Navigating Business Success with KPIs
The goal of financial reporting is to help leaders understand the health of their business and identify the triggers they can pull to correct course. Most small to medium sized businesses pay attention to basic financial statements like profit & loss and balance sheet statements, which is a great start but is not enough to reach the objective of making better decisions and improving future results.
There are two hurdles to reaching that goal: understand the past to see what you did well and where you fell short, and predict where you will end up if you change nothing and predict what changes will drive the most growth and profitability.
How do we do that without a crystal ball? The answer is to track financial and non-financial metrics aka Key Performance Indicators (KPIs). They are the compass that guides businesses. Understanding and leveraging these KPIs is essential for strategic planning, operational efficiency, and sustainable growth. Each company decides which KPIs are the most relevant to them, as usual – less is more. In this article we cover SaaS KPIs.
KPI Types
There are two types of KPIs: (1) leading and (2) lagging. Leading indicators are like a weather forecast, they hep you predict what is going to happen so you can prepare and make the right moves. Lagging indicators are like looking in the rear-view mirror. They show you what has already happened, helping you assess the results of past actions. Over the next few articles, we will cover the top leading and lagging indicators by industry.
Part 1: B2B SaaS (Software as a Service) Industry KPIs
For Business to Business (B2B) SaaS companies, certain financial KPIs are particularly crucial due to the unique nature of their business model. Please remember that there are many non-financials KPIs as well that are worth tracking.
Leading Indicators: Predicting SaaS Growth
1. Monthly Recurring Revenue (MRR): Predicts stable monthly income. There is an annual version of this metric called Annual Recurring Revenue (ARR) that can also be used as a lagging indicator.
Calculation: Sum of all recurring revenue from customers in a month
2. Customer Lifetime Value (CLV): Estimates total revenue from a customer over time.
Calculation: Average Revenue Per Account (ARPA) * Customer Lifespan
3. Customer Churn Rate: Indicates the rate at which customers stop subscribing.
Calculation: (Number of Customers Lost in Period / Total Customers at Start of Period) * 100
4. Expansion Revenue Rate: Focuses on the revenue generated from existing customers through upsells, cross-sells, and upgrades. Growing revenue within existing customer base is more cost effective and increases profit margins.
Calculation: (Revenue Gained from Existing Customers through Upsells/Cross-sells/Upgrades in a Period/Total Revenue at the Start of the Period from Same Customers) * 100
5. Lead Conversion Rate: Shows the effectiveness of converting prospects into customers. This is best tracked by salesperson and can help with commission calculations.
Calculation: (Number of Sales / Number of Leads) * 100
6. Renewal Rate: Reflects % of current customers that renew their contract, higher rates lead to higher CLV and higher revenues. This is closely related to but opposite of the Churn Rate.
Calculation: (# of Contracts Renewed/# of Prior Year Contracts) * 100
7. Marketing Campaign ROI: Evaluates the earnings from marketing investments.
Calculation: (Campaign Profit / Campaign Cost) * 100
8. Sales Pipeline Value: Total value of all potential sales. It helps forecast future revenue.
Calculation: Sum the value of all opportunities in your sales pipeline
Lagging Indicators: Evaluating SaaS Performance
1. Annual Recurring Revenue (ARR): Measures yearly recurring revenue, vital for long-term planning.
Calculation: MRR (see above) * 12
2. Customer Acquisition Cost (CAC): Shows the cost of acquiring a new customer.
Calculation: Total Sales and Marketing Expenses / Number of New Customers Acquired
3. Gross Margin: Indicates profitability after accounting for COGS (direct labor/materials/overhead).
Calculation: ((Revenue – COGS) / Revenue) * 100
4. Operating Cash Flow: Reveals cash generated from business operations.
Calculation: Net Income + Non-Cash Expenses + Changes in Working Capital
5. Net Profit Margin: Reflects the percentage of revenue that turns into profit.
Calculation: (Net Income / Revenue) * 100
6. Cash Burn Rate: Shows the rate at which the company spends its cash reserves. Indicates financial sustainability and runway.
Calculation: (Cash at Beginning of Period – Cash at End of Period) / Number of Months
7. Month over Month Revenue Growth: Measures the growth in revenue from one month to the next. Helps to identify seasonality and slow down in growth.
Calculation: ((Current Month Revenue – Prior Month Revenue) / Prior Month Revenue) * 100
8. Average Revenue Per Account (ARPA): Indicates average revenue generated per customer account. Helps in revenue trend analysis.
Calculation: Total Revenue / Total Number of Accounts
KPIs as Tools for Strategic Mastery
In summary, leading indicators help in forecasting and planning, while lagging indicators offer a retrospective analysis of business decisions and validate past actions. It is important to pick KPIs that are meaningful to your business and industry. Be wary of choosing too many metrics and not utilizing any at all. By continually monitoring and analyzing selected KPIs, businesses can make informed decisions, optimize operations, and chart a course for success.