Hi again! It’s August, which means we’re back in action with Part 4 of my SaaS Distilled series.
This time, let’s distill Ben Murray’s (aka the SAAS CFO) “How to Calculate and Understand the SaaS Quick Ratio”. Let’s jump in.
Oh, and in case you missed it, you can catch up with Part 1’s Core Metrics, Part 2’s Customer Acquisition Cost, and Part 3’s SaaS Churn Calculations.
If you’re a SaaS business with recurring revenue, you should know and understand how important your revenue performance is. SaaS Quick Ratio is a metric that shows sustainability of your company’s growth, and has become a standard metric investors key in on (particularly for SMB SaaS businesses).
A lot of people in the industry call it an efficiency metric as it shows how efficient you are with your retention strategy.
I don’t know if I agree that this metric could solely determine the efficiency of your company unless it’s used in conjunction with LTV:CAC and CAC Payback metrics.
SaaS Quick Ratio will not pinpoint your problem. It will, however, provide focus on areas of your business that require extra attention. The most important thing that SaaS Quick Ratio measures is the “direction of your bookings growth”. If you earn revenue from subscriptions, you most likely track components of MRR (if not, you absolutely should!).
MRR measures predictable monthly revenue streams, including:
- New MRR – MRR earned from new subscriptions
- Expansion MRR – MRR earned from subscription upgrades (switching to a higher paying plan, adding more users, reactivations)
- Churn MRR – MRR lost from cancelled subscription
- Contraction MRR – MRR lost from subscription downgrades (switching to a lower paying plan, removing users)
The SaaS Quick Ratio formula is simple and it looks at your MRR components:
(New MRR + Expansion MRR) / (Churn MRR + Contraction MRR)
It shows the ratio between your MRR inflows (New and Expansion) and MRR outflows (Churn and Contraction).
Generally, healthy SaaS Quick Ratio is considered to be 4 or above. It shows that you’re growing at an efficient rate. In simple terms, SaaS Quick Ratio of 4 means that for every $4 of added revenue, you lose $1 of revenue.
Anything below 1 means that you’re losing more money from existing customers than you get from new customers. You’re in trouble and you’re depleting more revenue than you make. Your business might not survive if you don’t implement drastic and quick changes.
SaaS Quick Ratio between 1 and 4 means that you’re growing at an inefficient rate and have room for improvement.
Sustainability of growth
The SaaS Quick Ratio metric illustrates how important it is to grow revenue at a sustainable rate. I recommend tracking this metric regularly to know whether your growth outpaces losses. Measuring SaaS Quick Ratio on a monthly basis will show you how reliable is your revenue growth given churn.
Example 1:
- New MRR: $15,000
- Expansion MRR: $6,000
- Churn MRR: $4,000
- Contraction MRR: $1,000
- SaaS Quick Ratio: ($15,000 + $6,000) / ($4,000 + $1,000) = 4.2
This is a healthy SaaS Quick Ratio and shows that new and expansion MRR is larger than churn and contraction MRR. Keep doing what you’re doing!
Example 2:
- New MRR: $15,000
- Expansion MRR: $1,000
- Churn MRR: $8,000
- Contraction MR: $4,000
- SaaS Quick Ratio: ($15,000 + $1,000) / ($8,000 + $4,000) = 1.3
This is an example of poor SaaS Quick Ratio. Even though the new MRR seems high, churn and contractions are going to kill you. It’s not a sustainable business model!
Increasing and maintaining a healthy SaaS quick ratio
It’s important to make sure that you have strategies in place to tackle high churn because you won’t sustain high revenue growth forever. A lot of times, especially during earlier growth stages, companies have no issues bringing in new customers and, initially, experience lower levels of churn. As companies become more mature, in a lot of cases, growth slows down or they can’t sustain the same levels of growth, and on top of that churn starts to increase.
Onboarding new customers is relatively easy but companies need to make sure they know how to retain existing customers. This is the focus area where all the effort needs to be put.
One way to improve a low SaaS Quick Ratio is to figure out why customers churn. This is where deep diving into churn analysis comes into play. To minimize churn you need to first figure out why your customers leave – exit surveys might come into play, and customer success teams buckle up to do their job.
Another idea is to fix your customer acquisition strategy which will increase growth in New MRR and replace lost MRR.
The goal of each SaaS company is to figure out how to bring new customers in while retaining old ones. If you do that, you’ll be golden!
If you care to chat about the SaaS Quick Ratio, or anything else SaaS ops/financing related, we’d love to help!
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