SaaS Talk™ with the Metrics Brothers: Episode Summary – SaaS Quick Ratio
Podcast Information:
- Title: SaaS Talk™ with the Metrics Brothers - Strategies, Insights, & Metrics for B2B SaaS Executive Leaders
- Hosts: Ray "Growth" Rike & Dave "CAC" Kellogg
- Episode: SaaS Quick Ratio
- Release Date: December 31, 2024
Introduction to the Metrics Brothers
In this episode of SaaS Talk™ with the Metrics Brothers, hosts Ray Rike and Dave Kellogg delve into the intricacies of the SaaS Quick Ratio, a key metric for assessing the health and growth efficiency of B2B SaaS companies. Known for their incisive analysis, Ray and Dave aim to unpack the SaaS Quick Ratio, evaluate its practicality, and discuss its relevance in today's SaaS landscape.
Notable Quote:
Ray Rike [00:31]: "And we go together like ebbs and flows."
Dave Kellogg [00:34]: "Are flows, ebbs are when it's going out and flows are when it's coming in."
Understanding the SaaS Quick Ratio
Definition and Calculation: The SaaS Quick Ratio is designed to measure the efficiency of a SaaS company's growth by comparing new Annual Recurring Revenue (ARR) growth to existing ARR contraction. Specifically, it is calculated as:
[ \text{SaaS Quick Ratio} = \frac{\text{New ARR + Expansion ARR}}{\text{Churned ARR + Downsell ARR}} ]
Ray and Dave break down the components:
-
Numerator:
- New Logo ARR: Revenue from new customers.
- Expansion ARR: Additional revenue from existing customers through upsells or cross-sells.
-
Denominator:
- Churned ARR: Revenue lost from customers who have canceled.
- Downsell ARR: Revenue lost from existing customers who have reduced their subscriptions.
Notable Quote:
Ray Rike [04:34]: "The SAS Quick Ratio... measures new ARR growth to versus existing AR contraction."
Historical Context and Origins
The metric was first introduced by Mamoon Hamid at SASTER events in 2015 and revisited in 2017, highlighting its foundational role in SaaS financial analysis. Despite its age, the SaaS Quick Ratio hasn't achieved widespread mainstream adoption, prompting Ray and Dave to investigate its enduring relevance.
Notable Quote:
Ray Rike [03:08]: "The sasquic ratio was first mentioned or used at a Saster event in 2015 by Mamoon Hamid..."
Benchmarking and What Constitutes a Good Ratio
One of the critical discussions centers around identifying what constitutes a "good" SaaS Quick Ratio. Based on research and authoritative voices like Mamoon Hamid and Ben Murray, benchmarks are established:
- Less than 1: Unsustainable, indicating that churn exceeds new ARR growth.
- 1 to 4: Shows growth but lacks optimal efficiency.
- 4 and above: Considered healthy, signifying robust ARR growth relative to churn.
Ben Murray, the SaaS CFO, supports a benchmark of 1:4, emphasizing that ratios below this threshold are problematic, while ratios significantly above indicate strong growth dynamics.
Notable Quote:
Dave Kellogg [08:34]: "The answer is, I think there's one answer, four."
Practical Implications and Growth Modeling
Ray models scenarios illustrating how different SaaS Quick Ratios impact a company's growth rates. For instance:
- SaaS Quick Ratio of 2.0: Results in a 12% growth rate.
- SaaS Quick Ratio of 4.0: Yields a substantial 33% growth rate.
This modeling underscores the non-linear relationship between the Quick Ratio and growth, highlighting its significance in strategic planning.
Notable Quote:
Ray Rike [08:27]: "...a 2.0 SaaS quick ratio... had a 12% growth rate... whereas a 4.0 ratio led to a 33% growth rate."
Debating the Metric’s Usefulness
Despite its theoretical appeal, Dave Kellogg expresses skepticism about the SaaS Quick Ratio's practicality:
- Unpopularity: It remains an "old, unpopular metric" with limited adoption among investors and VCs.
- Complexity vs. Insight: While it provides a high-level view of growth efficiency, Ray and Dave argue that more granular metrics (e.g., Net Revenue Retention, New ARR, Gross Revenue Retention) offer deeper insights.
- Efficiency Debate: Although the ratio represents "steps forward per step back," it fails to account for the cost associated with acquiring new ARR, limiting its usefulness as a standalone efficiency metric.
Notable Quotes:
Dave Kellogg [12:00]: "This is not a new metric... it's an old unpopular metric... there are better ways to measure what it's aiming at."
Dave Kellogg [10:55]: "If your CAC ratio is a half... if your CAC ratio is two... so you can kind of get why Tungas and others call it an efficiency metric..."
Alternative Metrics and Best Practices
The hosts advocate for alternative metrics that provide clearer, more actionable insights:
- Net New ARR: Calculated by adding new and expansion ARR and subtracting churn and downsell ARR.
- Gross Revenue Retention (GRR): Measures the percentage of ARR retained from existing customers, excluding expansion.
- New Logo ARR: Focuses solely on revenue from new customers, offering a clear view of acquisition efficiency.
Ray emphasizes the importance of segmenting these metrics by customer type, product, or other relevant dimensions to pinpoint specific areas needing attention.
Notable Quote:
Dave Kellogg [17:06]: "Net new ARR and other clawing... gross revenue retention is pretty high relative to new ARR..."
Conclusion: Rethinking the SaaS Quick Ratio
Ray and Dave conclude that while the SaaS Quick Ratio can serve as a high-level indicator of ARR growth efficiency, it doesn't provide the nuanced insights necessary for effective strategic decision-making. They recommend relying on a combination of more detailed metrics to understand and address the underlying factors affecting growth and retention.
Notable Quote:
Ray Rike [20:39]: "It helped me understand why most of my customers don't use the sasquik ratio... it's really not an efficiency metric."
Dave Kellogg [21:51]: "It's good to have the toolbox. It's good not to have a blank look on your face..."
Key Takeaways
- SaaS Quick Ratio offers a high-level view of ARR growth efficiency but lacks the depth provided by other metrics.
- Benchmarking: A ratio above 4.0 is generally healthy, while below 1.0 is unsustainable.
- Alternative Metrics like Net New ARR and Gross Revenue Retention provide more actionable insights.
- Segmentation of metrics is crucial for diagnosing specific growth or retention issues.
- Practical Use: Operators may find more value in a suite of metrics rather than relying solely on the SaaS Quick Ratio.
Final Thoughts: While the SaaS Quick Ratio provides a snapshot of a company's growth dynamics, Ray Rike and Dave Kellogg advocate for a more comprehensive approach using multiple, segmented metrics to gain a clearer understanding of a SaaS company's health and growth trajectory. This nuanced approach ensures that leaders can identify and address specific areas of strength and concern, fostering sustainable and strategic growth.