Calculating and Reporting SaaS KPIs
Why should SaaS leaders care about KPIs?
Financial statements will only take you so far – financial statements are the tip of the iceberg. To really understand and manage your SaaS business, you need all the information from SaaS metrics that lies below the waterline.
SaaS metrics improve decision-making – SaaS metrics provide transparency into your business results and improved decision-making that can supplement nicely organized financial statements. SaaS metrics are like your GPA (grade point average) when it comes to fundraising and exiting.
What are the different ways to track and report on revenue? Which makes sense in different cases?
Monthly Recurring Revenue (MRR) makes sense for self-service SaaS businesses – it is your monthly recognized revenue number. It is one month’s total of all your recurring revenue. Self-service SaaS businesses tend to look to MRR.
Annual Recurring Revenue (ARR) is standard for companies with an outbound go-to-market motion – ARR is the annual value (12 months) of your recurring revenue. Companies with an outbound GTM log opportunities in their CRM system and lend themselves to thinking in terms of ARR.
Committed Annual Recurring Revenue (CARR) – it’s a forward-looking revenue metric to maximize the revenue that’s currently in your business. It’s different from MRR, ARR, or recognized revenue because it represents forward-looking bookings and churns in the numbers.
GAAP Revenue – income statement revenue that will be reported in the company’s financial statements in accordance with Generally Accepted Accounting Principles in the USA. You have to recognize revenue when it is realized and not when cash is received.
For multi-year contracts, either track CARR or ARR – you have to be consistent. If you’re reporting CARR, make sure you’re not confusing total contract value (TCV) with a single year of ARR you just contracted. ARR and CARR go hand in hand, CARR just includes bookings as well as revenue. You tend to look at TCV, ACV, and single-year ARR in the bookings report for multi-year contract sellers.
A multi-year contract with increasing contract values needs to be internally defined – e.g. if you have a contract that’s $100K in year one but grows to $200K in year two. You can average it, but your sales comp plans are hooked to bookings so sales and the CFO, and Sales comp all will be involved. Usually, the bookings report will include just the first year of ARR but your comp structure could include it as multiple years, averages, or first year-plus-x.
What are the different revenue categories you should track?
First, create a clear and standardized view of the different revenue streams in your PnL – separate subscription, variable, and one-time revenue so you can make better decisions moving forward. Internally, you want to consistently define whether you’re talking bookings, revenue, or a derivative of revenue to track progress towards a goal.
Subscription – this has to be true contract subscription revenue, in your ARR/MRR.
Variable revenue – this includes revenue that fluctuates because it is tied to usage, consumption, transaction, processing, etc.
One-time professional services – like implementations or integrations.
Ongoing managed services – this is typically services revenue that’s likely to recur. There’s a lot more going on and founders want credit for services that are now on a subscription basis.
Other – this includes conferences, events, adjustments, etc.
You need to break out bundled offerings on your backend – even if you bundle services, subscription, and variable revenue in your marketing and promotion, your accounting needs to unbundle and allocate the revenue into the correct buckets.
What are the elements of a SaaS PnL?
| Definition | Common Mistakes | |||
| Bookings | – Executed contracts– These can be created for self-service SaaS based on MRR data | – Improper tracking in your CRM (mixing TCV with ACV or not tracking by ACV so you don’t know the time your revenue corresponds to)– Not tracking bookings by distinct revenue streams– Not tracking close date | ||
| Revenue | – The amount of money coming into your business based on GAAP (accrual) accounting | – Mixing revenue streams– Not having revenue recognition practices in place | ||
| COGS | – The direct costs of producing what you sold– Should have cost centers for each of your revenue streams (subscription, variable, services, etc.)– For example, COGs for software subscription revenue would include: tech support, DevOps, customer success | – Having just one cost center across revenue streams– Getting OpEx and COGS mixed up (putting development costs or commissions in COGS, or support into OpEx)– Not accounting for fully burdened compensation (wages, taxes, benefits) | ||
| Operating Expenses | – Expenses a business incurs through its normal business operations—attributed to areas like R&D, sales, marketing, and General & Administrative | – Salaries not coded to their respective departments– Attributing tooling expenses to G&A instead of their respective departments | ||
| Non-Operating Expenses | – For SaaS: Interest and debt. You can choose to include depreciation and amortization | – Coding Non-OpEx to regular OpEx– Not giving Non-OpEx its own GL accounts– Putting sales tax in PnL | ||
| EBITDA/Net Income | – Earnings Before Interest, Taxes, Depreciation, and Amortization– Net income with non-cash and non-operating items eliminated (Further reading here) | – Understand how you’re accounting for taxes in Net Income and your entity structure– If you capitalize R&D it will improve your EBITDA | ||
How can you correctly calculate SaaS Gross Margin?
Gross Margin is all revenue minus your COGS cost centers – for pure-play SaaS, COGS encompasses tech support, DevOps, services, and CS. Having the right definition of COGS for your business is really important.
Customer Success expense attribution depends on their function – if they’re focused purely on retention and don’t do any selling, then CS belongs in COGS. But if they have to close renewal deals and get commission and a quota for expansion, then they’re a sales and expansion cost that doesn’t go in COGS. If they do both, it’s common to allocate their expense between COGS and OpEx.
Expenses for AI/ML and data scientists could be in COGs or OpEx – if they have to do something to deliver revenue (e.g. work on a dataset for a particular customer), they’re in COGs. If they just help the dev team with algorithms, they don’t belong in COGs.
What are the key customer acquisition benchmarks?
| Metric | Definition | Benchmarks | ||
| CAC Ratio | Sales & marketing expense /New and expansion ARREffectively, the cost of new ARR. It can be calculated on a new logo, blended, or expansion basis. | – New: $1.50/$1 – Blended: $1/$1 | ||
| CAC Payback | CAC / (MRR-ACS)Measures the number of months required to pay back the upfront customer acquisition costs after accounting for the average cost of service (usually gross margin). | SMB benchmarks:– Good = <6 months– Normal = 6-12 months – Bad = 12+ monthsMid-market to enterprise benchmarks: – Great = <12 months– Normal = 12-18 months– Bad = >18 months | ||
| LTV to CAC | LTV / CACThe ratio of customer lifetime value to the cost of acquiring that customer. | The traditional cardinal rule is 3, but the median is 4 in SaaS | ||
| SaaS Magic Number | (Current quarter’s revenue – previous quarter’s revenue) x 4 / Previous quarter’s Sales and Marketing ExpenseSales-related SaaS metric that determines your efficiency in generating incremental recurring revenue. You take the growth in recurring revenue from a selected quarter minus the previous quarter’s revenue, annualize it by multiplying by four, and then divide the numerator by the previous quarter’s sales and marketing spend. | – >.75 is benchmark for most SaaS companies– >1 for low price-point short cycle SaaS | ||
Benchmark your business against like SaaS companies – these metrics are highly variable, you need to look at your peers or similar organizations and benchmark your metrics against theirs.
What are the growth metrics you should track?
| Metric | Definition | Benchmarks | ||
| New Bookings | Absolute $ and % YoY growth in bookings from new customers | — | ||
| Expansion Bookings | Absolute $ and % YoY growth in bookings from existing customers | — | ||
| Committed ARR | Contracted, but not yet live ARR, plus live ARR netted against known projected ARR churn | — | ||
| Quick Ratio | Net inflow of MRR (new + expansion) /Contraction (churn, downgrades) | >4 typically means you’re growing at a good rate. | ||
What are the key customer retention and value benchmarks?
| Metric | Definition | Benchmarks | ||
| Gross Dollar Retention | The retention of revenue from your existing customer base. | – 90% is typical and >95% is best in class– Small pricepoint self-serve business might shoot for >80% | ||
| Net Dollar Retention | Net dollar retention (also called net revenue retention) expands on the gross dollar retention. In addition to measuring churn and downgrades in the numerator, we now take credit for expansion MRR or ARR. | – Best in class would be >120%– Small pricepoint self-serve business might shoot for >100% | ||
| Logo retention | The share of current customer logos that you retain year-over-year. | Tracks with GDR:– 90% is typical and >95% is best in class– Small pricepoint self-serve business might shoot for >80% | ||
| Lifetime value | Average ARR * (1 / logo churn %)The revenue from a customer throughout their relationship with your company. | A relative measure, see LTV-to-CAC. | ||
What are the key margin, profit, and cash flow metrics?
| Metric | Definition | Benchmarks | ||
| Gross margin | Total revenue minus cost of goods sold (COGS). | – Best-in-class margins are >80%– 70% is considered good– Services margins should be at least 15-25% and can go as high as 50%– If you have managed services as part of your subscription, you should aim for ~30%– Hardware margins are usually <10% | ||
| EBITDA Profit | A measure of a company’s operating profit as a percentage of its revenue. | — | ||
| Burn multiple | How much net new ARR are you bringing in compared to your cash burn. | — | ||
| Months of runway | If you have positive cash flow you can look at the months of runway based on your cash balance and net cash burn | – Depends on the timing of your next raise | ||
| G&A expenses as a percentage of revenue | Spend on general and administrative expenses as a percentage of your revenue. | – Target <20%. This will get more efficient as you scale | ||
| R&D as a percentage of revenue | Spend on R&D as a percentage of your revenue. | – It can be very high at first, a mature SaaS typically settles in around ~20% | ||
| Sales and marketing as a percentage of revenue | Spend on sales and marketing as a percentage of your revenue. | – Combined sales and marketing is typically >30%, but you’re better off looking at efficiency metrics to understand the performance of sales and marketing investment. | ||
What is the SaaS Magic Number, and how do you calculate it?
(Current Quarter’s Revenue – Previous Quarter’s Revenue) x 4 / Previous Quarter’s Sales & Marketing Expense
The magic number compares this quarter’s revenue to last quarter’s sales and marketing spend – it’s more aligned with CAC ratio than CAC payback. It includes revenue, it incorporates churn in the revenue calculations.
It’s telling you how much revenue growth you get for $1 of sales and marketing – and it’s more encompassing than a sales and marketing efficiency metric. It indirectly measures more than just sales and marketing expense because it includes churn which could be the result of poor onboarding, poor product support, or bugs.
It’s mostly for high-velocity, SMB-type products – with a shorter sales cycle, you’re doing quarter-over-quarter growth. If you have a long sales cycle, then it just doesn’t make sense as the timing won’t line up.
What is the Rule of 40, and how do you calculate it? Can the rule of 40 be applied to small companies?
The Rule of 40 is your profit margin plus your growth rate – the result should be >40% to be considered healthy and attractive by investors. It illustrates the tradeoff between profit and growth. Private SaaS companies usually use EBITDA margin for profit, while Public companies typically use free cash flow margin.
It can start to matter above $3M in revenue – once you have all your company’s departments established: tech support, sales, marketing services, etc., you’ll have to prioritize investment between them. That’s where the rule of 40 comes into play to help you balance growth and efficiency.
For companies without robust finance teams and just getting started with KPI reporting, what are the highest-value things to do first?
Start with a properly formatted SaaS PnL first – then you can look at revenue growth, gross profit or margins by revenue stream or OpEx profile, and EBITDA margins.
Then work through the five pillars of SaaS metrics – if you’re mature, you should be doing all of them. If you’re early, you might focus on growth and retention and mature from there. They include:
- Growth
- Retention
- Margins
- Financial Profile
- Efficiency
As you get more sophisticated, what team members, tools, and processes do you layer in for powerful reporting?
Tools
Move beyond your general ledger – this is your primary record-keeping system early on, but you’ll quickly outgrow it.
A more robust invoicing system – this will replace your general ledger and allow you to keep track of missing payments, and have better insight and reporting on collected and expected revenue.
Revenue recognition tool – this will automate and help you recognize revenue when it’s realized for GAAP-compliant accounting.
Subscription management tools – like Recurly and Chargebee will hook up to your Stripe account and help you track them. They also help you pull metrics out of your ERP system.
BI tools for KPIs – to aggregate data and conduct calculations. Power BI has become a popular tool for this because it’s part of Office subscriptions.
Revenue analytics tools – like Profitwell or Chartmogul. Some are trying to hook right into your data sources and calculate for you, others just help you display the metrics and require more manual intervention. This is almost a commodity now.
Team
Add to your team over time – the typical evolution of a finance team will end up with two distinct functions. You’ll have the accounting side to close the books and invoice customers, then you’ll have the FP&A side to provide forward-looking insights. Team members you might add in order are:
- Outsourced accounting
- Add in-house accountant
- Add Manager of Accounting/Controller
- Add CFO
- Add FP&A analyst
Process
Implement a quote-to-cash process – connect your CRM system into your accounting so that as sales close on opportunities, that data flows into your CRM, you can invoice properly and collect on cash. You need really good data and reporting integrations between sales and finance to accomplish this.
How should you think about KPIs when forecasting?
You can’t forecast accurately if you don’t know where you’ve been – you have to have historic KPIs documented and calculated correctly to be able to forecast accurately.
Don’t just look at the current state, see how your KPIs are trending – if you’re investing more in sales and marketing, what’s that doing to your efficiency? As revenue scales, how does COGS scale and what does that do to your gross profit margin?
If you’re an investor comparing metrics across portfolio companies, what can you do to get the highest chance of getting good apples-to-apples data?
Define the calculation of SaaS metrics consistently across your portfolio companies – you have to define the calculation for each metric so that each portfolio company uses it in the same way. Align with yourself internally, then align with all of your portfolio companies on their definitions.
What are the most important pieces to get right?
You can’t just start by calculating SaaS KPIs – You need an accountant foundation. If you don’t have accounting, FP&A can’t do its job. You need accounting, then a PnL, then you can get to metrics. This will help you audit the information from, for example, sales and marketing so that you don’t end up working with faulty figures.
Clear and distinct revenue streams, and COGs – you need to be able to track the revenue and expenses back to their different sources so that you can have an accurate SaaS PnL and metrics.
What are the common pitfalls?
Poor accounting close practices – if you don’t have revenue recognition in place, there’s no CRM system, and you’re not tracking bookings, you can’t effectively create and use SaaS metrics.
Poor invoicing discipline – if you’re not invoicing every month or you’re missing invoicing, monitoring your metrics becomes a lot harder and won’t reflect the reality of your business.
Using a mix of cash and accrual basis PnL – the inconsistency of the data will cause a lot of headaches and confusion. Standardize on a single accounting form (typically, accrual accounting if you’re mature enough).