How the Best Fractional CFOs Measure Financial Efficiency: 8 Ratios for Evaluating Your Business
Updated: Aug 1, 2022
Entreprenuers and Startups need to have a deep understanding of their company’s financial efficiency at any moment. The Summit Group explains which metrics are important for measuring financial efficiency and how to improve efficiency.
Eight of the Best Financial Efficiency Ratios to Track
Financial efficiency ratios and metrics are powerful tools finance teams use to craft a company’s story. Like a chapter of a book, each ratio is powerful on its own. But when brought together, your corporate finance team can not only tell executive leadership, key stakeholders, and shareholders what the company’s path to growth looks like but apply a strategic lens to it.
But what are the most important ratios to analyze a company? There’s no definitive list, and the context of your company matters.
Liquidity ratios would matter to public companies but mean less for early-stage startups. An eCommerce business needs to track metrics like inventory turnover/asset turnover ratio, whereas software businesses don’t. And hardware businesses need to have a firmer grasp on supply chain efficiency and large-scale depreciation.
But for SaaS businesses, in particular, the following eight measures of financial efficiency should be top of mind.
#1 - SaaS Magic Number
The SaaS Magic Number is a sales efficiency metric that provides a holistic understanding of your business growth rate. This metric looks at the dollars’ worth of revenue created (ARR) for every dollar spent acquiring new customers (customer acquisition cost, or CAC) through marketing and sales. Here’s how you calculate it:
Once you have your magic number (which you measure on a scale of zero to one), you can understand how efficient your marketing and sales efforts are and whether you need to invest more (if the number is greater than 0.75) or less (if the number is less than 0.5) into those efforts.
#2 - Rule of 40
The Rule of 40 is a metric that balances growth and profitability against each other to determine the company’s sustainability. You calculate it by adding your growth rate and profit margin percentages together.
Ideally, when you calculate your Rule of 40, it should equal 40% or higher. That’s the common benchmark for sustainable growth (especially for later-stage SaaS companies).
#3 - LTV:CAC Ratio
Another sales and marketing efficiency metric, the LTV:CAC ratio, determines ROI per customer. You calculate the ratio by dividing customer lifetime value (LTV) in the numerator by CAC.
With the ratio, you can look at the long-term feasibility of your customer acquisition tactics and proactively make any necessary changes.
#4 - CAC Ratio
Customer Aquistion Cost plays a role in many of the ratios above, as it measures the cost to acquire a new customer. But the CAC ratio itself drives conversations around the success and improvement of current and future sales and marketing campaigns. Here’s the formula to calculate it.
When you calculate this ratio, you compare marketing expenses to new and expansion ARR to discover the percentage of new customers you need to gain to recoup that month’s sales and marketing costs in one year.
#5 - Net Revenue Retention
Retention is a critical component of a business’s growth trajectory. Net revenue retention determines not only the value of your product for current customers but their satisfaction with other product factors, such as pricing, reliability, and customer service.
The common benchmark for strong NRR is 120%, which means your SaaS revenue is snowballing as existing customer accounts gain in value over time rather than churning. Strong NRR indicates that you could experience high growth that doesn’t rely entirely on new customer acquisition.
#6 - AR Turnover Ratio
Divide net credit sales by your average accounts receivable. Again, as customer acquisition and retention fluctuates, it’s best to calculate AR turnover per month versus multiplying it by 12.
#7 - Net Sales Efficiency
Net sales efficiency accounts for new customer acquisition and churn by looking at sales and marketing spend alongside new ARR. This metric provides a target rate of return for your sales and marketing activities. And it also accounts for the impact your customer success team has on retaining customers.
Teams often calculate net sales efficiency on a per quarter basis. Take your net new ARR for the quarter, then divide it by the sales and marketing spend for the quarter. If you want to calculate per month, change ARR to MRR.
#8 - Human Capital Efficiency
A company’s growth relies heavily on effective headcount planning, which is the single biggest expense impacting profit and revenue. Human capital efficiency measures the number of employees across the organization to determine how many it will take to sustain current ARR and create a forecast for new ARR. Inefficiency in this metric could point to issues in customer acquisition or misaligned ratios for department-level resources.
To calculate your human capital efficiency, take your total ARR and divide it by the number of full-time employees.
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