Customers today demand the availability of cloud-based solutions. As a SaaS owner, this is good news for you. Median growth for SaaS companies lies somewhere between 26% and 36%, meaning that you stand a good chance of success if you pay close attention to your business.
There is something of a paradox in the world of SaaS. The business model of the SaaS company shows that fast growers lose money but show high valuations. As growth slows down, your startup valuation drops as profits increase. Why? Because the faster you grow, the more money you are spending. Unfortunately, you don’t see the revenue until later.
If you want to understand how your business is fairing, looking at only profits can be misleading. Just because you are losing money doesn’t mean that you aren’t successful, nor does it mean that you can’t assess the value of your company.
Because profit and loss analysis won’t tell you what you need to know, it is essential to look at four specific metrics to evaluate your business: growth, growth efficiency index, churn, and recurring profit margin.
As more startups appear, growth is demanded if you hope to emerge as a leader in the market. The primary indicator of your success is revenue growth. When it comes to measuring your success as a SaaS, revenue growth is a strong indicator.
When you are assessing growth, eliminate non-recurring revenue from any calculations. You want to measure future revenue growth and, to do this, utilize committed annual recurring revenue from the end of one period to the net.
The most successful SaaS will get very specific when measuring growth. Each component is an important factor in the valuation of your company. Your growth comes from new customer revenue, sales to new customers, upsells, cross-sells, and expansion revenue. It is also reduced by churn.
Growth Efficiency Index
Even if your company has healthy profits, you still need to concentrate on growing efficiently. The growth efficiency index, or GEI, is what you spend in new revenue to add a single dollar to replace churn.
Your new revenue includes sales and marketing costs, cost of free trials, sales costs, and marketing costs. The higher your churn is the lower your acceptable growth efficiency index. Why? Because the value of a single customer that is more than likely to churn.
If your churn is significant, revenue growth will be incredibly difficult. Therefore, churn can dramatically impact your primary metrics. The level of churn that you find acceptable, but it will be a strong predictor of the value of your company. Churn is such a strong predictor because:
– The presumption is that while growth is building an RRS (Recurring Revenue Stream), churn is decreasing the FRS, or future revenue stream.
– Churn of any type can indicate a dissatisfaction with your product.
– High churn rate, when compared to similar SaaS companies, indicates a major issue.
Recurring Profit Margin
It should first be said that a delay in profitability should be expected for any SaaS. In the beginning, you will spend more money than you will take in. Once, however, business slows down, you should become profitable.
Your recurring profits come from the marketing and sales costs to replace churn but without the cost of any other type of growth. So what does the RPM calculation look like:
Subscription revenue – cost revenue = gross profits
Gross profits – cost of churn replacement – the cost of research and development – general costs = recurring profits.
Recurring profits – revenue acquisition costs of NNR = profits lost
Building and maintaining a profitable SaaS company can be difficult. Assessing its status, on the other hand, is not so difficult. When you compare core profitability, revenue growth, and cost of revenue acquisition, you can assess the current financial status of your company.
Bear in mind that your metrics need to be assessed at different stages of your company’s life. When you are first starting, you cannot be considered efficient and should expect your overall profit margin to be low.
If you are still burning more money than you are making as an established company, things will need to be changed quickly if you want to turn things around.