SaaS, or software-as-a-service, is a frequently overlooked business model that is increasingly becoming more popular with the social distancing and work from home orders. SaaS is a business model where a service, either an application or program, is delivered through the Internet and hosted remotely by the software provider. The main advantage of SaaS is that companies and individual customers can access the service directly via Internet instead of having to install hardware. This not only means that it is cheaper, can be accessed from anywhere with Internet connection, but also that updates can be "pushed" automatically without the customer having to take any action. While this sounds great, not all SaaS businesses are built the same. Some are more profitable than others and some are able to retain customers better.
Here are some of the main SaaS metrics to be familiar with before investing in a software business:
1.Cost to acquire a customer (CAC): this is the sum of all the sales and marketing expenses, which are customer acquisition related expenses, over the number of customers added in that time period. This tells you the cost to acquire one customer.
2.Customer Lifetime: this is the average time for which the company retains a customer. This is defined as one over the churn rate and can be expressed in months, years etc... Churn rate should not be more than 15-20%.
3.Average revenue per account (ARPA) = This is the average revenue that the company receives from each customer (or "account"). This is found by taking the total monthly recurring revenue over the total number of customers.
4.Lifetime value of customer: this is the average revenue per account (another way of saying "the average dollar value received from each customer" or ARPA) over the churn rate. Alternatively, it can be defined as the ARPA/churn or ARPA*lifetime. Lifetime value : cost to acquire a customer should be above 3 in a healthy company.
5.Recurring Revenue: This is the heart of a software business. Recurring revenue allows a software company to better predict/forecast future revenue.
6.Bookings: This is a contract made with a customer that defines their commitment to pay the company money over a certain period of time in return for the service (access to the software).
7.Billings: A company can only "bill"/recognize revenue when the service has been delivered. For example, if a $12,000 deal was signed for a year, only $1000 is recorded as revenue each month. The rest is deferred revenue which is considered a liability because it is a service that the company has to provide in the future months. This is often a better looking indicator of the health of a SaaS company than simply bookings because a company can seem profitable but it could simply be just working off of its backlogged Billings.
8.Backlog: This is the revenue that has not yet been recognized / "booked" because service was not completed.
This is of course just the beginning to analyzing a SaaS business. One must also evaluate the software itself, customer base/market profile, as well as the company's competitive landscape.