When running a business based on Software as a Service (SaaS), keeping track of your company’s performance is as important for planning your growth as it is with any other business model. In order to properly track and understand it, every business determines its Key Performance Indicators (KPIs).
At Remitly, we’re committed to guiding business owners and immigrants as they get off the ground and manage their finances in the USA. This guide will break down five different KPIs in the world of SaaS to make sure that you have the data you need to grow your business.
Understanding Key Performance Indicators in SaaS
We’ll be looking at five different Key Performance Indicators (KPIs) and metrics in this article in the context of SaaS businesses. As we’ll see, these KPIs are hugely important for tracking the progress of your business. Watching trends in the data can also help with spotting problems before they escalate.
Introduction to KPIs: ARR, MRR, PO, SKU, ROI
Let’s take a quick look at the definition of each of these KPIs before taking a deeper dive into exactly what they can tell you about your business.
- Annual Recurring Revenue (ARR): This figure represents the total value of subscriptions to your service over the course of a year.
- Monthly Recurring Revenue (MRR): MRR is the revenue generated by your customers’ subscriptions over a month.
- Purchase Orders (POs): These are the contracts that are signed with clients who want to use your service.
- Stock Keeping Units (SKUs): SKUs may seem irrelevant for SaaS businesses, which don’t need to keep track of physical stock, but they can be immensely helpful for labeling and tracking sales of different subscriptions and tiers.
- Return on Investment (ROI): This metric shows how well your initial investments are working for you by comparing the current value of the investment with its initial cost.
Importance of KPIs in business metrics
Metrics like these help you track which subscriptions are selling best and the ways in which they are combined with your other products. They also help you plan around growth phases for budgeting and fundraising. Keeping a close eye on them is essential for any SaaS business.
Annual Recurring Revenue
Annual Recurring Revenue (ARR) is one of the key indicators that can help you make predictions for the future of your business as well as attract investors.
Definition of ARR
ARR is the amount of money generated annually by recurring subscriptions only. It is not impacted by your expenses, investments, or customers’ one-off purchases.
How to calculate ARR in SaaS
Calculating ARR can range from fairly straightforward to much more complicated, depending on how detailed you want your information to be. To get a broad idea of your company’s position, simply multiply the number of customers you serve by your average revenue per user.
The more complex formula involves adding the revenue from all of your new subscriptions during the year and the value of your existing subscriptions at the beginning of the year. To figure, you also add the revenue from subscription upgrades, then subtract the values of any downgrades or cancellations over the course of the year.
ARR’s role in forecasting and strategic growth
These ARR formulas are great for getting the data you need to forecast and strategize growth. By looking at year-over-year data, you can see the actual growth rate of your business as a percentage to see how well your business has performed when it comes to acquiring new customers and promoting upgrades to your existing customers. ARR can also be a key metric to show potential investors, who will want to see steady growth in your company.
Monthly Recurring Revenue
Another important metric is Monthly Recurring Revenue (MRR). It’s very closely related to ARR, but there are some key differences in the way the data is used.
What is MRR and why does it matter?
MRR is similar to ARR in that it shows how much revenue you can expect to take in during a given time period. Again, we don’t need to calculate any one-time revenue sources here, so only look at the revenue that is truly recurring, such as your subscription services.
MRR is great for zooming in on trends in your business and revenue streams. This gives you the information necessary to plan for coming months in your business by identifying trends and giving you the ability to track your monthly growth rate.
Calculating MRR for subscription-based businesses
Calculating MRR is nearly the same as calculating ARR, but you may need to make some adjustments for your payment schedules. If you bill your customers monthly, multiply your subscriptions by your number of customers. You may also need to take into account any variations in plans or any add-ons for your service. Again, simply total these up and multiply them by the number of relevant subscribers.
If you bill with a different frequency, you’ll need to start with different numbers. For example, if you bill annually, start by dividing the price of your annual service by 12. You can then multiply the result by the number of customers currently subscribed to your annual service. This gives you your average MRR.
Differences between ARR and MRR
Though they give similar kinds of data, ARR and MRR are going to be used for very different things. As mentioned before, ARR is perfect for taking a wide view of your business’s performance. This can be useful for planning new strategies for the coming year. It’s also a piece of data which is valued by potential investors or buyers who will want to see consistent growth.
MRR, on the other hand, is all about the small scale, providing you a detailed view of short-term revenue trends. It also allows you to keep track of the effects of any changes you implement in your marketing or business strategies. If you bill monthly, MRR will be your main focus. If you bill your customers annually, however, you may find it better to focus on ARR. That said, a check on MRR can still be very helpful to reveal important fluctuations or emerging trends.
Purchase Orders and Stock Keeping Units
Where metrics like MRR and ARR help you understand the growth of your business, daily operations can be tracked through your Purchase Orders (POs) and your Stock Keeping Units (SKUs).
Understanding Purchase Orders in relation to business Operations
Purchase Orders are your customers’ way of communicating to you exactly what services they intend to sign up for. These tend to be larger purchases and are one step in your clients’ procurement process. POs involve the client coming to you with their needs and an idea of which of your products they would like to sign up for. The PO will include pricing, IT support guarantees, and any necessary installation services.
POs are very helpful because they also allow you to plan effectively for larger orders. You can hire more staff and reallocate resources to meet the demands of the PO. It also means that you are able to plan for incoming revenue as the negotiations are finalized.
The role of SKUs in product management
SKUs are the identifying numbers associated with the software and services that you offer. These tags help you identify the exact service and its associated price. It can be tempting to use bundled services under one SKU, but this often means that your customers may not exactly understand what they’re paying for.
It’s good practice to support your customers with this granular information so that both you and your client know exactly what is being paid for and what they are owed. Even if you bundle later in marketing or at lower subscription tiers, you should be able to break down the pricing for your service very clearly, especially when it comes to fulfilling POs.
Return on Investment in financial management
Now that we’ve calculated ARR and MRR and we understand how purchase orders and SKUs help SaaS businesses track their software usage, it’s time to talk about Return on Investment (ROI). This is where it all comes together as you assess the work you’ve done to gain clients and keep them happy.
Definition and significance of ROI
ROI is the percentage of your upfront investment that you got back in net profit. In SaaS companies, this will involve the cost of paying for programmers and office or server space to host your business and its software. This statistic is crucial for making sure that you are allocating resources wisely as you build new services and prepare to roll them out to clients.
How to calculate ROI for SaaS companies
Calculating ROI is very intuitive. If it costs your company $20K to prepare a new software and you’re able to generate $100K in net profit with that software, the equation is as follows:
(100K / 20K) * 100 = 500%
This means that your product has a 500% ROI.
Interpreting ROI for business decision making
Though it may seem related to profit and profit margin, ROI is quite different. ROI looks at profit as a percentage of cost. This means that you know how much of every dollar you spend will come back to you in profit. Knowing or projecting ROI means that you can more effectively direct your spending to projects that will net you the greatest profit and direct your long-term strategies to create sustainability.
Integrating these KPIs to optimize your SaaS business
Running a solid business involves keeping a very close eye on all five of these KPIs. One doesn’t work without the other, and all of them are key to developing a winning strategy for your SaaS business.
How ARR, MRR, PO, SKU, and ROI work together
All of these indicators and data points interact. Knowing about your upcoming POs means you can track your top-performing SKUs. Incoming revenue can also be factored into your monthly and annual recurring revenue calculations. An up-to-date MRR allows you to strategize in the short term, and an ARR paired with insights from your ROI can help you allocate funds for longer-term projects and attract investors.
Moving forward with KPI-driven strategies
As your SaaS business continues to move forward, make sure to track only the KPIs that are most relevant to you. They can all be useful, but not all of them will need to be tracked constantly. If your software service is very straightforward, you won’t need so many SKUs. If you only bill your clients annually, MRR won’t give you as much usable data as it might for those companies who bill monthly.
At the end of the day, how you use the information is as important as having it. Set goals for your business and focus on making changes that will have the largest impact on the most relevant KPIs.
FAQs
What is MRR and ARPU?
Monthly Recurring Revenue (MRR) is your predictable monthly revenue earned through subscription pay models. Average Revenue Per User (ARPU) is found by taking your MRR (or ARR, if it’s annual data you’re after) and dividing it by your total number of users.
What does $1 million ARR mean?
To have $1 million in Annual Recurring Revenue (ARR) means that your business repeatedly earns $1 million in revenue over the course of a year. This revenue is expected to come in year after year due to the recurring nature of the SaaS subscription payment model.
What is the difference between ROI and ARR?
Annual Recurring Revenue (ARR) looks at the revenue earned in a year from only recurring revenue sources, like subscription services. This number will be a value in dollars. Return on Investment (ROI) shows net profit as a percentage or the money invested in developing the product or software.
Is ARR just MRR times 12?
It could be, but this will not give you the most accurate picture as it won’t account for any month-to-month changes in revenue. For the clearest results, calculate Annual Recurring Revenue (ARR) separately from Monthly Recurring Revenue (MRR).