How to Calculate Churn and Retention in SaaS

Guide to Churn and Retention Metrics

You’ve often heard that churn is a company killer for SaaS and subscription businesses.  To be more specific, high customer churn and long CAC payback periods will most definitely burn through your cash and ultimately lead to the demise of your business. 

Therefore, it’s critical to track, monitor and improve the health of your recurring revenue stream which is the engine of every SaaS business.  In this post, I will walk through some of the prominent churn and retention metrics that you should be tracking in your SaaS or subscription business. And I’ll dive into exactly how to calculate churn and retention.

Of course, the SaaS community loves metrics.  There might be other churn metrics, but the metrics below are the numbers that I track monthly. 

And, at the bottom of the page, you can download a free Excel template that will help you track, calculate, and dashboard (yes, I used that as a verb) your churn, bookings, and retention metrics.

Why is Churn Important to Track?

Let’s start with the “why.”  Recurring revenue is what you live for in a SaaS business model.  It pays the bills and drives a majority of your company’s valuation.  Therefore, as a manager of your business, you need a deep understanding of the variables and levers that affect your recurring revenue stream. 

There are many layers affecting your recurring revenue.  For example, you are acquiring new customers each month but also losing customers each month.  Your existing customers may be purchasing more product or getting rid of product.

There are a lot of little currents within that revenue stream, and it’s important to become intimately familiar with each one.

What is Churn?

Let’s start with the basics.  Churn means a lost customer, user, or any other way you track paying entities.  Your customer signs up for a subscription product and decides later to leave you.  That is churn.

Churn is tracked both on a dollar basis and customer basis.  For example, I lost three customers last month and $30,000 in annual subscriptions.

How to Calculate Churn

Let’s start with customer churn first.  When speaking about churn, you commonly hear monthly or annual churn referenced.  Stating it as monthly or annual makes it more understandable and relatable.  However, the actual measurement of churn can be over any time period.  You can measure, monthly, quarterly, semi-annual or annual.  And then annualize as needed.

If churn has changed dramatically, for example, in the last quarter, you can measure churn over that quarter and multiply by four.  Typically, SaaS businesses that invoice month-to-month and have lower price points, measure and communicate churn as monthly.  Mid-market and enterprise SaaS will measure and communicate churn as annual.

I measure monthly churn and churn for the trailing twelve months (TTM).  Why both?  When calculating the TTM churn, month-to-month spikes in churn will be smoothed out in the TTM number.  Therefore, I show a chart with monthly and TTM churn, so you can zero in on any monthly spikes in churn.

Monthly Customer Churn Formula

Trailing Twelve Months (TTM) Customer Churn (Annual Churn)

Revenue Churn or Dollar-based Churn

Now for dollar-based churn or revenue churn.  Same formulas apply, but we replace customers with dollars or revenue.  I live in the ARR world, so I am using ARR (annual recurring revenue) in the formula.  But if you invoice month-to-month, you can replace ARR with MRR (monthly recurring revenue) in the formulas below.

Revenue Churn

Trailing Twelve Months (TTM) Dollar Churn (Annual Churn)

The Complete Revenue Picture

But when we think about churn, we often visualize much more than just lost customers.  That would provide an incomplete picture and just one-quarter of the puzzle.  To complete the revenue picture, we must also track expansion, downgrades, and new.

Churn – lost customer or paying entity.  They cancel completely. 

Expansion – existing customer who buys more product.  Track the net dollar expansion, not gross.

Downgrade – existing customer who reduces the amount of product.  Track the net downgrade, not gross.

New – new customer acquired.

And as you can see in the definitions above, you not only track customers, but you also track dollar amounts.  Just like our churn example.  In the case of downgrades and expansion, it is important to track the net expansion only (not gross).

For example, if customer ABC is paying $1,500 in the first year and renews in the second year at $2,000 by purchasing your advanced module, the net expansion equals $500.  Same process for downgrades.

SaaS Retention – Two Forms

Ok, we just reviewed the components of your revenue stream above, but what happens when you combine these components into one SaaS metric?  It is called revenue retention and customer retention.  Of course, we live in the SaaS world, and there are many terms that describe retention. 

Net Revenue Retention

You may have heard of net negative churn or net revenue retention.  Different words, same concept and metric.  Net revenue retention explains the net movement (inflow/outflow) of ARR/MRR within your existing customer base.  As a side note, this is not cohort analysis which is something similar but different.

Again, net revenue retention focuses just on your existing customer base.

Gross Dollar Retention

And THEN you may have heard of gross dollar retention or dollar retention.  This is a smaller subset of net revenue retention.  Gross dollar retention is lost dollars from your existing customer base.  Lost dollars meaning churn and downgrades.

Again, you can replace ARR with MRR.  And you can measure over different time frames.

Software Bookings and Churn

I mention bookings a lot in my posts and models, and you can’t talk about churn and retention without talking about bookings.  A software booking is an executed contract between you and your customer for a subscription product (any maybe services, too). 

Understanding churn is not just tracking your lost customers, but also the net inflow and outflow of customers and dollars in your business.  And to do that, you must track all of your bookings (i.e new, expansion, downgrade).

In the MRR, pay with a credit card world, I see less talk about bookings.  But in the mid-market to enterprise world with multi-year contracts, a booking is common language and tracked religiously.

So, with tracking churn, you also track your bookings at the same time.

Time Frame is an Important Churn Consideration

Time frame is the wild card in the churn equation.  Again, this is not cohort analysis.  If your customers churn in less than twelve months on average, you would not want to use the trailing twelve months as a time frame.  Why?  Because your denominator (customer balance) did not even reflect the customer that you gained and then lost within the time period that you are measuring.

Therefore, you would likely measure monthly and quarterly churn.  If measuring quarterly churn, just multiply by four to annualize.  And I would measure on a rolling quarterly churn number.

The time frame you select depends on the volatility or stability of your customer base.  I suggest measuring different time frames to see how the results vary.

Summary

Your recurring revenue is the engine of your business.  It’s important to track and understand the multiple layers of your recurring revenue stream.  It impacts product decisions, operations, and company valuation. 

Even if you have no data tracked, it’s never too late to begin tracking your bookings and churn data.  Before you know it, you will have six months of historical and important data that will help guide company decisions. And my template below will show you exactly how to calculate churn and retention. 

Action Items

• Download my churn template below
• For the most recent closed month, enter your bookings and churn data
• Repeat every month
• Distribute the dashboard to your management team monthly
• Discuss churn and retention trends
• Track why you won key customers and lost key customers (saves you time when in M&A mode)

What churn and retention metrics are you tracking? I would love to hear in the comments section below.

Download my free template below.

Subscribe & Download