Why the Quick Ratio is a Crucial SaaS Metric

Most SaaS companies look at growth rate as their compass metric, and have laser-focus on keeping this as high as possible in order to grow their company.

But looking at just growth can disguise high churn rates. If you’ve got high customer acquisition, it can inflate your growth rate and make it look like you are on track for success. In reality, you could be losing revenue and customers through fundamental problems in your business mode, and missing it completely if you’re only looking at your headline growth rate.

This is why SaaS entrepreneurs and investors have started using the Quick Ratio to understand the growth of a company. Quick Ratio shows the ratio of your revenue gains to your revenue losses, so you can see immediately if your company has both significant growth and low churn. It packages all of the important information about your company into one number.

Tracking your Quick Ratio will help you understand your own company better by considering both the effectiveness of your customer acquisition and your retention efforts. In a single ratio, you can see how your sales, marketing, product, and customer success teams are doing, before deep-diving into the number and analyzing exactly where you’re succeeding and where you need to pick up the pace.

Here is how you can compute a Quick Ratio for your company, how you can use it to understand your growth better, and ultimately drive your SaaS business forward.

Cracking the Quick Ratio Code

What is the Quick Ratio?

The Quick Ratio originates in accounting, and is a company’s current assets over its current liabilities. Quick here means how fast a company can liquidate those assets to cover the liabilities. A company needs a quick ratio of greater than 1 to show that it can extinguish all of its liabilities with its available assets.

In SaaS, quick can mean two things: finding out at a glance how your company is growing, and growing your company quickly. The Quick Ratio, devised by investor and co-founder of Social Capital Mamoon Hamid, gives investors, founders, and team members an immediate view of a SaaS company’s growth efficiency.

There are four numbers that go into calculating your SaaS Quick Ratio:

  • New MRR—how much new revenue you’ve added in your time window.
  • Expansion MRR—the amount of existing revenue that has expanded, through upsells or upgrades, in your time window.
  • Churned MRR—revenue lost from customers abandoning your product in your time window.
  • Contraction MRR—revenue lost from downgrading customers in your time window.

The first two of those numbers define your revenue growth. The second pair are all about your revenue churn. Therefore, your Quick Ratio is essentially taking the two most important metrics for your SaaS company and mashing them together in an easy to understand ratio—growth over churn.

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Whereas in finance, a company only needs to have a Quick Ratio of over 1 to operate successfully, in SaaS, this number needs to be a lot higher. Here is a rough rule of thumb to go by:

  • Quick Ratio < 1: You’re dead. You could sustain a Quick Ratio of less than 1 for a month or two if you already have a good customer base, but anything longer and your churn is going to kill your company.
  • 1 < Quick Ratio < 4: You’re growing, and the growth might look good, but you are making it more difficult for yourself as you have to constantly keep up high levels of customer acquisition to replace lost revenues. You will grow, but slowly, and less efficiently.
  • Quick Ratio > 4: You’re growing at a good rate, and doing it efficiently. Hamid won’t invest in a SaaS company with a Quick Ratio below 4. This means that a SaaS company has to be adding $4 of revenue for every $1 it’s losing for investors to even start looking favorably upon it.

Efficiency is the key to the Quick Ratio. Customer acquisition is costly, whether it’s through a sales team or self-service. You are paying for each and every customer, and when you have a low Quick Ratio it means you are paying more for your growth through eventual loss of that revenue. If you can increase your Quick Ratio, you can grow and get your business to the right place quicker.

For more on benchmarking the Quick Ratio, check out this post or our 2016 SaaS Benchmarks.

How The Quick Ratio Works

But what do Quick Ratios actually look like for SaaS companies, and how do they change over time? Here is a 2 year growth chart for a fictional SaaS company.

2 Year Revenue Increase

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This is a company seeing considerable growth in its first 2 years—a prime example of a company that would be a great fit for a VC.

In blue is the recurring revenue carried over from the previous month. In red is the Net New MRR—how much net revenue you’re adding each month. This is the engine of SaaS. Net New MRR is made up of the magical numbers you need to plug into your Quick Ratio: New MRR, Expansion MRR, Cancelled MRR, and Contraction MRR.

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Breaking down the red bar from the most recent month for our SaaS company above, we can visualize how these numbers combine to create the Net New MRR:

Net New MRR Breakdown

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Using these 4 numbers you can either compute your net new MRR:

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Or you can take these 4 numbers and calculate your Quick Ratio. For that final month charted the Quick Ratio is 4.06, just creeping over Hamid’s standard:

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Why The Quick Ratio is So Powerful

So why, beyond if you’re looking for investment, should you care about your Quick Ratio? You already know your growth rate, and that should be the best indicator of your growth. But as your growth rate is a combination of your MRR gain and loss, it can mask these underlying numbers and how they relate to each other.

Say you have a SaaS company which goes from $10,000 to $12,000 in one month—a 20% growth rate. Really nice. Too many people would be happy to look at that number, think they’re crushing it, and move on. But the underlying numbers can tell a different story

Let’s look at 3 different ways you can get to that 20% growth and additional $2,000.

20% Growth With Different Quick Ratios

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  • Quick Ratio = Infinity—Firstly you could gain $2,000 without any churn. Then you are really crushing it. This would give you a Quick Ratio of infinity, which isn’t really helpful, but it could be realistic in the first few months of your SaaS growth when you are acquiring, but not losing, revenue.
  • Quick Ratio = 2—Here, you’re gaining $4,000 in expansion or new MRR, but at the same time losing $2,000 from churn and downgrades. Customer acquisition is strong, but your customer retention is losing the company money at the same time. While you have strong growth overall, this churn problem is going to become more and more of an issue with time.
  • Quick Ratio = 5—Here you are gaining $2,500 in extra revenue this month, less than with the Quick Ratio of 2, but, importantly, you’re losing far less. Instead of losing $2,000, you’re only losing $500.

Ultimately, you’re adding the same revenue in each of these scenarios, and growing at the same rate. However, by looking at the Quick Ratio, you can see easily whether this growth is sustainable. Sustainability allows you to continue adding revenue, but with the knowledge that you aren’t losing it at the same time. This means you can be confident to try the more expensive acquisition channels that are needed towards the later stages of growth, and aren’t constantly chasing revenue to stand still.

How Quick Ratio Changes Over Time

But the Quick Ratio isn’t stable. For each month (or each unit in your time frame—month, quarter, year) it will vary as you increase MRR through new customers and expansion, but also lose revenue from churn and downgrades.

If we breakdown the net new MRR for each month from the chart above we can see how each of these important metrics change in different stages of the company’s growth.

20% Growth With Different Quick Ratios

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  • Stage 1—Pure growth. In these early months there is just new MRR each month. Customers are either still evaluating the product, or are locked in to long-term contracts so no churn occurs.
    • Quick Ratio: Infinite. With no churn there is no denominator for the ratio. The Quick Ratio is irrelevant during these months.
  • Stage 2—Churn starts. As some customers start cancelling the service, keeping growth at a maximum becomes more important to retain significant MRR coming into the company and maintaining momentum.
    • Quick Ratio: Double digits. With the presence of churn, the denominator comes into the equation and a Quick Ratio can start to be calculated. However, as the number of possible churning customers is still low, the Quick Ratio will be artificially high with growth strongly outpacing churn.
  • Stage 3—Upgrades and Downgrades. Now the real work begins. As the initial cohorts start to cancel and downgrade, churn becomes more of an issue. Controlling this churn while still driving growth becomes the key to continual, positive net new MRR.
    • Quick Ratio: Single digits. As churn inevitably increases, a corresponding increase in expansion or new MRR is needed to maintain a high Quick Ratio. Your Quick Ratio during this stage is a good indicator of the growth efficiency in your company.

When the Quick Ratio is low, it means that churn is likely to be a significant problem in relation to the amount of revenue you’re bringing in. If you are in a growth phase early on in the start-up process this might not seem like an issue, but retention is king. Customer acquisition suffers from declining rates of return as you scale—you find it harder and harder, and more expensive to acquire new customers. Churn, however, is a constant throughout a SaaS company’s lifecycle.

Even with a successful SaaS, churn will stay as a constant percentage of your MRR, while avenues shrink for possible new or upgrading MRR. Because of this, constantly fighting to decrease churn and not relying on more and more customers to keep growth high is a necessity. The Quick Ratio allows you to see, at a glance, how these 2 numbers stack up against each other and whether you have a successful, sustainable business model.

3 Different Quick Ratio Stages, and What They’ll Do To Your Company

As your SaaS company grows your Quick Ratio will decline, but keeping as high Quick Ratio as possible in each of these stages will make a significant difference to your growth and company.

You can see the difference that striving for a continuous high Quick Ratio can have below. In blue is a company with 3 stages similar to above. An early stage of high growth and high Quick Ratio, a 2nd stage of continual growth and a successful Quick Ratio, and 3rd stage of a good, sustained Quick Ratio of 4.

In red is a company that has changed trajectory throughout the 3 years, with much lower Quick Ratios in years 2 and 3. The difference is stark. Whereas the blue company finishes the 3 year stint with almost $250,000 in MRR, the red company, with its lower Quick Ratios, is adding less revenue for each churned dollar month after month, and ends up with under $70,000, a difference of 3.5x.

High vs. Low Quick Ratios

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In the early stages where growth is incredibly important, high Quick Ratios are attainable through strong sales, marketing, and other customer acquisition channels. As the margins on these fall in the medium stages and growth slows, a high Quick Ratio comes through keeping churn down as that becomes a factor. Finally, in the 3rd “steady state” continually improving the service and maintaining the core value for your customers makes sure you can preserve a positive Quick Ratio and continue growing.

High growth is sexy. Seeing a big number month after month makes you feel like you are absolutely on the way to unicorn status. But unless you are looking deeper at that number, you could be setting yourself up for a fall.

SaaS is about efficiency. If you want to sustain your growth so those numbers keep on getting bigger and bigger and bigger, you need to know that your growth is as much from low churn as well as high acquisition. Calculating your Quick Ratio allows you to base your SaaS on solid fundamentals, which is the foundation you need for true growth.