Learn B2B SaaS Marketing

Mastering SaaS Quick Ratio: Boost Growth Efficiency and Drive Investments

by 

Lauren O'Bryan

Last updated: September 13th, 2024

For SaaS founders, CFOs, and investors, understanding the financial health of a business is crucial for making informed decisions. The SaaS Quick Ratio will give you exactly that – a quick overview of your business’s health so you can maintain a balance between revenue growth and churn. So, how can you use it to gain a competitive edge?

In this guide, we’ll cover everything you need to know about this vital metric, including how to calculate it, how to use it to assess business growth, and most importantly, how to improve your Quick Ratio.

SaaS Quick Ratio: What Is It and Why It’s Important

The SaaS Quick Ratio is a formula developed by Mamoon Hamid and released at the 2015 SaaStr Conference. The ratio measures a company’s growth and financial viability by calculating the proportion of revenue generated from new and existing customers to the revenue lost through churn.

This helps to understand how churn affects your business’s long-term viability so you can set a threshold for the maximum churn your business can withstand. It also indicates profitability and is therefore helpful for forecasting future revenue and planning budget allocation.

Since its introduction, the SaaS Quick Ratio has become a benchmark for investors and managers when assessing a business’s long-term viability and profitability.

How to Calculate the SaaS Quick Ratio

To calculate the SaaS Quick Ratio, you need to know your business’s revenue and churn rates. You can use either monthly or annual revenue data for this calculation, depending on your payment model. MRR is suitable for businesses with monthly subscriptions, while ARR is better for those with long-term contracts, such as enterprise clients.

The formula is revenue (all income from new customers and plan upgrades) divided by loss (the amount lost from canceled subscriptions and plan downgrades).

SaaS Quick Ratio = (New MRR + Expansion MRR) / (Churn + Contraction MRR)

• New MRR/ARR: Revenue from newly acquired customers.
• Expansion MRR/ARR: Additional revenue from existing customers through upselling.
• Churn: The revenue lost when customers cancel or don’t renew subscriptions.
• Contraction MRR/ARR: Revenue lost due to plan downgrades.

All of these metrics are baseline business data that every SaaS company should track.

Similar Metrics

Other metrics used to evaluate SaaS business performance include the SaaS Magic Number and Rule of 40.

SaaS Magic Number

The SaaS Magic Number measures the efficiency of total spend, or how much revenue is created for every dollar spent on each new customer.

The calculation looks like this:

SaaS Magic Number = (Current Quarter ARR – Previous Quarter ARR) / Previous Quarter CAC

Rule of 40

The Rule of 40 is a benchmark figure for business growth rate and profitability, where the aim is to reach or exceed 40%. Companies that hit this figure generate enough profit to continue growing, while those that don’t are not financially sustainable.

The formula for the Rule of 40 looks like this:

Growth Rate + Profit * 100 = GP ratio

The Gross Profit (GP) ratio is the magic number that should be at least 40%.

SaaS Quick Ratio Benchmark

The Quick Ratio benchmark is uniform across all SaaS niches – a ratio of 1 is bad, 1-4 is ok, and a ratio of 4 or above is excellent.

A ratio of 1 indicates that churn is outpacing profit, and the business will rapidly decline from here. A ratio of between 1 and 4 is not a death knell, but it does indicate improvements are needed in areas like customer acquisition and retention. A ratio of 4 or more indicates a comfortable profit margin with revenue sitting securely higher than customer churn.

Common Pitfalls

The common mistakes people make when calculating the Quick Ratio are not comparing the same timeframe and neglecting to consider other external factors.

You must compare monthly revenue against monthly churn because if you’re looking at figures that are not adjusted for the same timeframe, the results will be skewed. In addition, other factors like seasonality or sudden changes in the economy can sometimes temporarily affect revenue, and these need to be considered as well.

How the SaaS Quick Ratio Can Be Used for Informed Decision-Making

Of course, the SaaS Quick Ratio offers more than just a snapshot of financial viability for investors. Once calculated, it can guide strategic decisions about budget allocation and highlight areas that need improvement.

Identify Trends

The Quick Ratio can help identify trends in revenue growth and churn. Using MRR will highlight the short-term impacts of marketing campaigns or product changes on revenue. Over time, it can also pinpoint seasonal fluctuations and growth patterns, helping managers to prepare for the impacts ahead of time.

Growth and Investment Opportunities

A high quick ratio (above 4) indicates that a business is in a good financial position to invest in growth strategies. It can also be a good time to begin discussions with potential investors, as they will consider a high ratio a strong signal of investment security.

An Early Warning Sign of Trouble Ahead

A low ratio score will indicate one or more problems – poor customer acquisition, high customer churn, and general dissatisfaction. However, it also provides an opportunity for managers and founders to implement strategies that resolve these problems. They can focus on customer success initiatives, identify issues with product-market fit, refine pricing strategies, or even enhance customer targeting tactics.

Limitations of Using the SaaS Quick Ratio

While the SaaS Quick Ratio offers a useful snapshot of profitability and growth potential, it has several limitations that should be considered before using it as the sole basis for strategic decision-making.

• Lack of Efficiency Insights: The SaaS Quick Ratio doesn’t provide information on the efficiency of a company’s operations. Rather, it focuses on revenue growth and retention while overlooking how efficiently a company utilizes its resources.
• Exclusion of Other Financial Indicators: The ratio doesn’t account for other assets or liabilities that contribute to a company’s financial stability. As such, using the SaaS Quick Ratio as an indicator of a company’s overall financial health could be misleading.
• External Market Factors: The Quick Ratio will absorb external factors such as economic downturns, competitive pressures, or shifts in customer preferences, which may distort the perception of company profitability and growth. These external influences must be considered when making assessments using the Quick Ratio.
• Omission of Other Key Business Metrics: Important metrics such as customer acquisition cost (CAC) and customer lifetime value (LTV) are not considered in the Quick Ratio. These metrics are crucial for understanding a company’s broader financial picture and long-term viability.
• Potential for Artificial Inflation: The Quick Ratio can be artificially inflated by short-term promotional tactics or by focusing on lower-value customers who may churn quickly. This can give a misleading picture of growth and lead businesses to prioritize short-term gains over sustainable, long-term strategies.

Given these limitations, it’s important to complement the SaaS Quick Ratio with other metrics and a deeper analysis. A holistic approach will provide a fuller picture of the business’s health and long-term sustainability.

Strategies to Improve Your SaaS Quick Ratio

To improve your SaaS Quick Ratio, focus on actions that increase revenue and value from each customer and decrease the rate of customer churn and dissatisfaction.

Here are some of the best strategies to employ:

Improve Customer Retention

Improving customer retention rates will ensure customers stick around for longer, which leads to reliable recurring revenue and reduced customer churn.

Here’s how you can help customers feel valued and supported:

• Try personalized messaging and email nurture campaigns
• Include a dedicated customer success manager in the onboarding process
• Update customer support documentation and training guides
• Improve product features according to customer feedback
• Employ predictive analysis and churn indicators to proactively engage with at-risk customers

Beyond acquiring new customers, it’s crucial to maximize value from existing ones through expansion revenue.

Allow for Upselling and Cross-selling Opportunities

A tiered pricing model, package upgrades, and add-ons can significantly increase expansion revenue by encouraging customers to invest more in your services.

Some customers will be more hesitant than others to commit to a recurring subscription. But, they may be tempted by a freemium package and then easily convinced to upgrade once they discover the value of your product.

Develop a Customer Referral Program

Customer referral programs are an excellent way to gain new customers without increasing marketing spend. It’s a win-win situation for both existing and new customers. The existing customer receives a referral reward, and the new customer gets a subscription discount. This strategy will not only increase your customer base but also improve customer satisfaction and build on this relationship.

Improve Lead Generation

Improving lead generation overall will attract more high-quality leads who are more likely to convert, so:

• Update buyer personas and customer segmentation criteria
• Develop high-quality content that addresses customer pain points
• Refresh and republish once-popular content for an easy boost in traffic and clicks
• Optimize landing pages and PPC campaigns
• Make use of ad retargeting
• Adapt and share content across channels and in partnership with influential industry leaders

Once you’ve optimized lead generation and customer retention, the only thing left is to evaluate your product. Can it be made even better?

Continuously Improve Your Product and Service

At the end of the day, you’ll attract and keep customers around if you offer a product that fits their needs. Gather and analyze customer feedback to identify and resolve problems they have with your product.

You can also utilize data analytics to identify trends and issues that cannot be detected in direct customer feedback. This will help you provide excellent product-market fit in the ever-evolving SaaS market.

Wrapping Up

Understanding and leveraging the SaaS Quick Ratio allows you to quickly and easily evaluate revenue against churn, helping you make smart strategic decisions. While the SaaS Quick Ratio offers valuable insights, keep its limitations and the common mistakes people make when calculating it in mind.

When planning to grow your SaaS, the Quick Ratio will tell you whether you meet or exceed financial viability benchmarks. Another good starting point is to take our SaaS Scalability Score self-assessment. It measures how effectively your business attracts, engages, and converts leads – all essential elements for scaling a SaaS.