The SaaS (software-as-a-service) business model offers several benefits, including predictable revenue and agility. That’s what has made it a popular choice among software providers and buyers alike.
According to data from last year, there were 17,000 SaaS companies in the US alone, catering to roughly 59 billion dollars worldwide. Moreover, the global SaaS market is projected to be worth $908.21 billion by 2030, growing at a CAGR of 18.7% between 2023 and 2030.
As more entrepreneurs hop on the SaaS bandwagon, the market is becoming more competitive. How do you build and grow a successful SaaS company in such a landscape?
One of the key components to any growth strategy is to measure and improve profitability. By design, successful SaaS companies often enjoy high profit margins. That’s because they make money through recurring subscriptions (and occasional one-time fees for add-ons).
The predictability of revenue helps manage cash flow and resource allocation better, making your business profitable in the long run.
Expenses, however, can still add up in SaaS, including your dev talent spend, customer acquisition budgets, customer support infrastructure and cloud hosting costs.
Tracking the effectiveness of your growth levers, then, along with ensuring that your spending is proportional to your billings, can make all the difference.
In this article, we’ll take a closer look at the metrics your SaaS business should track to improve profitability. But let’s first understand the importance of measuring profitability.
Why Should SaaS Businesses Monitor Profitability?
First things first – profitability isn’t the same as profit. Profits offer an idea of how much money your company has earned in a given timeframe. On the other hand, profitability is an indicator of how efficiently you’ve earned those profits.
Tracking profitability can help you understand how well you’re utilizing available resources and whether you’re overspending or underinvesting in certain areas.
It can also help you assess your company’s financial health and determine whether your business model is sustainable.
Moreover, when you measure profitability over time, you can detect sudden dips in your company’s performance. That, in turn, can help you identify seasonal fluctuations in demand and generate more accurate revenue projections.
You can even compare your profitability ratios against industry benchmarks to understand how your products are faring. Additionally, it comes in handy when you want to decide the future course of action for your business or seek funding from investors.
At the same time, profitability ensures your SaaS business can cover its costs and weather economic challenges without solely relying on external funding.
6 SaaS Profitability Metrics You Should Track
The good thing about running a SaaS business is that you get access to a ton of data, making it easier to measure and improve profitability. You can use this data to track various metrics, such as monthly recurring revenue, customer acquisition costs and customer attrition rates.
Additionally, having access to such comprehensive data allows for a deeper understanding of customer behavior and preferences. This insight can inform strategic decisions to better serve and retain clients.
SaaS accountants play a crucial role in interpreting and leveraging this data effectively. They specialize in navigating the financial intricacies of SaaS businesses, offering valuable insights for optimizing revenue streams and minimizing costs.
With their expertise, businesses can implement targeted strategies to further enhance profitability and sustain long-term growth.
If you’re looking to make your business more profitable, here are the metrics that deserve your attention.
1. Gross Profit Margin
Gross profit margin is one of the most commonly used financial metrics. It measures the percentage of revenue you earn after subtracting the direct costs of producing or delivering a product or service.
You can calculate the gross profit margin using the following formula:
Gross profit margin = ((Total sales – Cost of goods sold) / Total sales) x 100
Measuring the gross profit margin helps you understand how well your pricing strategies are working. A lower ratio might mean you aren’t charging enough money for your products.
It can also indicate you’re spending too much on production or delivery and help you identify ways to bring costs down.
2. Operating Profit Margin
Operating profit margin accounts for operational expenses and overheads when measuring profitability. You can calculate it by dividing operating profit by total revenue.
Here’s what the formula looks like:
Operating profit margin = ((Total revenue – Operating expenses) / Total revenue) x 100
For SaaS businesses, expenses usually include costs related to infrastructure, employee salaries, and server maintenance. Measuring the operating profit margin provides you with a concrete picture of operational efficiency.
It can also help you understand how different departments, such as customer support, marketing, and sales, contribute to the company’s bottom line.
3. Net Profit Margin
Net profit margin is a crucial metric that offers deeper insight into a SaaS business’s overall financial performance. It takes into account a wider array of expenses, including interest, taxes, and depreciation.
You can use the following formula to calculate the net profit margin:
Net profit margin = ((Total revenue – Operating expenses – Interest, Taxes & Other costs) / Total revenue) x 100
Measuring the net profit margin is essential because it’s the money that remains in your company’s bank account after deducting all expenses. That, in turn, provides the most accurate picture of profitability and helps you devise effective ways to improve cash flow.
4. Return on Assets
Return on assets (ROA) is a financial metric that measures the profitability of your company’s assets. In other words, it indicates how effective these assets are in generating revenue.
You can calculate ROA using the following formula:
Return on assets = Net income / Total assets
Here, net income represents the total profit you earn after subtracting operating expenses, interest, taxes, and any other costs.
Monitoring ROA helps SaaS businesses assess the effectiveness of their resource utilization strategies. A low ROA might indicate that your company isn’t using available resources to their fullest potential.
5. Churn Rate
Churn rate may not be the first metric that comes to your mind when you think about financial metrics. However, given that the SaaS business model relies on recurring revenue, measuring churn rate can provide a unique perspective on profitability.
Simply put, the churn rate measures the rate at which customers cancel their subscriptions or stop using your products. You can calculate it using the following formula:
Churn Rate = (Number of customers at the beginning of the period – Number of customers at the end of the period) / Number of customers at the beginning of the period
A high churn rate means you have to constantly attract new customers to make up for the lost ones. That, in turn, can affect profitability and prevent sustainable growth.
Conversely, measuring this metric helps you identify effective customer retention strategies and make your business profitable in the long run.
6. Customer Lifetime Value
Customer lifetime value (CLTV) measures the average amount of money you can generate from a customer throughout their association with your company. As with the churn rate, CLTV isn’t a profitability ratio.
However, it’s integral to measuring and optimizing the profitability of SaaS businesses, because it reveals the break-even point for your acquisition costs.
The formula for calculating CLTV goes like this:
Customer lifetime value = Average revenue per account (ARPA) / Churn rate
Measuring CLTV can help you determine how much you should spend on customer acquisition, ideally segmented into cohorts according to campaign types and user personas. That, in turn, can help you make data-driven decisions for marketing campaigns and stay within a predefined budget.
Additionally, calculating the ratio of CLTV and customer acquisition costs (CAC) can be a good indicator of profitability. A low ratio highlights the need to cut down on marketing expenses and focus on reducing churn.
In today’s fast-changing SaaS landscape, focusing on profitability has become non-negotiable. As a SaaS business leader, you can use a broad spectrum of data to measure financial performance and become more profitable.
The most commonly used profitability ratios include gross profit margin, operating profit margin, and net profit margin. Additionally, metrics like churn rate and customer lifetime value provide insights into customer retention and help you implement strategies for long-term success.
Whether you’re starting a SaaS business or looking to take your company to new heights, these metrics can guide you on the path to sustained growth.