What is the SaaS Quick Ratio?
The SaaS Quick Ratio is a financial efficiency metric that aims to assess how well a SaaS business is retaining customers and revenue compared to generating new revenue. Put another way, it measures the monthly net inflow or net outflow of Monthly Recurring Revenue (MRR). For those accounting and finance professionals, it’s important to note the SaaS Quick Ratio is not the same as a balance sheet quick ratio used to measure a business’s liquidity.
In this post, we’ll explain why the SaaS Quick Ratio is an essential SaaS metric, how to calculate the metric with two examples, and we will finish by answering frequently asked questions.
Why the SaaS Quick Ratio is Important
The SaaS Quick Ratio metric is a valuable metric and benchmark to measure revenue growth from new MRR and Expansion MRR compared to Downgrade and Churn MRR. The ratio gives a useful snapshot of how well a SaaS business grows revenue and retains existing customers. Three ranges provide insights into revenue growth:
- Low Quick Ratio (Under 1): Growth is not keeping pace with high churn and downgrades. For every incremental $1 of revenue generated, the SaaS company is losing more than $1. Immediate business changes are necessary to avert a SaaS business failure.
- Intermediate Quick Ratio (Between 1 and 4): Growth is present but potentially unsustainable.
- High Quick Ratio (Over 4): Indicates a robust startup. For every $1 lost, $4 in incremental revenue is acquired.
How to Calculate the SaaS Quick Ratio
To calculate the SaaS Quick Ratio, divide the total revenue growth (New MRR and Expansion MRR) by the total revenue losses (Downgrade MRR and Churn MRR). MRR represents the predictable recurring revenue earned from subscriptions in a specific month. MRR multiplied by 12 gives the Annual Recurring Revenue (ARR), which can be used rather than MRR.
New MRR: refers to the revenue generated from new customers acquired during a month.
Expansion MRR: represents the additional MRR obtained from customers who upgraded to a higher pricing plan or purchased a recurring add-on. This includes the contribution of MRR from the reactivation of previously canceled subscriptions and free-to-paid conversions.
Churned MRR (or Cancellation MRR): reflects the MRR lost due to canceled or churned subscriptions.
Contraction MRR encompasses the MRR lost due to cancellations, downgrades to lower-priced plans, removal of recurring add-ons, or available discounts.
SaaS Quick Ratio Examples
Example #1
Suppose a SaaS company reached $600,000 in New MRR and $300,000 in Expansion MRR from successful upselling and cross-selling efforts – totaling $900,000.
New MRR: $600,000
Expansion MRR: $300,000
During the same period, the SaaS company experienced $150,000 in Churned MRR due to lost customers and $75,000 in Contraction MRR – totaling $225,000.
Churned MRR: $150,000
Contraction MRR: $75,000
Using the numbers above, we can easily calculate the SaaS Quick Ratio:
= ($600,000 + $300,000)/($150,000+$75,000)
= 4.0
In this example, its clear this SaaS business is in a reasonably healthy place with respect to how much incremental MRR it generates compared to how much existing revenue is churned and contracted. For every $4 of incremental revenue generated, they only lose $1 of revenue from existing customers.
Example #2
Suppose a SaaS company earned the same incremental MRR as in Example #2: $600,000 in New MRR, $300,000 in Expansion MRR – totaling $900,000.
New MRR: $600,000
Expansion MRR: $300,000
During the same period, the SaaS company experienced $250,000 in Churned MRR due to lost customers and $50,000 in Contraction MRR – totaling $300,000.
Churned MRR: $250,000
Contraction MRR: $50,000
Using the numbers above, the resulting SaaS Quick Ratio is:
= ($600,000 + $300,000)/($250,000+$50,000)
= 3.0
In this example, for every $3 of incremental MRR generated, they lose $1 of revenue from existing customers. While this number isn’t good or necessarily bad, determining how this number has trended will identify whether the SaaS business or investors should be worried. For example, if the SaaS Quick Ratio has improved month-over-month for the past two quarters, the SaaS business is clearly getting back on track. Alternatively, suppose the Ratio has slowly been degrading from greater than 4 and now sits at 3. In that case, immediate action is needed to either increase incremental MRR, reduce MRR Churn and Downgrades, or both.
Example #3
Suppose a SaaS company earned the same incremental MRR as in Example #1 and #2: $600,000 in New MRR, $300,000 in Expansion MRR – totaling $900,000.
New MRR: $600,000
Expansion MRR: $300,000
During the same period, the SaaS company experienced $400,000 in Churned MRR due to lost customers and $200,000 in Contraction MRR – totaling $600,000.
Churned MRR: $400,000
Contraction MRR: $200,000
Using the numbers above, the resulting SaaS Quick Ratio is:
= ($600,000 + $300,000)/($400,000+200,000)
= 1.50
In this example, for every $1.50 of incremental MRR generated, they lost $1 of revenue from existing customers. This number indicates that while they are at least generating enough incremental revenue to cover 1.5x the amount of revenue lost from existing customers, they have a serious customer retention problem. The SaaS business will need to understand the fundamental reasons why customers are leaving or downgrading their accounts and work to find ways to bridge these gaps.
Conclusion
Among other key metrics an SaaS accountant will want to track, the SaaS Quick Ratio holds valuable insights into how well a business attracts and retains customers. It can be easy to spend an unbalanced amount of time acquiring new clients and incremental MRR, and not focus on retaining or increasing MRR from existing customers. The Quick Ratio will quickly point out and flag if a SasS business needs to spend more time and resources keeping existing customers, or if it has room to spend more effort increasing incremental MRR.
Frequently Asked Questions (FAQs)
What is a Good SaaS Quick Ratio?
In the SaaS industry, a Quick Ratio exceeding 4 indicates a healthy position, which means it generated $4 in incremental MRR for every $1 of lost MRR. To drive business growth, it is crucial to address churn or downgrade rates and drive new customer growth. By focusing on reducing churn and maximizing revenue, a SaaS company can pave the way for its sustainable success.
What is the Average SaaS Quick Ratio?
The SaaS Quick Ratio is a vital SaaS metric that assesses the balance between cash inflows related to Monthly Recurring Revenue (MRR) or Annual Recurring Revenue (ARR) to MRR or ARR Churn and Contraction. SaaS businesses will have different Quick Ratios depending on their lifecycle. However, a ratio greater than 4 is considered healthy.
How Do You Calculate Quick Ratio in SaaS?
To calculate the SaaS Quick Ratio, divide the combined growth in total revenue ( New MRR and Expansion MRR) by the total decrease in revenue (Churn MRR and Contraction MRR). The formula is as follows:
SaaS Quick Ratio = (New MRR + Expansion MRR) / (Churned MRR + Contraction MRR).
What is the 40 rule of SaaS?
The Rule of 40 is a principle that SaaS businesses should aim for a combined revenue growth rate and profit margin of at least 40%. SaaS companies that exceed this threshold showcase sustainable profit generation, while those that fall below may face challenges related to cash flow or liquidity.
More articles you might find useful:
Calculate Monthly Recurring Revenue
Increase Your Revenue Per Account
A Guide to SaaS Revenue Recognition
