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Every year, ICONIQ Growth publishes our cornerstone research on the data behind scaling a B2B SaaS business. However, the different terms and metrics used to describe SaaS key performance indicators are often confusing and not well-documented. We often get questions from even established founders and finance teams on the best ways to calculate a certain metric.
We are excited to share this glossary of common SaaS terms and metrics as a companion tool to our Growth & Efficiency report. This is not intended to be a definitive guide to SaaS accounting. Rather, we hope to share some best practices and common approaches we often see companies use to most cleanly define and track these metrics on an ongoing basis. We also believe this is a topic that will only benefit from increased knowledge sharing and welcome any additional considerations or best practices you may have.
Select considerations and views are included below, with more detail included in the full report.
The ARR Funnel
Because of the recurring nature of SaaS businesses, it can be challenging to see how well a company is actually doing. An ARR waterfall is one of the fundamental building blocks of SaaS financial planning, allowing us to understand where a company is at the beginning of period, the puts and takes of ARR in that period, and where you landed at the end of the period. One of the best ways to measure the health of your business is to look at what happened with new customers (new logo ARR), your install base (expansion, churn rate), and the sum of all the above (net new ARR) on both a quarterly and annual basis. This same funnel can also be built for contracted annual recurring revenue (CARR), which takes into account signed, but not live, contracts.
SaaS Revenue Recognition
There are different ways to measure revenue for a SaaS business, which differ based on the contract length and terms. Understanding and tracking these different metrics allow companies to more confidently predict monthly revenues and also identify any concerning trends (e.g., a significant lag between bookings and revenue).
Categorizing Spend: Where should customer success be allocated?
SaaS companies categorize spend across operating expenses, including both people and non-people related operating spend across S&M, G&A, and R&D teams, and cost of revenue (COR or COGS) expenses, including costs associated with delivering a product and servicing customers.
Where certain line items of spend are allocated will be dependent on each company’s business model. It may make sense for a company that has a customer success team focused more on implementation and customer support to allocate costs related to this team as COGS, whereas for other companies where customer success handles renewals and expansions, costs related to this team may roll up to sales & marketing operating expenses. While there is not a straightforward answer for where to allocate CS employees and costs between COGS and OpEx, below is a framework we often see SaaS companies use to make this decision:
Calculating SaaS LTV and CAC
LTV / CAC is a great ratio that gives insight into a company's unit economics. However, the calculation will often be very dependent on the company's business model, customers, and finance model. Below is an example of a simplified approach that we like to use when calculating LTV and CAC for a given quarter:
*As LTV measures revenue, it's important to understand the actual impact on profit by factoring in gross margin. This is especially important when calculating your LTV/CAC ratio. Let’s say your Gross Margin is 60%, CAC is $2k, and lifetime revenue is $10k. This would imply your LTV/CAC is 5x which looks great on paper. However, when you take into account how much it actually costs to deliver services (your gross margin), you realize that the customer is really valued at $6k. Your LTV/CAC ratio is actually closer to 3x.
Published:
September 9, 2024
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