Saas (Software as a Service) companies are drastically growing nowadays. A SaaS is a software licensing model functioning on a subscription basis. However, the profit is sometimes difficult to calculate for companies offering such services. You might have heard of the many ways to keep track of profit, such as Cash Flow, Net Income or Free Cash Flow, etc. However, the three methods that come to mind to measure the profit of a SaaS Company are Gross Margin, EBITDA, and Net Profit. Let’s take a closer look at these methods and how they can help you save a lot of time and money.
Gross Margin and COGS
The Gross Margin is the difference of revenue and cost of goods/services sold and is divided by total revenue and is represented in percentage. In order to calculate the gross margin of a company, a good understanding of COGS (Cost of Goods Sold) is needed. The Cost of Goods Sold is defined as the cost of producing the goods that are sold by the company. This includes the cost of direct labor and the materials which are used to build or manufacture the products. However, it excludes the indirect costs, such as the cost of distribution and the cost of salesforce. Gross margin is calculated by subtracting the cost of goods sold from total revenue. The formula of gross margin is as followed:
Gross Margin = Revenue – COGS
For a Saas Company, there are only the costs of delivery of the application since there is no supply to manage in most cases. The below are the common costs that are used for calculating COGS in a SaaS company:
- Fees of the third-party websites, such as networks of content delivery, etc.
- Fees for hosting
- Support personnel costs
- Customer on-boarding and costs of success
Still, the other billing costs, such as credit card fees are normally not included in the cost of goods sold in a Saas Company. Besides, there are a couple more things that are not included since they do not require anything after the customer has been signed up.
About Net Profit
Net profit or net income refers to the remaining amount of money after the expenses are paid. Since an increase in revenue does not always confirm the increase of company benefits, net profit is mostly used to indicate the company’s success and profitability. Therefore, net profit will show how much benefits are actually left. Moreover, creating net profit month after month can generally help the company grow and expand as net profit can be spent to pay off debts, to save for future expenses, and to invest in new projects or products.
The calculation of net profit is rather straightforward. It can be calculated by taking the company’s total revenue from a period of time and then subtract the total expenses from the same period of time.
Net profit = Total revenue – Total Expenses
Also, net margin can be calculated into percentage as the following formula
Net Profit Margin (%) = Net Profit/ Revenue
However, it should be noted that net profit cannot measure how much the company has earned during a period of time. This is because the income statement of the company also covers non-cash expenses, such as amortization.
Why EBITDA is advisable for SaaS
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is usually used to determine the performance of a company’s finances. Additionally, it can be used to measure the operational profit of the company because it only takes the expenses necessary to run the business on a daily basis into account. EBITDA is also one of the methods to evaluate the profits without considering other factors, such as accounting practices, financing costs, and tax tables. A calculation of EBITDA is normally simple. Mostly, it requires both the details of the company’s income and cash flow or just one of the latter.
EBITA = Operating Profit + Amortization Expenses + Depreciation Expenses
Usually, EBITA is easy and simple to calculate if the company is running on the cloud. Most SaaS Company runs on the cloud. They provide their software and services on the internet. Almost all of them can access through web browsers, such as Google Chrome and Firefox. The users can access the services on any device with an internet connection. Therefore, it is quite common for a Saas company to use EBITA to measure profits. However, EBITA can sometimes be ambiguous if you’re using it for a single measure of earnings or cash flow. EBITA often does not take all aspects of a business into consideration. Therefore, EBITA might provide an incomplete financial performance.
For a SaaS company to be successful is challenging. Analyzing the growth of its revenues and profitability can provide almost all of what is necessary for the company to assess its current state. These crucial measures should be evaluated with consideration of the current situation. In the beginning stage of the company’s growth, operational efficiencies may not have been reached yet, and the sales could be pricier than they should be. However, if the trends are in the company’s favor, the early phase can be successful. Also, it should be noted that the company can use other key metrics to evaluate profits, but should not exclude these three metrics as they are the most important ones.