SaaS profit margins: how to calculate them and what are the benchmarks?
SaaS profit margins: how to calculate them and what are the benchmarks?
SaaS businesses are very popular because their operational leverage creates the potential to generate substantial returns. While a SaaS company/startup usually requires a substantial investment to develop a minimum viable product (MVP), SaaS profit margins tend to improve rapidly on the condition that there is a good product-market fit and cash is invested responsibly. This will ultimately translate into a healthy net profit and net profit margin.
Net profit is the last line on the income statement. It is the difference between net revenues and all the expenses. Between net revenues and net profit, there are several subtotals, such as gross profit, operating income (EBIT), and EBITDA. All these items can be expressed as a percent 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. The groups are:
- Cost of Service: the expenses that are directly linked to the sale of the product or service
- R&D expenses: additional software development costs
- Sales and marketing expenses
- General and administrative expenses
- Interest expenses and income taxes
A typical SaaS Profit & Loss Statement (P&L) Decomposed
By expressing the entire income statement as a percentage of net revenues, you can compare your profit margins with other SaaS businesses or SaaS profit margin benchmarks.
Nevertheless, keep in mind that there might be a good explanation why your SaaS profit margins deviate from the benchmark values. Here are some reasons your margins might be different:
- Business model variation
- Your company is at an earlier or later stage than those you’re comparing against. At an early stage, R&D and marketing and sales expenses might be a higher percentage of revenue because the product is immature and the company is not well known.
- Your company might be incorporated in a different country or carry a different capital structure or income tax rate.
- You may have different accounting practices. For example, some SaaS companies include customer support in Cost of Goods Sold, and some don’t. (Be careful: if your accounting practices get too creative and don’t reflect typical approaches for your industry and country, people may lose trust in your numbers!)
While the data from publicly traded companies are easy to find, they aren’t always good comps for SaaS startups.
Private SaaS company metrics are usually a closely-guarded secret. However, KeyBanc Capital markets publishes a great annual survey on private SaaS companies. Their most recent survey In 2021 included 354 companies. The companies were predominantly located in the US (67%), Europe (16%), and Canada (8%). More than half of the sample was VC-backed. The 2020 median company generated $8.5 million in annual recurring revenue (ARR) from 280 customers and had 75 employees.
SaaS profit margins: What do the benchmarks say?
Net revenues, Cost of Service, and SaaS Gross Profit margin
The most important driver of net income is revenues. The number of licenses sold, the price point, and the product mix are essential to understand your company’s revenues growth. Your subscription model (monthly/annual) and your business model (B2B or B2C) will impact your revenues and cost of service build (see our guide and template for sales forecasting for more on this).
SaaS companies selling to businesses, and especially to large businesses, 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 (the revenue is stickier).
According to KeyBanc Capital Markets, the 2020 median subscription gross margin, calculated as gross profit divided by total revenues, is 80%. The gross margin drops to 73 if the cost of customer support is included in the Cost of Goods Sold (COGS). These percentages remain quite stable for companies between $5 million to $100 million in revenue.
Marketing & Sales, General & Administrative (SG&A), and R&D expenditures
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 5 years from 2016 to 2021. As you can see below, over those five years, Atlassian’s gross profit margin has expanded slightly, R&D spend as a percentage of revenue has been relatively stable, but marketing and sales and general and administrative costs have gotten more efficient as the scale of the company has grown, shrinking from a combined 39% to 33% of revenue. That 6 point difference in efficiency has driven 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,(below), they spent significantly fewer resources on sales and marketing, but much more on R&D. (They are quite famous as an 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.
So, Atlassian was highly efficient and effective in acquiring new customers. If you have the ambition to also become highly successful, we strongly recommend you to track some important SaaS metrics, such as SaaS magic number, Payback Period, Customer Acquisition Cost (CAC), and Customer Lifetime Value (LTV), in addition to SaaS profit margins and operating expense ratios. If you are not sure how, we have you covered. We prepared an in-depth article and FREE downloadable template to get you up to speed:
