SaaS and recurring revenue businesses with subscription models are faced with large overhead costs to initially acquire their customers before they can become profitable. For these companies, analyzing accounting firm metrics is the key to staying viable in the early stages and beyond.
At Maxwell Locke & Ritter, we have compiled the five key metrics every SaaS and recurring revenue business should be evaluated on consistently. As one of the best mid-sized accounting firms in the country with a strong foothold in the technology sector, we are confident we can provide you with up-to-date and valuable information.
Monthly recurring revenue (MRR) for each customer represents the monthly subscription price charged by SaaS businesses.
Going hand in hand with MRR is the figure one gets when multiplying MRR by 12—annual recurring revenue (ARR). SaaS and recurring revenue businesses are often valued at ARR, so you want this figure to be as high as possible.
If you are a SaaS company, chances are you bill monthly under an annual contract. When you’re reconciling ARR to GAAP revenue, you should also consider the timing of your bookings and activation dates. It is also important to differentiate between true recurring and non-recurring revenue (or “re-occurring” revenue) because that will affect the valuation.
When considering your monthly recurring revenue, it is generally the most profitable option to upsell to existing customers, as it requires fewer sales and marketing in comparison to acquiring new customers. Upselling usually provides a better return on sales and marketing investments overall.
CAC represents the sales and marketing spend required to acquire new customers and the resulting incremental ARR.
Calculating the CAC ratio is useful to measure the payback time on the company’s sales and
marketing investment, as well as the efficiency of sales and marketing investment. Refer to the charts below.
Understanding the relationship between your CAC ratio and your profitability helps your SaaS company plan marketing efforts and strategies more effectively in the future.
Another use for the CAC metric is the CAC payback period, otherwise known as the CAC recovery period. This measures the number of periods it takes for a customer’s cumulative ARR to pay back the initial sales and marketing spend.
The CAC payback period is one of the best accounting firm metrics to study to understand the efficiency of your SaaS and recurring revenue business. Generally, your company should allow for a 12 to 18 months timeframe to recover your initial customer acquisition cost.
Customer retention and churn are two critical metrics for SaaS and recurring revenue businesses that should be consistently analyzed and understood.
The customer churn rate is the rate at which your business is losing customers within a certain time period, usually monthly or quarterly. Conversely, the customer retention rate is the rate at which your business is retaining customers. Churn is just as important to track as retention. SaaS businesses should analyze churn to understand why customers failed to renew subscriptions or contracts.
Even a small change in the monthly churn rate makes a significant difference in the long term ARR retention rate. With only a 2% monthly churn, half of all customers will be gone in three years. Add a 4% churn, more than 75% of customers will be lost in three years. Customer churn rates greatly impact a company’s ability to scale.
A negative churn rate is ideal for effective growth. This occurs when upsell’s and expansion outpace contraction and churned recurring revenue. Your company can achieve a negative churn rate by focusing on strong inside sales that focus on renewals and upselling within the existing customer base.
A cohort analysis is an effective technique to gain insight into your churn trends. These groups customers into “buckets”, or cohorts, and analyzes trends within those buckets over time. Cohort analyses allow your company to track customer behavior and a cohort’s reaction to different variables over time. Your accounting firm metrics should include these analyses frequently for a continual assessment of different variables over time.
The lifetime value of a customer is almost always measured in comparison to the cost of acquisition for the customer. This accounting firm metric is called the LTV:CAC ratio. This ratio is useful when determining the efficiency of your sales and marketing efforts.
Essentially this ratio answers the question: is the customer worth more than what it costs to sell to them? It is also a great way to assess your company’s ability to grow sustainably. The ratio is calculated as follows:
A ratio of 1:1 means your company is losing money the more you sell. The industry standard LTV:CAC ratio is typically three or higher for growing SAAS companies.
However, a higher ratio is not always preferable. if the ratio is too high, your company is likely underspending on sales and marketing and therefore restraining its growth.
Many investors abide by the Rule of 40 as one of their top accounting firm metrics to determine a SaaS and recurring revenue business’ success. This principle has gained momentum in recent years as a high-level performance accounting firm metric for SaaS and recurring revenue businesses.
The rule is calculated as follows:
Profit/EBITDA + Year-Over-Year MRR Growth Rate => 40%
Essentially, this rule states that your growth rate and your profit should add up to at least 40%. As an example, this holds that if your growth rate exceeds 40%, you can afford to lose some profit. Using the Rule of 40 can help your company analyze different trade-offs of growth and profitability.
Maxwell Locke & Ritter has been serving the greater Austin community with premier accounting services since 1991. We are happy to provide our clients with valuable resources regarding accounting firm metrics and much more.
We specialize in a large range of accounting services, including audits, tax, due diligence, and wealth management. For personalized and professional advice, please contact us to learn how you can get started with our accounting services. We look forward to working with you.