How To Calculate & Improve Your SaaS Quick Ratio
One of the most important things for a growing SaaS business is to continuously monitor its growth rate.
And to do that accurately and objectively, you need to use the right growth metrics.
However, when it comes to the SaaS business model, tracking revenue growth can be a bit challenging.
After all, you’re dealing with recurring revenues. Every new customer adds to that recurring revenue and every churned customer subtracts from it.
What’s more, you also have customers who are upgrading and/or downgrading their plans.
With all these considerations, how do you measure your SaaS business’ growth accurately?
That’s where the SaaS quick ratio comes in.
In this blog post, we are going to talk about how to calculate the SaaS quick ratio and how you can improve it.
What Is The SaaS Quick Ratio?
The SaaS quick ratio is a growth metric that measures a SaaS business’ ability to grow financially despite losses that it may incur.
It’s important to note that this is different from the finance quick ratio or acid test ratio, which is a liquidity metric that measures a company’s ability to pay its short-term debts.
The SaaS quick ratio, on the other hand, is all about revenue growth.
So make sure you don’t get confused between the two.
Monitoring your SaaS quick ratio is important because it accounts for the losses in your recurring revenue, unlike the simple monthly recurring revenue (MRR) or annual recurring revenue (ARR).
How To Calculate The SaaS Quick Ratio
To compute your SaaS quick ratio, you first need to find four SaaS metrics:
New MRR: This is the revenue that your SaaS business generates from new customers in a given month.
It’s important to note that this doesn’t include revenue from upgrades and downgrades. We’ll save that for the next SaaS metric.
Expansion MRR: This is the additional revenue generated from upsells and cross-sells in a given month.
Churn MRR: This is the recurring revenue that your SaaS business loses in a given month due to customer churn.
Contraction MRR: This is the amount of recurring revenue lost due to downgrades or plan changes in a given month.
Now that you have these four SaaS metrics, you can compute your SaaS quick ratio using this formula:
For example, let’s say that your SaaS business has the following monthly recurring revenues:
- New MRR: $10,000
- Expansion MRR: $6,000
- Churn MRR: $3,000
- Contraction MRR: $1,000
Using the formula above, we can compute for the SaaS quick ratio like so:
SaaS Quick Ratio = ($10,000 + $6,000) / ($3,000 + $1,000)
SaaS Quick Ratio = 4
This means that for every dollar of recurring revenue that your SaaS business loses due to churn or contraction, it generates $4 in new and expansion MRR.
If you have a SaaS quick ratio of around 1 to 4, you’re still in the safe zone. But it also means that churn and contraction are taking a lot from your recurring revenue growth.
If the SaaS quick ratio goes below 1, that means you’re losing money. You need to figure out a new customer acquisition strategy to win new customers, reduce your churn rate, and/or retain your existing customer base.
That brings us to our next point…
How To Improve Your SaaS Quick Ratio
In a nutshell, improving your SaaS quick ratio is a matter of increasing your new MRR and expansion MRR while decreasing your churned MRR and contraction MRR.
But let’s take a look at some specific ways how you can do these things:
1) Improve Your Customer Retention
One of the best ways to reduce churn rate and contraction MRR is by improving your customer retention.
There are a lot of ways to do this, but some of the most effective ones include the following:
Provide Exceptional Customer Support: A new customer should feel that you value customer success and that you’re always available to help them with their concerns. If you can, make it possible for them to contact your support team via multiple channels, like email, phone, and live chat.
Offer a Robust Customer Onboarding Process: Make sure that a new customer knows how to use your SaaS product and that they are getting the most out of it. Helping them start strong will go a long way in building a good relationship with them, and it also helps you retain their lifetime value through loyalty.
Regularly Engage With Your Customers: Don’t just wait for your customers to come to you with their concerns. Proactively reach out to them and see how they’re doing.
Consistently Improve Your SaaS Product: Always be on the lookout for ways to make your SaaS product better. Introduce new features from time to time. And revamp the user interface if you need to. SaaS growth plays a huge part in retaining existing customers and enticing a new customer.
This way, your customers will have fewer reasons to churn.
Customer retention is one of the keys to success. The net promoter score (NPS) is a popular metric for measuring customer satisfaction and loyalty, and it can be a helpful tool for measuring your company’s customer retention rate.
To calculate your NPS, simply ask your customers how likely they are to recommend your software to a friend or colleague, on a scale of 1-10. The NPS is calculated by subtracting the percentage of customers who give you a score of 6 or below from the percentage of customers who give you a score of 9 or 10. A positive NPS score indicates that you have more promoters than detractors, and thus a higher customer retention rate.
Conversely, a negative NPS score indicates that you have more detractors than promoters, and thus a lower customer retention rate. By improving your NPS score, you can increase your customer retention rate and improve your quick ratio (the number of paying customers divided by the number of total customers). In turn, this will help to ensure the long-term success of your SaaS business.
By improving your customer retention, you can reduce churned MRR and contraction MRR, which will have a positive impact on your SaaS quick ratio as your gross margin increases.
2) Acquire More Customers
Of course, another way to improve your SaaS quick ratio is by acquiring more customers.
But we all know that it’s so much easier said than done. So you need to be ready with the right customer acquisition strategies.
Again, there are tons of possible ways you can do to get more customers. But here are a few best practices that may help you.
Invest In Lead Generation: Make sure that you’re doing everything you can to generate high-quality leads. Whether it’s through offering lead magnets, optimizing your opt-ins, or running ads, you need to bring in a steady stream of leads.
Nurture Your Leads: Just because someone has signed up for your email newsletter doesn’t mean they’re ready to buy your product. You need to nurture your leads by providing them with valuable content that will help them move further down the SaaS sales funnel.
Optimize Your Sales Process: Take a close look at your sales process and see if there are any areas that can be improved. Maybe you’re not closing as many deals as you could be. Or maybe your conversion rate could be higher through unique gimmicks that will hook your audience to your SaaS product.
By acquiring new customers, businesses can offset any losses from existing customers and ensure continued growth. Of course, customer acquisition is not free, and it’s important to keep an eye on the customer acquisition cost (CAC) ratio. This is the ratio of the cost of acquiring a new customer to the lifetime value of that customer. If the CAC ratio is too high, it will eating into profits and make it difficult to sustain growth. However, if it’s managed correctly, customer acquisition can be a powerful tool for increasing the quick ratio and ensuring long-term success.
3) Craft A Solid Upsell Strategy
Another factor that can increase your SaaS quick ratio is your expansion revenue from upselling.
Having your existing customers upgrade to higher plans can significantly increase your average revenue per user and build your relationship with your customers.
This is why it’s important to have a solid upsell strategy in place.
Some of the best ways to do this include the following:
Identify The Right Upsell Triggers: First, you need to identify the key triggers that will prompt your customers to upgrade their plans. Maybe it’s when they reach a certain number of users or when they start using a certain feature more frequently.
Whatever the case may be, make sure that you’re aware of the key upsell triggers for your customers.
Make The Upsell Process Seamless: Once you’ve identified the right upsell triggers, you need to make sure that the actual upsell process is as seamless as possible.
This means having an automated system in place that will do most of the work for you.
The last thing you want is to lose customers and add to your churn because they find your upselling process too complicated or time-consuming.
Offer More Value: Finally, you need to make sure that your upsell offers are actually worth upgrading for. This means adding more features or getting a bigger return on investment (ROI).
If you want to increase your SaaS company’s MRR growth, one of the best things you can do is focus on upselling. By convincing your existing customers to upgrade their plans or add on additional features, you can quickly boost your MRR. And since it’s easier and cheaper to sell to existing customers than to acquire new ones, improving your upsell rate can have a major impact on your bottom line.
But how do you craft a successful SaaS upsell strategy? Start by segmenting your customer base and tailoring your upsell pitches accordingly. You should also make sure that your offers are valuable and relevant to your customers’ needs. And finally, don’t forget to timing your upsells properly – too early and you risk frustrating customers who aren’t ready to commit, but too late and you could miss out on a golden opportunity. By following these tips, you can create an upsell strategy that will help you drive MRR growth and achieve negative churn.
Measuring your SaaS Company’s Health
The MRR churn and deferred revenue are both key indicators of a SaaS company’s health.
The MRR churn is the amount of MRR that is lost each month, while the deferred revenue is the amount of MRR that has been invoiced but not yet recognized. The MRR churn is important because it shows how well a company is retaining its customers.
If the MRR churn is high, it means that a lot of customers are cancelling their subscription each month, which is bad for business. The deferred revenue is important because it shows how much MRR a company has in the pipeline.
If the deferred revenue is high, it means that a lot of customers have paid for their subscription but have not yet started using the service. As a result, the deferred revenue can be seen as an indicator of future growth.
The SaaS Quick Ratio is a ratio that compares the MRR churn to the deferred revenue. It is important because it shows whether a company is growing or shrinking. If the ratio is high, it means that the company is losing more MRR than it is generating in new customer subscriptions.
This is not sustainable in the long term and will eventually lead to bankruptcy. However, if the ratio is low, it means that the company is generating more MRR than it is losing each month, which is healthy for business. The SaaS Quick Ratio is thus an important metric for investors to watch when considering whether to invest in a SaaS company.
EBITDA Margin and SaaS Quick Ratio
EBITDA Margin is a financial ratio that measures a company’s earnings before interest, taxes, depreciation, and amortization as a percentage of its revenue. EBITDA Margin is a good way to measure a company’s profitability and compare it to other companies in its industry. The higher the EBITDA Margin, the more profitable the company is.
The SaaS Quick Ratio is another financial ratio that measures a company’s ability to pay its short-term obligations with its current assets. The Quick Ratio is important because it shows how well a company can manage its finances and whether it has enough cash on hand to cover its short-term debts. A high Quick Ratio indicates that a company is in good financial health and is able to pay its obligations. A low Quick Ratio indicates that a company may have difficulty meeting its financial obligations.
Both EBITDA Margin and the SaaS Quick Ratio are important ratios to consider when evaluating a company’s financial health. EBITDA Margin provides insight into a company’s profitability, while the Quick Ratio shows how well a company can manage its short-term obligations. Companies with high EBITDA Margins and Quick Ratios are generally considered to be in good financial health.
Role of a SaaS Chief Financial Officer (SaaS CFO) in Improving Quick Ratio
A SaaS CFO can play an important role in measuring and improving your saas company’s quick ratio. The quick ratio is a measure of a company’s ability to pay its short-term liabilities with its most liquid assets. For saas companies, the quick ratio is particularly important because of the subscription-based nature of their business model.
A high quick ratio indicates that a saas company has a strong financial position and is able to cover its short-term obligations.
A low quick ratio, on the other hand, indicates that a saas company may have difficulty meeting its short-term obligations. Saas companies with a low quick ratio should take steps to improve their financial position by increasing their cash reserves and reducing their debt.
A SaaS CFO can help a saas company to measure its quick ratio and identify areas where improvements can be made.
The SaaS CFO can help to identify areas where you are not collecting enough revenue and develop strategies to improve your collections. In addition, the CFO can also help to negotiate better payment terms with customers and suppliers. By taking these steps, a SaaS CFO can play an essential role in ensuring that your company has a healthy Quick Ratio.
Other Iceberg Model Examples in SaaS
The beauty of systems thinking and the iceberg model is that it covers a lot of possible aspects of your business, not just quality assurance.
Here are several more examples of how SaaS companies apply the iceberg model for problem-solving:
Churn is the boogeyman of any SaaS business as it never dies. You can only contain it to an acceptable level.
Bugs can be debugged. But churn is eternal.
Fortunately, there are many ways to reduce churn for your SaaS business. And the most effective way to do that is to find the root cause.
So let’s look at an example of how you can use the iceberg model to find out the very thing that is causing your customers to leave.
In this case, a user opting out of your SaaS solution is the event. The pattern is that more and more follow suit.
You can do different things to find the underlying structures that allow a steady churn rate. The easiest one is to ask leaving customers why they want to discontinue their subscription. You would need to compile their responses and find out the most prevalent reason.
There are varying causes to this:
- It can be a poor user experience
- It can be a steep price range
- Or it can be that they are switching to a competitor of yours
Let’s take the last one as an example.
Most of your customers say that they prefer your competitor’s services as it’s more suitable to their needs.
Again, that can be caused by so many possibilities.
Do the competitors offer better prices? Better features? You will need to dig deeper to find the structure that makes your users leave.
After looking into your SaaS solution, you realize that it has become so similar to your competitors’ products.
You started out strong with a unique value proposition that drew the attention of your target audience. But along the way, your feature updates made your product look similar to your competitors.
Somewhere along the way, you lost the uniqueness that attracted your customers in the first place.
That could be due to the mental model that you need to beat your competitors’ features in order to go toe to toe with them. That may be true in some cases.
But losing your unique value proposition will cost you your customers. All it would take is for your competitors to offer a better deal.
Now slow growth is not always a problem for a SaaS company. It depends on what your business prioritizes at the moment. There’s a time to focus on profit and a time to prioritize growth.
If you’re a SaaS startup, you probably want to grow as fast as you can so that you can grab a piece of the market and catch up to your competitors. You may even be using the T2D3 framework to achieve this goal.
But if your growth has been stalling for the past several months, you need to find out what’s causing this pattern to emerge.
Again, there are many different possible structures that could lead to your stunted growth.
For our example, let’s say lack of product-market fit is the culprit. You’re not getting more customers because your marketing and sales teams are directing their efforts to the wrong target audience.
But why would they do such a thing? What kind of mindsets and beliefs would make marketing professionals target the wrong audience?
You decide to dig deeper and find out that your marketing team thinks that it’s always better to prioritize prospects with higher buying power.
And this thinking led them to disregard whether or not the product matches their needs.
That’s where you can solve your growth problem at its core. It takes a change in mindsets and beliefs to rework your marketing and sales strategy.
Who knows? Rethinking your target market may even lead to an opportunity for a blue ocean strategy. You could dominate a market all by yourself and maximize your growth.
Whatever misguided mental model your marketing and sales teams have, you can replace it with one that serves both your organization and the target audience that you should be having.
Another problem that you can solve with the iceberg model is poor employee performance. This example isn’t exclusive to SaaS. All businesses experience this.
So let’s say you have an employee who shows up late to work on a Monday, of all days.
Trying to search for a pattern, you notice that there are also a few others who consistently clock in late. And it has been going on for a few weeks now.
That’s a clear sign that one employee showing up late on a Monday morning isn’t just an isolated incident. And that it’s time to find the structure that’s causing this behavior.
Digging deeper, you find out that it has been common practice to stay in the office till 10 PM.
And it has been tough on some of your employees, causing burnout and exhaustion that leads to them clicking late.
Now, what mental models would cause employees to stick around way past closing time?
You ask your employees why they do it and learn that they believe that putting in extra hours is necessary to show their dedication to their jobs. To leave work on time was too early.
But you know that there are other ways to excel at work.
Now, identifying what mindsets lead to your employees’ performance will help you plan the right approach in addressing it. This could result in a change of culture that would improve employee performance and, ultimately, your bottom line.
The iceberg model in business helps you solve not just minor issues, but their very source. It’s not just a change in external behavior, but an internal transformation.
Dealing with problems at their core will take time, effort, resources, and a whole lot of leadership. Since you’re dealing with mental models and probably applying a system change, it won’t happen immediately.
You can fix a few bugs overnight. But changing mindsets and organizational culture takes a whole lot more.
Yes, it may take a lot of effort. But when done right, you won’t need to deal with those problems again.
For more strategies to help your SaaS business, check out our blog here.