Measuring your company’s margins against industry SaaS growth benchmarks
SaaS businesses are popular because their operational leverage creates the potential to generate substantial returns. While a SaaS company or startup usually requires a significant investment to develop a minimum viable product (MVP), SaaS gross margins tend to improve rapidly on the condition that there’s a good product-market fit and cash is invested responsibly. Ultimately, this will translate into a healthy net profit margin.
But how do you know if your profit margins are healthy? In this guide to Saas profit margins, we’ll explore how you can measure the success of your SaaS business against industry benchmarks by calculating your expenses as a percentage of your net revenues.
Net profit is the last line on the income statement. It’s the difference between net revenues and the total of all expenses.
Between net revenues and net profit, there are several subtotals, such as gross profit, operating income (EBIT), and earnings before interest, taxes, depreciation, and amortization (EBITDA). Each of these items can be expressed as a percentage of net revenues to calculate the gross profit margin, EBIT margin, EBITDA margin, and net profit margin.
There are several groups of expenses that need to be subtracted from net revenues to get to net profit:
Each of the above expense items can be used as a benchmark for measuring profitability by calculating it as a percentage of your net revenues. This helps you quickly and efficiently gauge how healthy your SaaS business is compared to direct and indirect competitors.
Below is a chart that breaks down each of these expense categories.
Now that you understand that each income statement item can be expressed as a percentage of net revenues, you can see how to obtain a SaaS gross margin calculation. By expressing each item on an income statement as a percentage of net revenues, you can compare your profit margins with SaaS growth benchmarks.
Keep in mind, however, that there might be a good explanation for why your SaaS profit margins deviate from the benchmark values.
Here are some reasons your margins might be different from your benchmarks:
While the data from publicly traded companies are easy to find, they aren’t always good comparables for SaaS startups to measure their margins against. Private SaaS company metrics are usually a closely-guarded secret, but industry surveys can give us a good idea.
The 2021 KeyBanc Capital Markets annual survey on private SaaS companies surveyed 354 companies (KeyBanc Capital Markets, 2021). The companies were predominantly located in the US (67 percent), Europe (16 percent), and Canada (8 percent). More than half of the sample was VC-backed. In 2020, the median company generated $8.5 million in annual recurring revenue (ARR) from 280 customers and had 75 employees.
Below we review some calculations SaaS businesses can make using net revenues, cost of service and gross profit margins, as well as marketing and sales, general and administrative, and R&D expenses.
The most important driver of net income is revenues. The number of licenses sold, the price point, and the product mix are essential to understanding your company’s revenue growth. Your subscription model, whether it’s monthly or annual, and your business model, whether it’s B2B or B2C, will impact your revenues and cost of service.
For more information, see our guide and template for sales forecasting.
SaaS companies selling to businesses, and especially to large ones, usually bear a much higher upfront customer acquisition cost (CAC) than companies selling to consumers. However, business customers generally pay much higher prices and have lower churn rates. In other words, the revenue is stickier.
According to the survey by KeyBanc Capital Markets, the 2020 median subscription gross margin, calculated as gross profit divided by total revenues, is 80 percent. The gross margin drops to 73 percent if the cost of customer support is included in the COGS. These percentages remain quite stable for companies that earn between $5 million and $100 million in revenue.
While subscription-based software companies can become very profitable in the long term, the point of net profitability might take a long time to reach.
For example, Atlassian Corporation, the highly successful software company behind Jira and Trello, booked its last net profit in 2016, despite more than quadrupling its revenues in the five years from 2016 to 2021.
Over those five years, Atlassian’s gross profit margin had expanded slightly and R&D spend as a percentage of revenue had been relatively stable. However, marketing and sales and general and administrative costs had become more efficient as the company scaled, shrinking from a combined 39 percent to 33 percent of revenue. The six-point difference in efficiency drove their operating income margin into profitable territory.
On an operating level, Atlassian Corporation only became profitable in 2020 because the company invested heavily in earlier periods, choosing vigorous growth above profit margins. Comparing Atlassian’s margins with typical SaaS profit margins, they spent significantly fewer resources on sales and marketing but much more on R&D. In fact, they are a well-known example of product-led growth, and the financials reflect it.
Their G&A expenditures in the high teens are in line with the SaaS profit margin benchmark, demonstrating that Atlassian has been efficient and effective in acquiring new customers.
Besides those mentioned, other important SaaS metrics to track include SaaS magic number, payback period, customer acquisition cost (CAC), and customer lifetime value (LTV), in addition to SaaS profit margins and operating expense ratios.
Tracking and benchmarking your SaaS profit margins by calculating your expenses as a percentage of your net revenues is a fast and effective way to know where your company stands relative to your competitors. Whether you look at your sales and marketing expenses, R&D costs, or other vital SaaS metrics, dissecting your income statement can help you take stock of important industry benchmarks.
SaaS companies have unique metrics to look at that can help Finance leaders better understand the health of their business. If you want more information on measuring SaaS metrics, we have you covered. We’ve prepared a free downloadable template and in-depth article to get you up to speed. See What does the SaaS magic number mean for business growth?
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