This post was originally published here.

What is the SaaS Quick Ratio? How can it help you determine if you’re headed in the right direction as a business?

Every business puts in a lot of effort to acquire new customers. Unfortunately, even if you do a great job acquiring customers, churn or downgrades can still slow down your growth.

And unless you’re careful, you sometimes fail to see this until it’s too late. Many SaaS organizations get sidetracked by leading indicators of customer acquisition without making sure those leading indicators actually lead to successful and sustained acquisition.

This is where knowing your SaaS Quick Ratio can help.

What is the SaaS Quick Ratio?

The SaaS Quick Ratio evaluates the direction of your growth. 

To put it more precisely, it calculates the monthly net inflow and outflow of ARR or MRR in your SaaS business. You can think of the SaaS Quick Ratio as one of your best tools to measure the growth efficiency of your company.

In today’s post, we will explain how to calculate the SaaS Quick Ratio. We will also give our opinion on why this is important and what we think is a good ratio.

How to calculate the SaaS Quick Ratio

The SaaS Quick Ratio compares the growth of bookings against the contraction of bookings. It’s calculated on a monthly basis using bookings and churn.

For our numerator, we’ll use bookings growth across all sources. This means both newly acquired MRR or ARR coming from new users and expansions from our current customers.

 And for our denominator, we are measuring bookings’ contraction. This amounts to lost MRR or ARR from current users through churn and downgrades.

Let’s take a look at the formula:

SaaS Quick Ratio = (New MRR + Expansion MRR) / (Downgrade MRR + Churn MRR)

Of course, this particular formula uses MRR as inputs. If you want to calculate your annual quick radio, switch to ARR. 

An example of SaaS Quick Ratio

As you can see, it’s fairly easy to calculate the Quick Ratio.  All you need to do is accurately monitor your new bookings, expansions, churn, and downgrades. Having a dedicated FP&A tool can greatly help with this, as you won’t have to question the validity of your data.  Now let’s try a simple example. Say we have $150K of new bookings and $225K of expansions in the numerator. In the denominator, we’ll go with $75K of churn and $15K of downgraded bookings:

(150K + 225K) / (75K + 15K) = 4.2

In this case, our SaaS Quick Ratio of 4.2. Is that good or bad?

What your SaaS Quick Ratio means

Consider the ranges below if you want to evaluate the health of your MRR growth.

SaaS Quick Ratio over 1: Your business is in trouble. It is possible to make it through a Quick Ratio of less than one for a month or two at best with a solid customer base, but your business is shrinking. This is an all-hands on deck situation.

Quick Ratio between 1 and 4: This is a mixed bag. The good news is that your business is growing. The bad news is that you have to maintain very high levels of customer acquisition to make up for lost bookings, and unless that acquisition is very efficient, you could end up losing money on each customer. The growth potential is there but your organization needs to do better to keep the customers you’re acquiring. Dig into your post-sale experience across product usage, customer success, and metrics like NPS to understand root causes of your high churn.

Quick Ratio over 4: Your business is growing strong and you’re keeping the customers you’re bringing in. You’re in a good position to attract investment with such a healthy quick ratio. 

Why is the SaaS Quick Ratio so important and useful?

For any SaaS company, healthy MRR or ARR is everything. This is why it’s so important to know whether you are a net positive or net negative each month.

From our perspective, the SaaS Quick Ratio is great because:

• It’s easy to calculate
• It can help businesses assess if they have too low of a price point
• It’s great for pinpointing problem areas helping companies know what to focus on
• It’s one of the quickest methods to find out if you’re experiencing net growth or net contraction

What you should do next

Take a look at your bookings and retention data and use the formula we’ve shown you to calculate your Quick Ratio for the last three months. 

What does it tell you? Does your company have a net ARR/MRR inflow or outflow? Is it positioned for growth? Or is it in that 1 < X < 4 limbo of uncertainty?

Perhaps it’s a good idea for you to implement the SaaS Quick Ratio in your monthly (or even weekly) reporting.

It may be your best way of knowing it’s time to take corrective action.