How To Measure (And Reduce) Your SaaS Burn Rate
According to a study by CB Insights, the number one reason why startups fail is running out of cash as a result of poor financial management or failure to raise capital.
And in the competitive and fast-paced world of SaaS, understanding your cash flow and burn rate is essential not just for survival. But also for ensuring that your SaaS business is on the right track.
In this article, we’ll take a closer look at the SaaS burn rate and how you can measure it. We will also look at some practical tips to reduce it without necessarily affecting your SaaS company’s performance.
So let’s get to it.
What Is SaaS Burn Rate?
SaaS burn rate is a metric that SaaS companies use to measure the amount of money they are spending each month, relative to the total cash they have.
These include the following expenses:
- Cost of Goods Sold (COGS): This is the cost of labor, materials, and other costs associated with developing your SaaS product and retaining your customers.
- Operational Expenses: This covers day-to-day expenses such as salaries, office rent, marketing, and advertising costs, etc.
- General and Administrative (G&A) Costs: These are the costs associated with the management of your SaaS business, such as bookkeeping, legal advice, and compliance costs.
To put it another way, the SaaS burn rate tells you how quickly your SaaS company is “burning through” its available resources.
So companies with a high SaaS burn rate will be running out of cash faster than those with a low SaaS burn rate.
So is cash burn just the same as spending?
Well, yes and no, depending on the case.
If we’re talking about the gross cash burn, then yes, it is the same as spending because it encompasses all SaaS-related expenses that are made in a given month.
However, if we’re talking about net cash burn, then no. It’s not the same as spending because it takes your revenue into account. So the net SaaS burn rate can actually be negative if you generate more revenue than the amount you spend in a given month.
The difference may also be observable depending on the growth stage of a SaaS business.
You see, some SaaS startups in their earliest stages may not necessarily be generating any revenue. In that case, the cash burn (whether gross or net) would be equal to the total expenses for the company.
However, for SaaS companies that are already generating revenue, the gross and net SaaS burn rates can be significantly different from each other.
We’ll talk about these metrics in more detail later on.
Burn Rate SaaS Metrics You Need To Track
The thing about measuring burn rate is that there is more than one SaaS metric you need to track.
To get the most insights into your cash flow, you need to track the following burn rate SaaS metrics:
Gross Burn Rate
As we mentioned earlier, the gross cash burn is the total SaaS expenses you have for the month. And the gross burn rate measures how much of your total cash is spent on those expenses.
To calculate your gross burn rate, divide your SaaS spending for the month by your total cash at the start of the month.
For example, let’s say that your SaaS business has $100,000 in the bank at the start of the month and spends $20,000 on SaaS-related expenses during that month. The gross burn rate for January would be 20%.
In other words, you’re spending 20% of your capital for each month.
Net Burn Rate
The net SaaS burn rate is a measure of how much cash you spend after taking into account all of your SaaS revenue sources.
To calculate your SaaS net burn rate, subtract all of your SaaS revenue streams from your SaaS spending for the month. Then divide that number by your SaaS total cash balance at the start of the month.
For example, let’s say you have $100,000 in cash at the start of January and spend $20,000 on expenses during that month. But then you also generate a revenue of $10,000 for that month.
Your net burn rate for January would be 10%.
The SaaS burn multiple is a measure of how much cash you are spending in order to earn one dollar of revenue.
Calculating this metric involves your net new annual recurring revenue (Net New ARR). This is the annual recurring revenue you’ve generated from new customers and upsells from existing customers, minus the revenue you lose due to churn.
For example, imagine that your ARR grows by $50,000 as a result of acquiring new customers and an additional $10,000 from customers who upgraded their plans. However, you also lose $5,000 due to churn.
This would give you a net new ARR of $55,000.
To calculate your SaaS burn multiple, divide your net cash burn (total expense minus total revenue) by your total net new ARR.
For instance, let’s say that your annual net cash burn is $100,000 and your total net new ARR is $55,000. Your SaaS burn multiple would be 1.82. This means that it costs you $1.82 to earn one dollar in recurring revenue.
A higher burn multiple means that it costs more for you to acquire new customers and grow your business.
So a SaaS burn multiple of 2.0 or higher is generally considered to be high. On the other hand, anything below 1.0 means that you are generating more revenue than you are spending. In this case, your SaaS business is actually growing its cash balance.
The cash runway is another very important metric to track when you’re measuring SaaS burn rate.
It derives its name from an airport runway. Just as a plane needs enough land space to take off, your SaaS business needs enough runway (or cash) in order to keep operating until it can take off (grow and generate revenue).
The cash runway tells you how long your SaaS company can continue to operate at its current burn rate before it runs out of cash.
To calculate it, divide your total cash balance by your net monthly SaaS burn rate.
For example, if you have $100,000 in the bank and are burning through $10,000 per month, then your cash runway would be 10 months.
This metric is important because it gives you a clear picture of how much time you have to reach profitability or raise more capital.
If your SaaS business has a short cash runway, then you need to take action to either reduce your SaaS burn rate or raise more capital.
Why Is It Important To Measure Burn Rate?
As you may have observed about what we’ve talked about so far, measuring your burn rate and the metrics associated with it can put your finances into perspective.
But let’s talk about some more specific reasons why you should track your burn rate:
It Helps You See How Long Your Business Can Survive
Your burn rate and cash runway can help you identify how long your SaaS business can survive before you need to raise more capital or make other changes.
This information can be very helpful in planning for the future of your SaaS business.
It Can Help Inspire Investor Confidence
If you’re looking to raise capital from investors, one of the key metrics they’re likely to look at is your burn rate. A lower SaaS burn rate generally indicates that your SaaS business is healthy and sustainable.
If you have a high burn rate, that may be a red flag for investors and make them more hesitant to invest in your SaaS business. A lower burn rate, however, can attract more investors and give them confidence that your SaaS business is a good investment.
It Can Help You Avoid Cash Flow Issues
Tracking your SaaS burn rate can help you make sure that you don’t run out of money before you’re able to generate enough profits to sustain your SaaS business.
If you see your SaaS cash runway decreasing, it may be time to consider cutting back on unnecessary expenses or raising more capital in order to avoid any potential cash flow issues down the line.
How To Reduce Your Burn Rate
Now that you know why it’s important to track SaaS burn rate, let’s talk about how you can actually reduce your SaaS burn rate.
It will mostly revolve around cutting costs and increasing your cash balance. Here are some tips to get you started:
1) Maximize Free Tools & Free trials
As a SaaS business, you may also be using other business-to-business (B2B) SaaS products for your daily operations, as well as for customer acquisition and retention.
However, if you’re running a SaaS startup with only a few customers, then you may not need the full version of these SaaS products. Instead, look for cheaper alternatives or take advantage of the free trials that are available.
Even better, you may even find freemium products that you can use for free forever. This can help save your SaaS business a lot of cash in the long run.
2) Hire Only When Necessary
Building your own teams across different departments can be one of the most important steps you need to take for your SaaS business to grow. However, it can also be one of the most expensive things to do.
That’s why it’s important to only hire when absolutely necessary and make sure that you’re getting the right people for the job.
If possible, try outsourcing tasks or hiring project-based freelancers before committing to adding a new full-fledged team member to your SaaS company.
This will help you save some cash while still making sure that your SaaS business runs effectively.
3) Find Alternative Sources Of Revenue
If your SaaS business is still in its early stages, then it may be difficult to rely solely on your SaaS product for revenue.
In this case, it’s important to consider alternative sources of income such as affiliate marketing or consulting services. These can help you increase your SaaS cash runway and reduce your SaaS burn rate while you focus on growing your SaaS product.
If you’re offering a business-to-consumer (B2C) SaaS product with a freemium model, you may also consider running ads on your free plan.
This is a common practice among B2C SaaS apps, such as Spotify and most mobile apps. This ad revenue can help you alleviate your SaaS burn rate.
4) Delay Your Payments As Much As Possible
Delaying payments can help you buy yourself some time and help reduce your burn rate in the short term.
Negotiate with suppliers or vendors to see if you can push back on the payment date.
Not only will this help retain your SaaS business’ cash on hand temporarily. It also gives you more time to increase your cash balance either through investors or your SaaS company’s revenue.
5) Optimize Your SaaS Pricing Strategy
Your SaaS pricing strategy is another important factor when it comes to reducing your burn rate.
The most recommended pricing strategy for SaaS businesses is a value-based pricing strategy.
This strategy involves setting SaaS prices based on the perceived value of your SaaS product. This means you have to do some extensive research and testing to find the right SaaS pricing structure that both customers and you are happy with.
By finding the right balance between SaaS pricing and value, you can optimize your recurring revenue while also expanding your customer base.
The thing is that your research process may incur additional costs. This is why it’s important to be constantly aware of your burn rate and make sure you don’t go overboard with the research process. Or you could also seek out more capital to fund this research.
And that brings us to our next point of conversation.
6) Raise Capital From Investors
The fastest way for SaaS startups to raise funding and increase their cash balance is to seek out venture capital.
Here are some stages of funding that may be applicable to your SaaS business:
If your SaaS startup is in its earliest stages, you may arrange for a seed funding round. This involves pitching your SaaS product to angel investors to get them interested and invest in your SaaS business.
The funds raised in a seed funding round are typically used for the very first needs of a SaaS business, such as market research, product development, and building the founding team.
Series A Funding
If you’ve already had some success with your SaaS startup, then a series A funding round may be more suitable for you. This is where previous investors inject more money into your SaaS company while also introducing new investors to the SaaS company.
Series A funds can be used for a wide range of purposes, such as marketing and expanding your SaaS product’s customer base.
Series B Funding
If your SaaS business has been operating for some time, then it may be ready for a series B funding round. This type of funding is more suited to SaaS startups that have already achieved product-market fit and need funds to scale their SaaS product.
Series B funds are typically used to help SaaS startups expand their marketing, sales, customer support, and business development departments.
7) Bootstrap Your SaaS Startup With A Lifetime Deal
The thing about raising capital from investors is that you are giving away some equity in exchange for money. Hence, if you want to retain the most amount of equity in your SaaS company while still reducing your burn rate, then bootstrapping is the way to go.
Bootstrapping involves using your SaaS business’ own revenue and resources to fund its operations and investments. A great thing about this approach is that it helps SaaS businesses maintain full ownership of their SaaS products without having to give up any equity.
The thing about raising funds through bootstrapping is that it can be significantly slower than seeking venture capital.
After all, you’re just relying on SaaS revenues to grow the SaaS business.
However, there is one method that allows you to acquire a one-time cash inflow without relying on investors. And that method is offering a lifetime deal (LTD).
A lifetime deal is a temporary offering where you sell lifetime licenses that give your customers access to your SaaS product for life, in exchange for a one-time payment.
This is a great way to quickly generate revenue that you can use to fund long-term growth.
Final Thoughts About Burn Rate In SaaS
Burn rate is an important metric to understand when running a SaaS business. By accurately estimating how much money you need each month, you can make sure that your SaaS company remains viable and continues to grow.
There are several ways to reduce your SaaS burn rate, which primarily revolve around cutting unnecessary expenses and increasing your cash balance.
Ultimately though, it’s important to be aware of the financial health of your SaaS business so that you can make informed decisions about its future. If done properly, burn rate won’t be a cause for concern and instead will help your SaaS business reach success.
Looking for more guides that can help you grow your SaaS business? Check out our blog site here.