Understanding SaaS finance terminologies is important for a company’s success. They let you measure how well your SaaS business is earning profit and give you in-depth insights to create a robust SaaS strategy. Below are the SAAS finance terminologies that every newbie must know.
1. ARR and MRR
ARR is Annual Recurring Revenue. It is a vital SaaS business term that signifies how much recurring income you can expect, depending on your yearly subscription. This gives an in-depth overview of your business health and the rate you need to grow to get the desired success.
In simple terms, ARR = recurring monthly revenue*12
The way to calculate ARR will depend on plenty of factors, such as the complexity of the SaaS business model and the current pricing strategy. ARR is a great way to measure and predict relationship changes, as shown by the renewals, upgrades, lost customers, or downgrades.
MRR (Monthly Recurring Revenue) is also a vital financial metric that also gives you valuable insight into the health of your SaaS business. MRR is the sales you are adding and subtracting every month. In simple terms, we can say that MRR shows you how your company grows on a monthly basis.
Since you are charging your customers on a subscription model, it is vital to track the money you get each month as revenue KPI. This is an excellent way to measure the immediate effects of changes to your product or pricing strategy and then strategize ways to boost that number.
MRR (Monthly Recurring Revenue) = total monthly revenue – non-recurring revenue
Marketing at the wrong platforms can ruin the profit margins quickly. The only way to prevent this to track Cost Per Acquisition (CPA). It means this important SaaS term will let you understand if you have a positive ROI or not. CPA measures the sales and marketing costs required to onboard or get a new customer.
CPA = total marketing expenditure + total sales expenditure / new monthly customers
This will give you the total expenses you spent on every newbie customer. If you are spending more money to get customers than you get, you have a big problem. Remember, if your Customer Lifetime Value (LTV) is more than CPA, you are in the right direction.
ARPU is Average Revenue Per User. It is the amount of money a single customer generates for a SaaS company. It is a vital SaaS financial metric because it let you find the best ways to cross-sell and upsell prevailing customers.
An upsell shifts the customers to a more costly version of your product. On the other hand, cross-sells are the additional features you sell with your products. ARPU is calculated by dividing the total business revenue in a given time by the average number of customers in that same period.
ARPU = Total monthly revenue / total monthly customers
Once you understand this term, you can strategize diverse ways to boost that average and set KPI goals.
Customer Lifetime Value (LTV) is another top financial SaaS metric. It let you understand the long-term success of your SaaS business by allowing you to predict your sales, set budgets, and plan a multi-year basis.
LTV is an average gross revenue that the customers will earn before they churn (cancel). It means total company income minus expenses for a single customer. Although there are tons of ways to calculate LTV, you can use the simple formula:
LTV = Average Monthly Revenue Per User * Average Subscription Length
It will give you the expected earnings you should mint from every user. After that, you can multiply it by the recurring customers that you possess to find out how much amount you will make over the lifespan of your business. When you have LTV of diverse customer groups, you will know the important target area to focus on growing your business fast.
5. Churn Rate
Churn is an important element for the success of a SaaS company and is like the hole in your customer retention bucket. It is also a vital parameter in the income forecasting of a business. CR is closely associated with the monthly recurring revenue and, therefore, should be calculated and analysed together.
Churn rate is the rate at which your SaaS customers are canceling their recurring revenue subscriptions. It is typically measured on a monthly basis. Being able to spot weak points in your business allows you to make the best improvements.
Churn rate = the total number of customers at the beginning of the particular time period – customers at the end of that period divided by customers at the end of the particular time period.
Remember, it is impossible to reduce Churn rate to zero. It is because there will always be customers that try your services or products for some time and then stop using. If you have high CR for your SaaS business, it signifies that there is something wrong with your product. Thus, make sure you maintain your CR below 10%.
6. Burn Rate
Burn rate is an essential SaaS finance term that tells how much money a SAAS company is losing over a given time. In simple terms, this important metric determines how much time the provider will take to keep running before being able to have positive cash flows.
For example: if your SaaS business has a burn rate of $770,000, it signifies that your company would be spending $770,000 per month.
Tracking BR lets you monitor the financial health of your SAAS business and spot any sudden changes that might block continuing operation. Managing it needs a balanced approach to risk. There are two kinds of burn rate. Both of them are quite simple to understand.
a) Gross Burn Rate
The gross burn rate is the total expenditure of a company during a given period.
b) Net Burn Rate
The net burn rate means when a company is over-spending than it earns. It means it is the difference between cash out and cash in. It is calculated as the revenue of a company minus its total expenses.
7. Deferred Revenue
Any SaaS company should implement deferred revenue as a part of its accounting program. It not just makes life easier, but also allows easy business planning. In simple terms, we can say that deferred revenue lets you better understand your real monthly revenue and monthly recurring revenue.
Deferred revenue is also known as unearned revenue. It is the payment collected from customers for future products or services. For example, if your customer pays $6000 for a one-year subscription. You divide it up evenly among twelve months – $500 per month.
The seller records the payment on the balance sheet as a liability.
In the case of long-term subscriptions, the company invoice a customer. Since deferred revenue is included in a balance sheet item, it is calculated at a given point in time.
An essential thing to note is the price to service the deferred revenue. Since you have already got upfront payments for future services, you need to have future cash outflow with no extra cash inflow. Also, make sure you should not invest this unearned cash in your future projects until it is earned.
8. Renewal Bookings and Renewal Rate
A booking is when the customer agrees to take your products and services. Renewal bookings are the bookings from existing contracts. It is calculated at the time of the renewal date but might be taken as of the date of the renewal order of a customer.
Renewal rate is another term used for customer retention in SaaS business. It is a rate of customer renewal. It is always expressed as a percentage.
TCV (Total Contract Value) is one of the beneficial metrics to discover in SaaS. It is different from that of the total invoice amount over the contract. TCV means the total worth of a customer contract after it’s been executed.
It includes recurring income and fees (professional service fees, onboarding fees, and other) TCV offers a clear picture of how much your SaaS business can expect to mint from each customer once they’ve signed the contract.
Offering your customers all the SaaS resources and tools they require to use your software is an excellent way to ensure that they engage and turn into long–term customers. One of the great ways to ensure the success of customers is with a comprehensive onboarding system. It is one of the most vital touchpoints for the SaaS business.