As you name the boat, so shall it float. No wonder that a software distribution model vaguely defined as “SaaS” became obsessed with abbreviations.
We’ve got hundreds of three-letter terms and impossibility to break through the buzz to indeed essential financial KPIs for SaaS companies.
There’s a word for 136 key performance indicators, and the word is madness.
When we say “key”, we mean “things that are essential”.
Having dozens of “key” metrics, you have three options to go:
- ignore that buzz and track (almost) nothing, failing to understand how your business is rolling because you have no info to work with.
- track what is easy to track, failing to understand how your business is rolling without KPIs that matter.
- track everything that walks and moves, failing to understand how your business is rolling, because having too much information can be as useless as too little.
I’m not saying it’s a conspiracy, but...
We at Eleken got fairly good at fixing SaaS trouble spots redesigning good products to make them top products — take a look at our case studies for Gridle or Handprinter. We know which way to look for valuable metrics.
In this article, we have a go-to kit of actionable financial KPIs that will free you from digging through piles of listicles. They will link to stats that you can tie into the goals of your business and specific tasks that you can improve on.
Let’s set the stage with a quick definition.
What is Financial KPI?
KPI stands for a key performance indicator.
Financial KPIs for SaaS is a number or metric companies track to gauge the efficiency of their SaaS finance. They give you visibility into performance and a measuring stick to track success.
Why you need KPIs
You can’t improve what you don’t track. An unmeasurable goal is not a goal at all, because how will you know when it's been accomplished?
Running a business with no goal is no better than throwing ideas at the wall waiting for something to stick.
It may work, but it will definitely work better if you have a dartboard to aim your throws, access their accuracy, and draw conclusions based on previous attempts.
That’s what KPIs do — they provide a measuring system for your attempts.
In this article, we’ll raise the starter kit of SaaS key performance indicators that will help us to:
- figure out whether you can sustain a profitable business
- understand how your revenue is doing month to month
- measure how much you’re losing due to churn
Now that we have that out the way, let’s dive in.
Step 1. How to master unit economics for startups
In the first step, we’re going to measure your SaaS unit economics, or how good you’re dealing with an average consumer.
If you earn with a consumer less than you spend to acquire one, it’s time to reconsider your business model. And if you can make a profit from one customer, good chances are that you’ll succeed with thousands and millions of them.
For further calculations, we need two KPIs: customer lifetime value (LTV) and customer acquisition cost (CAC).
How to calculate customer lifetime value
Lifetime value or LTV means the total amount that you expect to earn per customer over their entire lifetime. You need to multiply the figure you’re charging on average for a customer in a given month by the average lifetime of your subscribers.
The formula is pictured below.
If you have customers that are on multi-month subscriptions, simply divide the cost they are paying by the number of months in the subscription period to get their average monthly payment.
Say you have 30 subscribers, 20 of them priced $10/month according to your basic plan, and the 10 that left pay $100/year billing annually. For those 10 subscribers, you need to divide $100 by 12 months to get ~$8,33 per month.
Now we take all your 30 customers to calculate the average revenue per user.
(20 x $10) + (10 x $8.33) / 30 = $9.4
If one user brings $9.4 per month, and you know that users stay with you for, let’s say, 20 months on average, using the formula above we can figure the lifetime value of one user.
$9.4 x 20 = $188 LTV
How to calculate customer acquisition cost
Here we need to bring together all your costs spent on sales and marketing over a given time and divide them by the number of paying users acquired during the same time.
If you had spent $2,400 and acquired 30 new customers over a month, the calculation would look like this:
$2,400 / 30 = $80 CAC
Determine the LTV to CAC ratio
Now when we have customer lifetime value and customer acquisition metrics ready, let’s take a closer look at the ratio between the two.
The result has to be more than 1, otherwise, we’re losing money with every new customer instead of earning them. But it’s not enough to just break even — to run a successful business, we need to reach at least the ratio of 3.
The LTV, according to our example calculation is $188, and the CAC is $80. The ratio we get dividing the first number by the second one is 2,35.
Not bad, but there’s still room for improvement. The stronger the ratio, the faster each customer pays back their costs. It’s particularly important for SaaS since the cost of acquisition gets paid before the customer contributes to the profit, making small payments gradually over a long time.
Step 2. SaaS Monthly Recurring Revenue
SaaS is a recurring revenue business based on small repeated monthly payments. So now, when you can measure your unit economics, it would be nice to know whether your business is sustainable relating to the time.
To track how much money you make monthly, we need another KPI, called monthly recurring revenue, or MRR.
How to calculate monthly recurring revenue
For the formula, we need to know the total number of paying users. Say, we have 30.
Another number we need is our average revenue per user. Fortunately, thanks to the LTV calculations above we know that we earn $9.4 per user per month.
Now we are ready to measure our MRR. Let’s multiply the total number of paying customers by the average amount they pay every month.
The calculations are the following:
(20 x $10) + (10 x $9.4) = $294 MRR
With MRR, it’s important to track changes in the dynamics. As you get consistent revenue month after month, you can estimate where you’ll be and plan your business accordingly.
Step 3. Tracking Monthly Recurring Revenue Churn
Churn makes a massive impact on everything you hold dear in a subscription business. You perfect your product, spend on acquisition, show your users the value and do your best to make them happy with your product. And one day they just leave.
Know your enemy. Let’s figure out how your profit erodes as users leave, canceling or failing to renew the subscription. Monthly recurring revenue churn is a financial metric we need here.
MRR churn calculation
We’re going to measure your losses due to active cancellations and due to payment problems, usually delinquent credit cards.
All you have to do is to summarize the amount of money lost during the month due to cancellation and delinquent churn.
For instance, your MRR churn in the next month is going to be $100 given that you’ve got 8 people that rejected to renew the $10/month subscription and another and another 2 you count churn since your billing system was unable to charge the monthly payment from them.
(8 * $10) + (2 * $10) = $100
And in case if you have churned users with multi-month subscriptions, divide the cost into the number of months to get the losses for one month only, as we did for the LTV formula.
We have financial KPIs for SaaS companies, what’s next?
Now when we demystified some financial metrics for SaaS companies, let’s clarify why it pays back to rally around the limited amount of the most important metrics.
First, it helps to empower the team around a clear measurable goal.
Shopify CEO Tobias Lutke in his article shows how a single metric became Shopify’s compass for growth. He’s chosen modification of MRR — Committed Monthly Recurring Revenue — to send weekly emails to the team showing the changes that happened to the core metric and held weekly meetings to go over the plan of growing the metric.
Lutke calls this simple two-step framework “the motor of a fast-growing multi-million dollar business”.
Second, by checking the impact on your SaaS operating metrics, you can evaluate the efficiency of your experiments.
You can see the results in the picture.
Third, you may figure out that your product needs some significant changes in the UX/UI to become more valuable from the user experience standpoint.
The example here is provided by our client, Handprinter, which focused on the problem with user onboarding. The root was in a poor user experience that prevented visitors from converting into users, and we solved the problem through the ground-up UI/UX redesign.
That’s all for now, but in case if you find that little abbreviated SaaS KPIs adorable and need more, you may google “saas metrics and kpis”. But I’d rather read our nerdy compilation of the best books on SaaS metrics every startup owner should read.