What is SaaS Quick Ratio?
SaaS quick ratio is a metric that assesses a company’s ability to grow its recurring revenue despite the churn incurred. Essentially, the ratio compares the company’s revenue inflows (new and expansion MRR) and its revenue outflows (churned MRR and contraction MRR) to show net revenue growth. SaaS quick ratio is widely regarded as an indicator of the efficiency of a company’s growth.
Understanding SaaS Quick Ratio
The metric can be confusing for people acquainted with some finance metrics. SaaS quick ratio and finance quick ratio (acid test ratio) are two different metrics that share a common name. Recall that, in finance, the quick ratio is a metric that evaluates a company’s ability to meet its short-term liabilities.
On the other hand, SaaS quick ratio is not related to the company’s liquidity position, as the metric is only concerned with its growth. However, both quick ratios provide investors with snapshots of the risk associated with a company.
Nowadays, SaaS quick ratio is gaining more recognition among industry professionals and investors. Many investors require companies to provide their estimates of a quick ratio. By analyzing a company’s quick ratio, investors can evaluate its growth prospects and the sustainability of the growth.
The quick ratio provides a better picture of the company’s growth prospects than other metrics such as MRR because it considers both positive and negative sides of the company’s growth.
How to Calculate SaaS Quick Ratio?
SaaS quick ratio compiles the company’s revenue inflows with its revenue outflows. The metric can be calculated using the following formula:
- New MRR – The monthly recurring revenue (MRR) from new customers
- Expansion MRR – The monthly recurring revenue (MRR) from existing customers (e.g., upgrades)
- Churn MRR – The monthly recurring revenue (MRR) lost due to the subscription cancellations
- Contraction MRR – The monthly recurring revenue (MRR) lost from existing customers (e.g., downgrades)
Why is SaaS Quick Ratio Important?
SaaS quick ratio is probably the most important metric that indicates a company’s growth efficiency. This is because it considers both additions to the revenue from new and existing customers and lost revenue from churned and existing customers.
A low quick ratio generally signals that a company faces problems with sustaining revenue growth. Instead of driving the business forward, the company’s additional revenue restores the revenue lost due to customer churns or downgrades.
On the other hand, a high quick ratio indicates high and steady growth in the company’s revenue. Simply speaking, if a company reports a high quick ratio, its additional revenue not only covers any lost revenue but also indicates revenue growth.
Generally, a quick ratio that exceeds 4 (a company earns additional revenue four times faster than it loses its revenue) is considered an indicator of a healthy business that manages to sustain high growth rates.
Although a quick ratio of 4 is already considered an industry-accepted standard, there are still debates about the accuracy of the benchmark. It is worth noting that every company’s situation is unique. Thus, the benchmark must not be used without a complete understanding of the business context.
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