Economics Posts

Common ways of miscalculating and misinterpreting SaaS unit economics

When it comes to measuring subscription businesses, unit economics are crucial.

Miscalculating or misinterpreting these numbers can be really harmful for your business.

This set of metics will tell you if you’re building a sustainable business, and that is only possible with profits. One can say that making no profits is not necessarily bad, pointing Amazon as an example.

Amazon haven’t been profitable for years and still a very successful business. There are good reasons why one would raise capital and make investments that lead you to be unprofitable – like hiring new sales people and accelerating sales on a SaaS business – but they key point here is availability of capital fueling faster growth.

Despite investments, let’s see how to avoid miscalculating or misinterpreting your unit economics.

ARR vs ACV vs TCV

What comes to your mind when you read the letters ARR?

Well, if you’re in the financial market you may refer to the NYSE:ARR stock, if you’re a tech guy you may think of Application Request Routing; but for us SaaS professionals, ARR means two things only: Annual Run Rate and Annual Recurring Revenue.

Although both metrics are related to your business revenue, they mean two very different things.

EBITDA vs Gross Margin vs Net Profit

We recently discussed how revenue should be recognized in a SaaS company, comparing it to bookings and billings, and it’s pretty straight forward.

Profit is harder to define. There are multiple ways to keep track of it, with metrics such as: Operating Income, Net Income, Free Cash Flow, Cash Flow or something else. One of the most used metrics across the SaaS industry is EBITDA, but still, it can get confusing due to the way we recognize revenue.

The three most common metrics used to measure a SaaS company profit are EBITDA, Gross Margin and Net Profit. Let’s explain in details each one of these metrics.

The rule of 40% for SaaS and subscription business

The famous investor and also founder of TechstarsBrad Feld — recently wrote a post on this blog titled “The Rule of 40% for a Healthy SaaS Business”. A couple of days later, Tomasz Tunguz an also famous venture capitalist at Redpoint Ventures also wrote a post about it, titled “The Data Behind The Rule of 40%”.

These are both awesome blog posts, and this one you’re reading now is a compilation of pretty much everything you need to know about the much discussed topic.

Why should you offer yearly billing to your SaaS customers

Yearly billing can make all the difference in the world for the health of your SaaS business, and I’m going to show you why.

The way a company decides to bill its customers will directly impact revenue streams needed to maintain cash flow and business operations. If you’re building a SaaS company looking for a recurring revenue model, you should take some time to carefully choose your billing period/options.