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According to McKinsey's report "SaaS and the Rule of 40: Keys to the Critical Value Creation Metric," the average ART (Accounts Receivable Turnover) ratio for SaaS companies is 5.2. SaaS companies collect their receivables from customers in an average of 70 days (as of 2021, as I couldn't find free available data).
The definition is straightforward. Accounts Receivable Turnover is a financial metric used to assess how efficiently a company collects customer debts. It measures how often a business can convert its receivables into cash within a given period.
Using a 5th grader's logic, we can explain it through the following example. Imagine you have a lemonade stand where some customers pay you right away, and some take a promise note to pay later. Accounts Receivable Turnover is like counting how many times a year you get all your promise notes turned into actual cash. If you can turn those notes into cash many times a year, you are doing a great job getting your money back fast!
Okay, let's get into the metric formula after drinking all that lemonade.
Accounts Receivable Turnover = Net Credit Sales/ Average Accounts Receivable
Net Credit Sales: These are the sales made on credit minus returns or allowances.
Average Accounts Receivable: This is calculated by adding the opening and closing balances of accounts receivable for a period and dividing by two.
There are plenty of reasons why this metric matters to your Saas company. In practical terms, the swift collection equals better cash flow. That's universal, considering Business 101. The typical SaaS companies operate on a subscription-based model, where consistent and predictable cash flows are fundamental to their success. That's one of the reasons why this model has been created. As indicated by a high ART, efficient collection processes ensure the company has a steady cash stream. It means you have a healthy SaaS business at the core model. Remember that not every revenue stream is treated and evaluated the same for the same reason. The cash from the ART is helping you finance your organization's sustaining daily operations. Regular expenses like payroll, server costs, and office leases require a constant cash inflow. Another underlying fundamental is the ability to fund growth initiatives your go-to-market and product team brings up. Investments in product development, new market expansion or segmentation, and customer acquisition with new marketing campaigns are essential for a SaaS company's growth and require substantial financial resources. The last one is the financial stability that must be accentuated enough. A healthy cash flow provides a buffer against market downturns and unexpected expenses, contributing to the company's overall financial stability. The more you collect and collect fast, the better you are.
Other benefits relate to the customer payment behavior. For instance, a high ART ratio can indicate a company's customer base's financial health and payment behavior. In the SaaS industry, where recurring revenue models are the norm, it's crucial to have clients who pay their dues timely. Remember that while you secure your deal with the 12, 24, or 36 months or more deal term, the customer's financial health might change during the contract term. That's why when you observe prompt payments, you are ensured that reliable revenue streams are in place. That also means they are forecastable (means predictable). Monitoring ART helps identify changes in customer payment patterns, allowing for proactive credit risk management. These are not easy actions, but you can consider multiple like adjusting your credit policies, engaging with an external credit agency, diversifying your customer base (distribution), etc. Since these efforts take time to give you a return, early reading out of that metric and awareness of the trend help to improve the timing of these efforts.
The ART ratio is not just a financial metric; it reflects a company's operational efficiency, particularly in its credit and collection policies. In a competitive field like SaaS, where customer relationships are key, efficient policies are determined by balancing the risk and accessibility and optimized collection efforts. We see this very clearly now with the companies that struggle to renew. At the same time, their solution is dispensible or operates on the peripheries of the core activity of the organizational setup or function. There is a lot to unpack here, but for now, I'll refer to a mechanism or policy that explains how to deal with non-payment or overdue accounts, encouraging the companies to pay you. In other words, you know what to do if something goes wrong.
Let's try to think about the hypothetical SaaS company, "CloudTech Inc.," which specializes in cloud storage solutions. This table describes the components and logic of the ART calculator.
Based on these calculations, a slight decrease in the turnover ratio from Year 1 to Year 2 indicates a minor slowdown in collections or increased credit sales. I wouldn't call it a trend, but it could have been if we had more FY data.
Another conclusion from the table is that the ART of around 8x is considered healthy in the SaaS industry, suggesting that, on average, CloudTech Inc. collects its receivables about 8 times a year, or roughly every 45 days. If you think about it, it's not bad, but this example doesn't tell us the volume of these deals the company operates with.
Is 45 days excellent or bad? To illustrate this, I created a demonstrative comparison of well-known companies that at some point reported their data that allow you to calculate that from their 10-Q report:
Please remember that each of these companies is very complex, including their offerings, payment terms, etc. It's never an apple-to-apple comparison, but it gives you an idea of how the market operates and what your benchmark should be. In the end, there is a reason why these companies have a significant reported cash flow.
Conclusion
The Accounts Receivable Turnover is a vital metric for SaaS companies, offering insights into their financial health and efficiency in debt collection.
Regular monitoring of this ratio can aid in maintaining a healthy cash flow, optimizing credit policies, and making informed business decisions. While reporting and monitoring are primary domains of finance and operations, go-to-market teams often need to be made aware of their contributions to these metrics. I wouldn't recommend focusing their time on these as a critical metric. Still, they should participate in the financial reviews with a clear understanding of why the company is creating specific policies and why these must be in place. I've seen this too many times where one side is trying to close the deals to retire quota while finance is left with the high cash flow risk customers that are not bringing enough money to the company. Revenue operations must handle these translations in the form of reasonable policies. A few recommendations for the GTM teams on contributing effectively to ATR metric:
Customer selection: prioritizing relationships with financially healthy customers with a track record of timely payments can improve ART. It might involve refining customer acquisition strategies to target more reliable customers.
Clear payment terms: offering clear, concise payment terms and potential incentives for early payment can encourage quicker turnover. Sales teams should be well-versed and communicate these terms effectively to customers.
Proactive credit management: monitoring ART can provide early warnings about changes in customer payment behaviors, allowing sales and marketing leaders to adjust strategies accordingly. It might involve collaborating with finance teams to refine credit policies or to engage in proactive outreach to customers showing signs of delayed payment. Consider this criterion to help you improve your account assignment to your reps and potentially overall segmentation exercise.
Leveraging Technology: Implementing or improving automated billing and payment systems can reduce delays in invoicing and payment processing, thus improving ART. Automation in this space is always critical. Many of these monitoring or action triggers can be automated if you implement suitable systems. Your CSM team can handle them effectively before seeing the pattern in your customer base.
Training Sales Teams: Ensuring your sales team understands the importance of ART and how their actions impact it can lead to more mindful sales practices that align with the company's financial health. An alternative way to handle this is to de-incentivize the deals that are not converting or paid on time. That could be designed and embedded in your sales compensation model.
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