Business leaders in every niche look to financial ratios and metrics to evaluate their company’s performance. It is no different in SaaS, and every year Baremetrics helps more SaaS companies keep an eye on these ratios to grow as rapidly as possible.
Given the unique nature of the SaaS industry, it is not unusual to find that some financial ratios within this niche will look a lot different from typical industry financial ratios. This article details three key ratios for your SaaS company: the current ratio, quick ratio, and acid test ratio.
Together, these financial ratios offer easy insight into a company’s sufficiency through its many growth (or dip) phases. When we say easy insight, here’s an example of what we mean:
If you were told that your company’s quick ratio is below 1, would you know what it means?
Yes! With these numbers at your fingertips, it’s easy to understand where your company stands financially.
What Is the Quick Ratio?
True to its name, the quick ratio is a financial analysis metric that is quick to calculate because it does not contain as many variables as, e.g., the current ratio in its calculation. All you need to calculate the quick ratio is accurate records of the assets and liabilities for the month under review.
The formula for calculating the quick ratio is detailed below:
Quick Ratio = (Cash + Cash Equivalents + Marketable Investments + Accounts Receivable) ÷ (Current Liabilities)
The only assets applied during this calculation are those kinds of assets that can be converted to cash within 90 days. Take a look at the variables included in the formula above. The assets, in addition to cash and cash equivalents, include marketable investments and accounts receivable, which are the liquid assets accessible within 90 days of the analysis.
These assets that are readily liquid in such a short time are called quick assets.
Does the SaaS Quick Ratio Work the Same Way?
The answer is not quite. Calculating the SaaS quick ratio is slightly different from the way it is estimated in other industries. It’s different for reasons that will become immediately clear when calculating the quick ratio of a sample SaaS company later in this article.
For now, let’s just say that SaaS companies look at assets and liabilities through different lenses, and their financial analysis reflects that outlook.
What Is the Current Ratio?
For very good reason, you will find that the most talked about financial ratio is the quick ratio. It’s quick, easily calculable, and an executive cannot make a wrong decision by applying only the quick ratio. However, the popularity enjoyed by the quick ratio does not make the current ratio any less useful in decision making.
The quick ratio calculates values that apply to the short term, whereas the current ratio looks at longer (e.g., one year or more) periods. When you think of the current ratio, think of current assets and current liabilities; these variables are involved in its calculation.
The current assets on every balance sheet include inventory, cash, cash equivalents, marketable securities, prepaid expenses, and accounts receivable. The values of these assets are usually convertible to cash within one year.
The current liabilities include all debts and obligations that are to be settled within one year. Short-term debt, accounts payable, and other accrued debts and liabilities are examples of current liabilities.
Current assets are added up and divided by the total current liabilities to obtain the current ratio:
Current Ratio = (Total Current Assets) ÷ (Total Current Liabilities)
If Company A has accrued liabilities worth $100,000 while its current assets stand at $150,000, the current ratio stands at 1.5. For Company A, this means they are slightly out of trouble, but not in a great place either. With a current ratio of less than one, there are fewer current assets than liabilities, which is considered a risk to creditors and shareholders. At 1.5, the value of the current assets may be slightly higher, but, after the current liabilities are settled, the company might be in the red.
What Is the Acid Test Ratio?
The acid test ratio is actually just another name for the quick ratio in financial analysis. It is often helpful in more situations than the current ratio as it ignores all the assets that are not easy to liquidate. If the acid test ratio is much lower than the current ratio, it means that there are more current assets that are not easy to liquidate (e.g., more inventory than cash equivalents). If Company A’s acid test ratio or quick ratio is 1.1, it means that Company A depends more heavily on inventory than any other current asset. This finding is not an indication of imminent danger, but a closer look at the type of company that shows these numbers can reveal more information.
If Company A is a retail store, these numbers (current ratio and acid test ratio) might not be cause for alarm because retail stores typically have a lot of inventory.
However, if Company A is a SaaS company, these numbers could be terrible news.
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Quick Ratio (or Acid Test Ratio) vs. Current Ratio
Quick assets can be quickly culled from current assets when there are no separate records of the company’s quick assets. The quick ratio is calculated using fewer variables than the current ratio, and its value can readily signal the company’s short-term financial health.
If you’re worried about covering debts and liabilities within the next 90 days, the quick ratio will provide you with the most useful information. Interestingly, for companies with no inventory assets, the quick ratio and current ratio may be identical, except for a few minor differences, such as some accounts receivable that are not easy to liquidate.
Whereas the quick ratio is lauded as the more beneficial financial ratio of the two, the type of company or industry where this financial analysis is conducted is worth noting. Omitting the inventory in calculating the quick ratio for a supermarket (where inventory is often moved quickly) may not provide an accurate view of that supermarket’s financial health or liquidity.
In different companies, these financial ratios can fluctuate. If care is not taken, it is easy to lose sight of accurate financial metrics on which essential decisions can be based.
Is the Quick Ratio Applicable to SaaS?
As noted frequently in this article, the niche industry matters when financial ratios are calculated. A SaaS company’s views of its current assets and liabilities are incomparable to those of a retail store or supermarket, and this unique perspective is reflected in financial analysis.
That said, a SaaS company can still apply the quick ratio to provide valuable insights on the direction of its growth.
What Is the SaaS Quick Ratio?
The quick ratio is defined above, and a formula is provided. However, the quick ratio formula provided is generic and applies in several industries, but the variables computed are different when it comes to the SaaS industry.
The SaaS quick ratio is different from every other quick ratio calculation you may find in financial analysis articles and books:
SaaS Quick Ratio = (New MRR + Expansion MRR + Reactivation MRR) ÷ (Contraction MRR + Churned MRR)
Below is an example of values computed by Company Z to depict their SaaS quick ratio.
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Table 1. SaaS quick ratio example.
SaaS Quick Ratio = ($150k + $100k + $125k) ÷ $90k = 4.2
From the information in Table 1, it may already be clear that Company Z is growing efficiently. Company Z shows increased growth MRR (i.e., the sum of new MRR, reactivation MRR, and expansion MRR) and low churn. However, it isn’t enough to glance at the table and decide the company is growing; the exact value of your SaaS quick ratio can mean different things.
The SaaS Quick Ratio Ranges
Understanding where your company’s SaaS quick ratio falls within the industry ranges can tell you what parts of your business need improvement. For the example above, you could decide that lowering your churn rate even more in the coming months will keep your company in the green. You may be correct, but Table 2 gives you the quickest view of the next steps for your company.
Table 2. SaaS quick ratio ranges.
SaaS Quick Ratio Value
Your company may not survive another month or two.
Your company is growing, but slowly. It can be challenging to keep your company afloat if growth MRR remains the same.
Your company is growing efficiently. For every $1 lost or churned, your company is making back four times or more in growth MRR.
Use Baremetrics to monitor your SaaS quick ratio
As easy as it is to write up Company Z’s MRR in Table 1, the numbers are messier before they get to that point. Your SaaS company likely uses CRM and/or payment processing software, and the data required to compute all required MRR values can be all over the place. Integrating innovative software that can cull MRR values from CRM and payment processing systems is a valuable short cut.
Baremetrics monitors your SaaS quick ratio, computing everything from your company’s MRR as shown by your membership or subscription payments/upgrades as well as monthly churn rates. Integrating this innovative tool can make financial analysis seamless for your SaaS company, and you can start a free trial today.