Updated: Aug 24, 2022
Quick Ratio for a SaaS startup is a measure of net inflow (or net outflow) of that startup’s recurring revenue. It measures growth in a startup’s recurring revenue through new customers and upsells versus contraction in their recurring revenue through churn and downgrades. Quick Ratio is typically calculated on a monthly basis.
Quick Ratio is an important input into strategic planning and is keenly tracked by investors because it is a directional metric, which signals whether your startup is on an upward trajectory for growth, bumbling along sideways, or slipping into a downward trajectory.
Essentially, Quick Ratio is like the pulse of your business and is very telling about its health status.
How to calculate Quick Ratio
Quick Ratio in SaaS is calculated by following these steps:
Determine total revenue won from new customers and customer upgrades/ upsells
Determine total revenue lost due to cancellation and downgrades
Divide total new revenue by total lost revenue
Quick Ratio is typically calculated on a monthly basis and utilises booked (i.e. realised) Monthly Recurring Revenues (MRR) figures for calculations, which can be extracted from your accounting or your payment processing system. This is done to ensure that the ratio is calculated with revenue numbers from live customer contracts rather than deals that have a start date in the future and are yet to materialise as revenue.
To elaborate with an example,
If your startup acquired new customers totaling an MRR of £25,000 in January 2022 and earned an additional £15,000 from upgrades from existing customers in the same month, then the total new revenue for January 2022 will be £25,000 + £15,000 = £40,000.
In the same month, if your startup lost customers to the tune of £7,000 in MRR and further lost £3,000 of MRR due to customer downgrades, then the total lost revenue for January 2022 will be £7,000 + £3,000 = £10,000.
In this example, the Quick Ratio for your startup for January 2022 will be £40,000 / £10, 000 = 4.
Typical pitfalls when calculating Quick Ratio
When working with Quick Ratio, it is important to be mindful of the following pitfalls:
1. Expected revenue vs. realised revenue:
Quick Ratio should be calculated with realised revenue figures, not with future revenue figures. Given this, MRR is better suited rather than Annual Recurring Revenue (ARR) because it accurately captures the revenue booked for the selected month.
2. Direction, not efficiency: Quick Ratio highlights the direction that your business is moving towards. It does not signal whether it is doing so in an efficient manner. For example, if your Quick Ratio is low, it can indicate that you need to improve your new customer acquisition or lower your customer churn (or both). However, it does not give you insights into whether you are acquiring new customers at optimum costs or whether your marketing tactics are effective. For efficiency in this regard, it is better to lean on
Is there an industry benchmark for Quick Ratio
Once you have your startup’s Quick Ratio, it’s important to understand what is considered a good Quick Ratio.
To begin with, a Quick Ratio of <1 is terrible and signals high risk in the business. To further elaborate, when the Quick Ratio is less than 1, it means that you are losing revenue faster than you are acquiring new revenue. If this is the case then your startup, in its current form, is not sustainable and its relatively high churn/downgrade rates will eventually lead to its collapse.
If your startup’s Quick Ratio is >1, it indicates that you are on an upward growth trajectory because you are acquiring new revenue faster than you are losing existing revenue. Therefore, you have a net positive inflow of revenue each month which will accumulate to give you higher total revenue figures continuously.
Within the VC and startup ecosystem, you will find that a Quick Ratio of 4 or higher is considered an optimum target. At this level, your startup is earning £4 in new revenue for every £1 it is losing.
A ratio between 1 and 4 still indicates growth, although at a slower pace. If your startup’s Quick Ratio is between 1 and 4, you may want to look at improving efficiencies or limiting churn/downgrades to make your business a more attractive proposition.
To learn more about SaaS KPIs that matter, check out our Ultimate Guide to Top 5 SaaS KPIs that investors care about.
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