How to Use Accounting Metrics for SaaS Businesses
SaaS businesses have been popping up everywhere thanks to the advancement of cloud technology and the success of products such as Microsoft Office 365 and Salesforce. Accountants who do not work in a SaaS business often use SaaS products, and many of our managers seem to think that switching to a SaaS model is a quick path towards a steady stream of growing income.
But switching to a cloud-based platform carries risk, and managers can find themselves making bad decisions because they do not really understand how the SaaS model is different from traditional legacy software nor the downsides of switching to said model.
Above all else, managers have to actually understand accounting metrics to assess the true health of their business. Accountants like you may already know these metrics, but it is on you to educate your boss on how they can use and understand these metrics to get the most out of SaaS model.
The Right Kind of Revenue
Any small business manager, especially a SaaS business, will talk about how their business is growing. But what metric are they using to determine growth? Total revenue or the total number of accounts hold some value, but the most important metric is monthly recurring revenue (MRR).
MRR simply means how much money all your customers have agreed to send your business every month. It is easy to calculate. The manager just takes the total revenue and removes any one-off sales, or multiplies the number of subscriber by the cost of a subscription. Since SaaS businesses generally rely on subscriptions, it is important to track recurring revenue to understand your business’s growth.
“I suggest that you always validate what you are doing with data, and that data has to relate to our business KPIs,” explains Yali Saar, CEO of Tailor Brands. “Within the digital space there is no lack of numbers and ways to slice and dice our data. We employ a team of analysts and work closely with our financial controllers to be sure that all decisions made will positively affect the company’s growth metrics.”
Some business managers may intentionally slash down prices, seeking to drive down revenue in order to obtain more subscriptions. While that can work sometimes, make sure your manager understands that revenue should be the primary means to determine whether the business is growing or not, not the number of subscriptions.
Average Revenue per Consumer
Getting more revenue is good. Getting more customers is good. But eventually, your business will have an easier job getting more revenue from its existing customers than finding more customers, and you have to make sure your boss understands that.
Remember that if your business’s customers bought one subscription, they may be interested in buying further subscriptions or a higher-tier subscription which offers them more services. Always look to offer more and better products, and aim to set long term goals for the average revenue per customer. There is more than one way for a business to expand.
Cash Flow Matters
According to Time magazine, 29 percent of small businesses are killed by a lack of cash flow. Too many small business equate revenue and accounts receivables with cash flow and think that they are on a sound financial footing. They then discover that they cannot pay salaries and expenses with accounts receivables, and go broke even while customers owe them money.
This threat becomes even greater for SaaS businesses. Because most SaaS business eschew receiving one large lump sum in exchange for a steady subscription, they have to ensure that their customers are constantly paying them on time. If a customer does not pay you, the business loses money both in not receiving cash and by providing the service for which your business is supposed to be paid for.
Look to explain the difference between revenue and cash flow as well as the latter’s importance as soon as you can. Offer suggestions on how the business can maintain a steady, growing cash flow, such as these tips provided by Quaderno. MRR may help track whether the business is growing, but cash flow will track whether the business will live or die.
Cost of Acquisition and Lifetime Value
As noted above, your managers will often try to use the number of subscriptions or consumers as a way to track the health of their business instead of MRR or the revenue per consumer. But how much is the business spending acquiring each consumer? What is its cost of acquisition (COA)?
Analytics company Control points out that cost of acquisition is heavily tied with another metric called customer lifetime value (CLV), which essentially represents how much money a company can get out of a consumer from beginning to the end. Any business, SaaS or otherwise, which has a higher COA than a CLV is a business in jeopardy.
Keeping cost of acquisition low normally is not a major challenge for startups because startups are not spending a great deal on marketing at first. But as the business grows, talk to your boss or business owners about streamlining their marketing strategy to only use the methods which actually acquire customers. Furthermore, keep the CLV high by implementing various customer retention strategies.