SaaS quick ratio: How to measure growth efficiency

In SaaS, growth is king. But is your SaaS company’s growth sustainable?

The SaaS quick ratio offers a window into the sustainability of your company’s growth. By measuring how effectively your business balances new revenue and customer retention, this metric helps you understand the overall efficiency of your revenue engine.

In this article, we’ll explore how the quick ratio can guide you toward smarter growth strategies and long-term success.

You'll learn:

• What the SaaS quick ratio is and its importance
• How to calculate and interpret your quick ratio
• Factors influencing your quick ratio and tips for improvement
• The impact of usage-based billing on your quick ratio
• How Orb can help you optimize your quick ratio for sustainable growth

Let’s get started by explaining the SaaS quick ratio as well as its components.

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What is the SaaS quick ratio?

The SaaS quick ratio is a metric that evaluates if a company can grow its recurring revenue sustainably, even in the face of customer churn. Think of it as a litmus test for growth efficiency. It’s a way to gauge whether a company's revenue engine is truly firing on all cylinders, or if it's merely treading water.

At its core, the quick ratio is a simple yet powerful calculation. It compares a company's revenue inflows (new subscriptions and upgrades from existing customers) to its revenue outflows (lost revenue from cancellations and downgrades).

A high quick ratio signals that a company is adding new revenue at a faster pace than it's losing it. In other words, the SaaS quick ratio is a clear indicator of healthy and sustainable growth.

Let's break down the components of this equation:

• New MRR: This component represents the monthly recurring revenue generated from new customers. It's a testament to the effectiveness of a company's sales efforts in attracting and onboarding fresh subscribers.
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• Expansion MRR: This is the extra monthly recurring revenue earned from existing customers. It usually comes from upsells and cross-sells. It shows a company's ability to deepen its relationship with its customer base and get more value from them over time.
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• Churned MRR: This is the monthly recurring revenue lost due to customer cancellations. It's an unavoidable reality in SaaS. A high churn rate can be a red flag for underlying problems with product-market fit, customer satisfaction, or pricing strategy.
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• Contraction MRR: This refers to the decrease in monthly recurring revenue from existing customers. This revenue dip is usually due to downgrades or a reduction in the number of seats. While not as alarming as churn, it still represents a loss of revenue and can show a need to improve customer retention efforts.

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Why does the SaaS quick ratio matter to SaaS businesses?

While building a SaaS product, it can be easy to fall into the trap of chasing vanity metrics. The SaaS quick ratio, however, cuts through the noise and provides a clear-eyed view of a company's true growth efficiency.

It acts as a financial health check. It reveals if the top-line growth figures are masking underlying churn issues or if the business is genuinely thriving.

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Why is the SaaS quick ratio so important for scaling businesses?

For scaling businesses, the SaaS quick ratio is particularly crucial. As a company grows, so do its customer base and revenue streams. This expansion also brings new challenges, such as increased churn and a more complex customer landscape.

The SaaS quick ratio serves as a vital compass. It helps businesses navigate these challenges and make sure that their growth is both rapid and sustainable.

It helps companies spot potential weaknesses in their customer acquisition or retention strategies. As a consequence, businesses can make better decisions to address issues before they turn into major problems.

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How does the SaaS quick ratio affect SaaS business strategies?

The SaaS quick ratio plays a critical role in shaping a company's strategic direction.

A healthy quick ratio signals to investors, stakeholders, and the company itself that the business model is sound. It also shows that customer acquisition and retention strategies are effective. In other words, a good quick ratio means the company is primed for long-term success.

It can also influence decisions related to pricing, product development, and marketing investments. With this in mind, it’s clear to see how the SaaS quick ratio goes beyond just a measure of growth efficiency.

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How to calculate the SaaS quick ratio

Calculating the SaaS quick ratio is refreshingly straightforward. It's all about comparing your MRR gains to your MRR losses. Let's break down the formula:

SaaS quick ratio = (new MRR + expansion MRR) / (churned MRR + contraction MRR)

Now that we’ve shared the formula, here’s a quick summary of the components we explained before:

• New MRR: This is the fresh revenue stream coming in from newly acquired customers each month
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• Expansion MRR: This is the extra revenue generated from your existing customers.
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• Churned MRR: This represents the revenue lost due to cancellations.
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• Contraction MRR: This is the revenue dip caused by existing customers.

Essentially, you're stacking up all the positive revenue movements against the negative ones. The resulting ratio gives you a snapshot of your growth efficiency.

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What’s a good quick ratio?

Generally, a quick ratio above 3 is seen as a sign of a healthy, thriving SaaS business. To put it simply, you're bringing in $3 of new or expanded revenue for every $1 lost due to churn or contraction.

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Is a high quick ratio good?

Yes, a high quick ratio is generally a very positive sign. It suggests that your customer acquisition and retention strategies are on point, and your business is on a solid growth trajectory.

However, it's important to remember that context is key. A sky-high quick ratio might also indicate that you're not reinvesting enough back into the business for further growth.

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Factors that affect your SaaS quick ratio

Your SaaS quick ratio is a dynamic indicator influenced by several key factors within your business. Let’s take a closer look at each of those factors:

• Customer acquisition: The rate at which you acquire new customers directly impacts your new MRR. A strong sales and marketing engine translates to a higher influx of new subscribers and a healthier quick ratio.
  
  Tip: Invest in targeted marketing campaigns. Refine your sales process and offer compelling incentives to attract new customers.
• Customer expansion: Upselling and cross-selling to your existing customers contribute to expansion MRR. The more successful you are at expanding your accounts, the higher your quick ratio will climb.
  
  Tip: Find opportunities to provide more value to your customers through premium features and add-ons.
• Customer churn: The rate at which customers cancel their subscriptions affects your churned MRR. High churn can drag down your quick ratio, signaling issues with your product, pricing, or customer satisfaction.
  
  Tip: Proactively engage with your customers. Be ready to gather feedback and address any pain points to reduce churn and improve retention.
• Customer downgrades: When customers opt for lower-priced plans or reduce their usage, it leads to contraction MRR. Customer downgrades negatively impact your quick ratio, showing a need to boost customer value and loyalty.
  
  Tip: Focus on delivering exceptional customer service. Show the value of your product and offer flexible pricing options to prevent downgrades.
• Pricing strategy: Your pricing model can influence all four components of the SaaS quick ratio. A pricing strategy that aligns with customer value and encourages upgrades can boost your quick ratio.
  
  Tip: Regularly evaluate your pricing structure. You can experiment with different tiers and packages and make sure your pricing reflects the value you provide.
• Product-market fit: The degree to which your product meets the needs of your target market directly impacts customer acquisition, expansion, churn, and contraction. A strong product-market fit is essential for a healthy quick ratio.
  
  Tip: Conduct thorough market research and get user feedback. Doing so will let you iterate on your product to ensure it remains relevant and valuable.

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Impact of usage-based billing on your SaaS quick ratio

Subscription models can sometimes act as a barrier to customer acquisition and expansion.

This is where usage-based billing enters the scene. It offers a dynamic and adaptable approach that can positively impact your SaaS quick ratio.

Usage-based billing can be a gateway to greater flexibility for your customers. Instead of being locked into rigid plans, they pay based on their actual usage of your product or service.

Implementing usage-based billing also makes your offering more attractive to a wider range of customers while also opening doors for increased revenue generation.

How does this translate to a better SaaS quick ratio? Let’s take a closer look:

• Lower barrier to entry: Usage-based billing can attract customers who may be hesitant to commit to a full subscription upfront. This lowering of the barrier to entry can lead to an increase in new MRR as more customers sign up to try your product with less of an upfront financial investment.
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• Increased expansion potential: With usage-based billing, customers are incentivized to use your product more, as they only pay for what they consume. The effect of this incentive can drive organic expansion MRR. Why? Customers will likely scale their usage and unlock higher value tiers.
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• Reduced churn: Customers who experience fluctuations in their usage needs are less likely to churn if they have the option to scale their subscriptions up or down accordingly. Of course, this reduction of churn helps minimize churned MRR and maintain a healthy customer base.
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Usage-based billing also lets you tailor your pricing models to different customer segments. This adaptability can contribute to a higher expansion MRR and a lower contraction MRR, ultimately boosting your quick ratio.

Remember: If you have any questions about billing for your SaaS or need assistance in setting up a usage-based billing system,contact Orb today.