SaaS Quick Ratio - How to Calculate it, Definition, and Benchmarks

Why is the SaaS quick ratio important?

The SaaS quick ratio offers insight into the cash flow and sustainability of your business. Here are three major reasons the SaaS quick ratio is important.

1. Offers a qualitative snapshot of your revenue position 

The SaaS quick ratio shows you how much recurring revenue is flowing in and out of your business. It measures the number of dollars you are earning for every dollar of revenue you lose to churn. It also tells you how churn is affecting your growth. 

These insights are the reason investors often use the SaaS quick ratio to evaluate the risk and viability of investing in a business. 

2. Shows you where your revenue is headed

Your SaaS quick ratio is a directional metric that tells you where your revenue is heading. It helps to answer the question: Is MRR or ARR rising or falling?

3. Tells you how much churn you can absorb

Given how important growth is from a valuation standpoint, you can reverse engineer the SaaS quick ratio formula to determine your worst-case churn. Plugging your minimum acceptable SaaS quick ratio and targeted growth rate into the formula, you can determine the maximum churn rate your company can absorb to maintain sustainable growth. If your current churn rate is higher than your result, you must reduce churn before attempting to increase MRR or ARR. 

How to calculate the SaaS quick ratio?

You can calculate your SaaS quick ratio using the following formula: 

You can also use an alternative formula, created by venture capitalist Tomasz Tunguz, which you can use to figuring out the growth rate you need to achieve a specific Quick Ratio number using just your churn rate or vice versa: 

In the above formula, the annual rates can be replaced with monthly rates.

Let’s take a look at how to use these formulas.

Example of a SaaS quick ratio calculation

Here’s the data we have for SaaS company A:

• $400,000 new MRR
• $120,000 expansion MRR 
• $150,000 revenue churn
• $30,000 contraction MRR 

To apply Tomasz Tunguz’s formula, let’s take the data for SaaS company B:

• 24% annual recurring revenue growth rate (which equates to ~2.26% monthly growth rate)
• 12% annual dollar churn rate (which equates to ~1.06% monthly dollar churn rate)

SaaS quick ratio = ( 24% + 12% ) / 12% = 3‍‍

What is a good SaaS quick ratio?

It’s been empirically observed that a company’s revenue growth rate has historically had a higher R² correlation to EV/NTM multiples compared to other metrics such as GRR, NRR, gross margin, etc. Better predictors such as the Rule of 40 and Rule of X have growth rate as one of their components which shows how important it is to optimize this metric.

SaaS quick ratio benchmark numbers provide one way to do this by placing your business’ revenue growth in context with churn and contraction revenue.

According to Mamoon Hamid, four or higher is a good number for your SaaS quick ratio. This means that a SaaS company can survive churn if its growth in bookings is four times more than its contraction. While this metric points to the health of your business’s net revenue, you should consider the context of this growth when interpreting it.

‍ Note that early stage companies might have quick ratios greater than four since they’ll experience faster growth. In addition, they’ll have fewer customers compared to mature companies, leading to lower potential churn. Early-stage companies will also have spent less time in the market and might not have reached a point where their customers begin churning.

The impact of churn 

Does high churn really matter as long as you are growing revenue? Yes, it does.

It's far less expensive and more profitable to retain existing customers than to acquire new ones. According to Bain Capital, an increase of 5% in retention can boost profits by as much as 95%. In tough macroeconomic times when you’re looking to grow efficiently and cut costs at the same time, preventing churn and prioritizing retention is essential.

The SaaS quick ratio illustrates the outsized impact churn has on your growth rates. 

Plugging a quick ratio of 4 (the ideal quick ratio) and an average annual dollar churn rate of 10% into the SaaS quick ratio formula gives an ARR growth rate of 30%. Let’s calculate the growth rate you need to maintain assuming churn and ARR growth rate increases over time.

• If the quick ratio is 4 and churn increases to 15% you will need a 45% growth to maintain a sustainable cash flow. 
• If churn increases to 20%, you’ll need a 60% growth rate to maintain a quick ratio of 4.
• At 30% churn you will need a 90% growth rate to maintain a quick ratio of 4. 

As churn rises, sustaining a commensurate growth rate becomes highly unsustainable. At 30% annual churn (i.e, 2.93% monthly churn), you will need to grow your ARR at 90% annually (i.e, ~17.5% monthly) to keep up. You might grow by that amount for a month or two and keep up. But, that kind of growth is likely not sustainable in the long run especially in the current economic climate which demands efficient growth. 

Put another way, the quick ratio tells you how much you’re losing per dollar earned in bookings. A quick ratio of two tells you you’re losing 50 cents for dollar earned. Not an appealing picture to investors since you’re losing half your bookings every month.

It is far easier to prioritize reducing churn than increasing growth to overcome your company’s churn rate.