MRR. ARR. CAC. Unicorns, pipelines and ACS 606.
There’s a lot of new terminology that comes with joining a Software-as-a-Service team. Not surprisingly, the industry known colloquially as ‘SaaS’ has a language all its own.
After all, SaaS businesses are known to be fast paced and fast growing. And with a ton of pressure to grow fast, Software-as-a-Service companies have developed their own set of metrics and rules of thumb to drive success quickly. All of which comes with its own lingo, and means there’s a lot to catch up on—from the language to the key financials and KPIs. But there’s not a lot of time for a lengthy learning curve if you want to start adding value right away.
If you’re coming into SaaS for the first time, it might seem daunting. You want to start bringing your own financial prowess to the table as soon as possible and put your own financial planning best practices into place. And because they’re so fast growing, SaaS companies benefit from strong strategic planning and reporting, which makes your role even more critical. But it also means you need a quick way to prime yourself.
Don’t worry—we’ve got you covered! Here’s a primer on everything you can expect when you join a SaaS finance team for the first time.
Start with the Basics
First things first: What’s so special about a SaaS business? And what makes one tick? While not all of them are unique to SaaS, here are a few basic terms you may hear thrown around the Zoom call your first day on the job. Bonus points if you use one yourself when you start discussing SaaS companies and the recurring revenue model they rely on:
Subscription Software Revenue
Unlike the one-time fee you might pay for most of the products you buy, SaaS is based around Subscription Software Revenue. Collected as recurring revenue, it’s paid over time based on a long-term contract. That makes it predictable and ongoing, lasting until the subscription term ends (at which time, it may be renewed) or a customer cancels their subscription.
Subscriber count tracks the number of SaaS customers on recurring-revenue plans.
A sales pipeline helps SaaS companies visualize the journey they take prospective buyers through on their way from initial brand awareness to final sale and further on, to retention.
A unicorn is a company with a valuation of $1 billion or more.
What Are the Key Financials of a SaaS Business?
Subscription-based businesses collecting recurring revenue have some unique ways of slicing and dicing revenue numbers for their various reporting needs. To make your mark in the world of SaaS finance, you should understand those revenue numbers.
Monthly Recurring Revenue
Monthly Recurring Revenue (MRR) is the value of all SaaS subscriptions stated as a monthly recurring amount. Companies will generally use either MRR or Annual Recurring Revenue (below) depending on a range of factors, including contract length, investor interest and whether they take a short- or long-term view.
Annual Recurring Revenue
Annual Recurring Revenue (ARR) is the value of SaaS subscriptions stated as a yearly recurring amount—even though the subscription price may be set at a monthly, quarterly or annual price. For example, the value of all monthly subscription rates multiplied by 12 would be one way to calculate ARR.
ARR and MRR at a Glance
New ARR / New MRR: New ARR/MRR is the total amount of ARR/MRR sold to new customers in a specified period of time.
Expansion ARR / Expansion MRR: Expansion ARR/MRR calculates the recurring revenue that can be attributed exclusively to upsells and upgrades to existing customers.
ARR / MRR Churn: Your churn rate looks at the revenue (displayed as either a percentage or value) you’ve lost due to churning customers over a specific period of time.
Net ARR / Net MRR: Net ARR/Net MRR adds your New ARR/MRR to your Expansion ARR/MRR and subtracts any revenue lost from churn or downgrades.
Committed ARR / Committed MRR: Committed ARR/MRR (or CARR/CMRR) factors any known bookings or cancellations into your ARR/MRR equation—factoring known new subscriptions and known subscription churn into the ARR/MRR equation by adding them to your actual numbers.
How Do SaaS Businesses Measure Success?
To maintain and grow subscribers, SaaS companies use a number of KPIs to measure the success and efficiency of their business. These are often key business drivers that factor into bottom-up planning activities and help project operational and financial objectives. These include:
Customer Acquisition Cost
Customer Acquisition Cost (CAC) is the cost of acquiring a customer, including sales, marketing, etc. It’s usually calculated as such: Sales Costs + Marketing Costs / Number of New Customers.
Lifetime Value/Customer Lifetime Value
Lifetime Value (LTV) (otherwise known as Customer LTV) is the average revenue earned from individual customer relationships, spanning from the moment a customer signs to the moment they churn.
The LTV-to-CAC ratio compares the customer lifetime value (LTV) to the cost of customer acquisition (CAC) in order to better understand the cost of growth. If the LTV:CAC ratio is too low, it’s costing too much to acquire a customer. If it’s too high, not enough is being spent to accelerate growth.
CAC Payback Period
The CAC Payback Period (also known as the Months to Recover CAC) is the amount of time it takes to recover the cost of acquiring a customer.
Average Cost of Service
Average cost of service takes into account the total sum of all the expenses a SaaS company takes on to support customers over a period of time—including customer support, account management and even technical support costs such as hosting and R&D amortization—and then divides it by the number of customers to get the average.
Average Revenue Per Unit
Average revenue per unit (ARPU) measures your average revenue per user (or unit) over a specific amount of time. That allows you to see your growth potential on a per-customer level—something that’s important if you want to model your revenue generation capacities for both the long- and short-terms and identify trends in specific customer segments.
Gross Revenue Retention Rate
Your Gross Revenue Retention Rate (or Gross Renewal Rate) calculates the amount of recurring revenue (expressed as a percentage) that you’ve retained from existing customers during a specified period of time—factoring in cancellations and downgrades, but not expansion revenue.
Since holding onto your existing customers is much easier than acquiring new ones, customer retention is an important way of determining the health of a SaaS business. It refers to the number of customers your company retains over a given period of time and can be calculated by dividing the number of currently active users with the number of active users you had at the start of a specified time period. Watching customer retention closely can help you better understand customer lifetime value and tell you when your marketing or customer strategies may need tweaking.
Customer Satisfaction Score
The Customer Satisfaction Score (CSAT) helps SaaS companies assess how satisfied customers are with a product or service, often measured with a quick survey question, such as “How would you rate your experience with us?”.
What Systems Does SaaS Rely On?
To understand the full picture, SaaS teams need to combine and consider leading and lagging indicators from source systems across the entire company. While many of those aren’t unique to SaaS, some of the core systems this specific industry rely on include the following.
Enterprise Resource Planning System
An Enterprise Resource Planning (ERP) system integrates data from a wide range of business processes to improve day-to-day activities such as project management, accounting and supply chain management, as well as cross-functional collaboration between departments, including finance, sales, marketing, customer success, human resources and so on.
A General Ledger (GL) keeps track of all company transactions and categorizes them into accounts, such as assets, liabilities, income, etc. Financial statements are created from the information in the general ledger.
Customer Relationship Management System
A Customer Relationship Management (CRM) system keeps track of customer and prospect data, such as contact information, sales history and marketing interactions, to create a 360-degree view of the customer.
Human Resource Information System
A human resource information system (HRIS) keeps track of human capital, including employee information, applicant tracking, payroll, benefits administration and so on.
Planning, Forecasting and Reporting for SaaS
If you’re planning, forecasting or reporting for a Software-as-a-Service business, you’ll likely be drawing on data from all of the systems above, to identify growth opportunities and provide insights into the business. An understanding of the following processes will help.
Gross Margin Planning
Gross margin planning involves forecasting revenues and costs to assess the future outlook of revenue retention and funds available for scaling growth.
Determining when revenues are officially earned can be complex for subscription-based businesses, since recurring revenue has the potential to be canceled, upgraded or downgraded throughout the contracted period. Subscription revenue recognition—as outlined in the Generally Accepted Accounting Principle (GAAP)—accounts for this, splitting up revenue based on the performance obligations of the SaaS provider in the following way:
- Deferred Revenue: Revenue is deferred when cash has been received but service obligations have not yet been fulfilled. If you charge $1,200 for a yearly subscription of your SaaS product, for instance, but only receive $100 per month, just that $100 can be recognized as income on a month-to-month basis—even if you’ve been paid upfront.
- Accrued/Unbilled Revenue: Revenue is accrued when service obligations have been fulfilled but services have not been billed for yet. If you charge at the end of the month, for example, that unbilled revenue is considered a receivable or asset until your customer is billed.
ASC 606 is the revenue recognition standard SaaS companies must comply with, developed by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB).
Once you’ve got the lingo down and understand everything that makes it unique, Software-as-a-Service is an exciting, fast-paced place to be (we would know!). And to help them thrive in a competitive business, SaaS companies are ripe for the type of strategic wisdom the best financial professionals bring to the job. We’re confident you’ve got that covered!