The SaaS Magic Number is like mile markers during a marathon. They both serve as benchmarks to track progress and performance while striving to reach the finish line.
Metrics allow a company to evaluate its progress, identify opportunities, surpass roadblocks, and course-correct its business model as needed. One such metric that focuses on improving sales efficiency for subscription businesses is the SaaS magic number.
This finance KPI (key performance indicator) is a representation of every dollar spent on both Sales and Marketing initiatives and the resulting revenue. By keeping a close eye on this metric, you and your team will be better able to calculate company growth attributed to your Sales and Marketing efforts. It can also tell you when to shift focus from customer acquisition to customer expansion.
What is the SaaS magic number?
A SaaS company's magic number is the amount of money an organization makes for every $1 invested in Sales and Marketing. This is a critical metric to monitor, especially for startups continuously experimenting with its Sales and Marketing spending.
In order for a SaaS company to improve its revenue growth and financial health over time, it must be able to grow its ARR faster than it costs to maintain profitability. Investors love to keep tabs on this metric as it is a solid indicator of whether a startup is growing fast enough to justify its valuation.
By reviewing the company's progress in real time, business leaders can compare progress from the previous quarter to the current quarter and decide whether or not they should be making a larger Marketing investment or cutting back.
Why is the SaaS magic number so important for Finance teams?
The SaaS magic number allows teams to improve their cash flow management, optimize Marketing costs, and reduce CAC (customer acquisition cost).
So what does this Sales efficiency metric mean for organizations? It means that they can have greater insight into how they should be spending their Marketing dollars and adjust spend as needed to support future performance and annual growth.
How to calculate the SaaS magic number
By following a simple formula, this financial metric is easy to calculate. To get started, you must first take the current quarter's recurring revenue and subtract it from the previous quarter's recurring revenue. Then multiply this number by four (which is the annual run rate) and divide it by Sales and Marketing expenses from the previous quarter.
SaaS Magic Number Formula:
SaaS Magic Number = (Current Quarter ARR - Prior Quarter ARR) x 4 / Prior Quarter Acquisition Spend
By following this magic number calculation, you and your team will be better able to allocate funds where needed to support future growth.
Magic number benchmarks
In a perfect world, a company should strive to have a magic number between 1 and 1.5. This range shows that a company's efficiency is at an optimal level.
Below, we will be diving into the different SaaS magic number benchmarks so you can see whether your company is on the right track or not.
Magic number lower than .5:
A magic number between .5 to .75 signals to investors that your company is on the right track. However, any number below .5 should be a cause for concern. If your organization continues to calculate a low number, consider restructuring your business model to improve overall efficiency.
You can also use other key metrics such as Free Cash Flow, Gross Profit Margin, or Cash Runway to determine whether or not your team is spending more than it's earning.
Magic number of between .75 to 1:
A magic number of .75 to 1 is a solid position for most companies. However, with that being said, there is still room for improvement. Consider reviewing your Sales and Marketing strategy to see if there are any changes that can be made to improve performance and efficiency.
Magic Number above 1:
If your magic number is greater than 1, you are likely growing sustainably. Revenue growth should be predictable, and you can test new Marketing channels and customer acquisition models to drive incremental revenue.
However, you should also calculate your payback period, LTV/CAC, churn rate, and gross margin to gain greater insight into the performance of your company.
How to improve your SaaS magic number
Are you looking to optimize your company for rapid growth? If so, it may be time to restrategize. The following sections will review some of the key ways to improve this valuable metric.
Speed up your sales cycle
As a business leader, you already know that longer sales cycles can mean higher expenses and slowed organizational growth. It might also indicate that it will take longer to recover your Sales and Marketing investments. While speeding up the sales cycle can improve efficiency, it may also come with some unexpected drawbacks, like higher churn rates. Before shortening your sales cycle, consider your unique company and business model.
Re-evaluate paid channels and cut back where needed
Marketing activities can add up, especially when it comes to paid channels. Be sure to keep a close eye on things like LinkedIn or Google ads. Chances are high that some ads are outperforming their counterparts, which means you may have an opportunity to cut back. Take some time to optimize your ad spend, so you are not overspending on underperforming resources.
Look for low-cost, high-reward Marketing Initiatives
If you want to improve your SaaS magic number, consider working smarter, not harder. How do you do this exactly? By prioritizing low-cost, high-yield Marketing projects. A tried-and-true marketing initiative that delivers a positive ROI is content marketing. While there may be an initial investment upfront to create and optimize website content, this effort will continue to pay off for months to come by bringing in new site visitors organically.
Expand product offerings for your current customer base
You don't have to sign new customers to improve your yearly revenue growth. In fact, one of the easiest (and most resourceful) ways to improve your magic number as a business owner is to sell service expansions to your already existing customers.
All seasoned businesses know the importance of calculating the SaaS magic number. While this simple metric measures Sales efficiency, it can also be an indicator of future performance and help steer your company's strategy toward success. However, with that being said, there are a plethora of SaaS metrics business leaders should be tracking when building a startup from the ground up.
If you are looking to better track performance metrics and gain greater insight into the inner workings of your SaaS organization, consider incorporating a strategic finance solution into your day-to-day processes. FP&A software helps consolidate essential data from different sources, provide real-time information to key stakeholders, and align all senior management on the metrics that matter most.
To learn more about how an FP&A software can help your company scale, request a demo today.
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