# Advanced KPIs: Software-as-a-Service – Magic Number

This is part 2 of our series on Advanced KPIs, previous segments are available in our archives.

Software-as-a-Service: Magic Number

As we discussed previously, Sales Efficiency can help you make decisions about your sales & marketing spend by measuring how much revenue you generate from every \$1 you spend. (Hint: If you generate more than \$1 you should spend more.)

However, it can be hard to calculate Sales Efficiency if your company is a Software-as-a-Service (subscription). For subscription businesses it is hard because you will not know how much revenue you generated from January sales until 12 months later! This is why SaaS businesses use a metric called the Magic Number.

You calculate your Magic Number by taking the amount of incremental revenue you generate in a given quarter, multiply it by 4 and divide it by the sales and marketing spend for the previous quarter. For example, if you spent \$10k on sales and marketing in Q1 and generated \$5k of incremental revenue in Q2, then you would calculate your Magic Number as:

Why do you multiply the incremental revenue by 4? You are estimating how much that new business will be worth over 12 months (4 quarters) instead of waiting 12 months to find out. This shortcut allows you to calculate your Magic Number every quarter and make changes immediately instead of waiting a year! (More explanation here)

That sounds like hocus pocus.

Ha, that’s a pretty good pun. Seriously, though, you are right that it seems dangerous to extrapolate revenue by simply multiplying by 4. Let us break down the strengths and weaknesses of the Magic Number.

The Good

• You can calculate the Magic Number and make decisions quickly, before you know the Lifetime Value of your customers (LTV). This makes it useful in the early stages of a product or service which might not have years of data.
• Subscription businesses are typically very stable, so simple multiplication can be a fairly accurate projection of future value. In many SaaS businesses, the Quick Ratio projection can be over 90% accurate.