when a current customer downgrades their plan or lowers the number of users on the plan—the lower the contraction rate, the better.

Inherent to all SaaS companies is growth and loss, especially in the software as a service industry where consumers pay as they go. Consumers can pay for their services all at once or spread the cost out over the contract term. This creates a predictable, reliable income stream for a SaaS company, which is highly appealing to investors and financial institutions.

However, SaaS customers can stop or downgrade their subscription at any time; this is the downside of having a subscription-based model. Known as churn, this loss of revenue is essential to pay attention to. It often takes time for the customer acquisition cost to match the earned income for the SaaS company. A customer has to be around long enough to recoup the price put into acquiring them; otherwise, growth is not sustainable, and the company will not be profitable.

Growth and loss are a part of the game of business. The SaaS Quick Ratio evaluates whether the company is on a healthy track despite the losses that come with growth.

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What is a Good SaaS Ratio?

Finding the right number for your company in its growth stage may not be a cut-and-dry number. For a young company, which is experiencing high growth, a high ratio is a good benchmark. A more established or fully scaled company will naturally have different numbers than the younger company. Finding the correct target number for your company will take time and is a number you should keep an eye on.

Generally, a number between 3-5 is considered a good number for young companies. The higher the ratio, the better. However, regardless of the ratio number, the number one goal is to reduce churn. Solve that, and the numbers will sort themselves out.

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Fixing Low SaaS Quick Ratio

Though the SaaS Quick Ratio does not precisely pinpoint the problem, it will shed light on the area that needs extra attention. The Quick Ratio will help establish whether the problem is a growth or retention problem, and it helps create a tactical direction of what needs focus.

By knowing what the problem is, a company can take steps to get its quick ratio into a healthy range. Usually, a way to fix SaaS quick ratio metrics is to prioritize customer retention and reduce churn. Engage with current customers. Leverage marketing. Educate customers on existing products, upgrades, and new products coming down the line.

When the company experiences churn, deal with the underlying issue aggressively and effectively, communicating and interacting with clients and consumers. Knowing what numbers are struggling will help pinpoint what area of the equation needs the most work.

The SaaS Quick Ratio is an excellent habit to be in the practice of tracing. By consistently tracking and reviewing numbers, you will know when and where there are strengths and weaknesses. Through this monthly feedback across all four growth and loss metrics, you will have a clear path towards taking action to get your company to a strong, healthy SaaS Quick Ratio.

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References:

  • holistics.io/blog/developing-an-intuitive-understanding-of-the-saas-quick-ratio/
  • slideshare.net/03133938319/saastr/32-50_45201052010010203040506070Month_23_Month_23Net