Do you know the definitions of MRR vs. ARR and how to calculate them? These are key metrics for software as a service (SaaS) organizations. Annual recurring revenue (ARR) and monthly recurring revenue (MRR) both address the company’s financial performance, however they differ in timeframe, calculation, flexibility, and comparability.
Let’s start with the ARR definition in SaaS – this is a measure of the total value of recurring revenue generated by a SaaS company on an annual basis. Essentially, ARR provides an indicator of the overall health and scalability of a business. MRR is another key performance indicator (KPI), however it measures the total monthly revenue generated by a SaaS company.
A Closer Look at MRR vs. ARR
Let’s dive a bit deeper into ARR and MRR, their importance, key differences, how they are calculated, and which to use and when. Both ARR and MRR are widely used metrics among organizations that generate recurring revenue. While both provide insights into predictable revenue streams, they differ on types, relevancy, and calculations.
Understanding ARR
Simply put, ARR is the value of recurring revenue that a SaaS business earns from its subscribers, normalized to a one-year period. Your projected ARR is a metric used to predict the total amount of revenue the business will accrue on an annual basis.
The Importance of ARR
As previously discussed, ARR (as well as MRR) are critical metrics in addressing the financial health of the business. However, the importance of ARR doesn’t end there.
- Financial reporting: ARR is a standard metric used in annual reports and financial statements to depict the business’s overall health and financial performance.
- Revenue visibility: This metric provides a clear picture of the company’s future growth trajectory.
- Revenue forecasting: ARR provides the company with the ability to more accurately forecast revenue and cash flow.
- Budgeting: With a more precise understanding of revenue and cash flow, companies can better plan expenses and spending.
- Competitive benchmarking: By comparing ARR to industry peers and competitors, SaaS companies gain a better understanding of their market position and areas that may require improvement.
- Investor appeal: Used for long-term investment purposes, investors often use ARR SaaS to assess a business’s value and future potential.
Types of ARR
While there are a variety of ARR types, the five most common include:
- Add-on ARR: ARR is derived from additional features or services purchased by existing customers.
- Subscription ARR: The most common type of ARR, it refers to customers that pay a recurring fee for products or services.
- Tiered ARR: This type of ARR offers customers different pricing tiers or plans.
- Usage-based ARR: ARR is based on the consumption of a product or service.
- Tiered usage-based ARR: This type combines tiered ARR and usage-based ARR for different pricing tiers based on usage.
Calculating ARR
Key components of ARR include revenue from new sales and upgrades, retention from renewals, and revenue lost due to customer churn, cancellations, and downgrades.
You may have heard of the 12 times MRR formula, where you simply multiply MRR by 12 (the number of months in a year). While multiplying MRR x 12 seems logical, other considerations come into play. Let’s look at a couple of examples.
Example 1:
A SaaS business has 20 subscribers, and they each purchased a $2,000 yearly subscriptions: ARR = $40,000 (20 x $2,000).
Example 2:
A SaaS business has 20 subscribers, and they each purchased a $2,000 yearly subscription, however 5 of the current customers upgraded their plans to $2,500 annual subscriptions and 2 customers churned: ARR = $38,500 (13 x $2,000) = (5 x $2,500).
Feeling good? Then let’s switch gears to: what is MRR in SaaS?
Understanding MRR
A vital metric for tracking and predicting a SaaS’s financial health, MRR is the predictable total revenue generated from active subscriptions within a specific month. However, unlike regular monthly revenue calculations, MRR excludes one-time fees.
The Importance of MRR
Given that a month is enough time to assess the performance of a company, MRR is used to gauge monthly trends. Additionally, the monthly trends serve as a barometer of the SaaS’s business health.
- Operational management: Ideal for monitoring monthly fluctuations, identifying growth trends, and assessing the impact of recent marketing or sales initiatives, MRR enables SaaS organizations to track day-to-day financial performance.
- Short-term planning: A reflection of immediate cash flow, MRR is valuable for making short-term financial decisions like budgeting and resource allocation.
- Identifying subscriber loss: MRR expedites the identification of customer churn, enabling for fast corrective actions.
- Cash flow management: MRR provides a clear picture of monthly recurring revenue, enabling SaaS companies to better manage cash flow.
- Customer acquisition and retention: As a key indicator of customer acquisition and retention strategies, MRR helps in identifying areas for improvement.
- Pricing and packaging: MRR provides SaaS organizations with the information needed to optimize pricing and packaging strategies.
- Customer lifetime value (CLV): MRR offers insights into CLV, growth, and momentum.
Types of MRR
Like ARR, MRR also has various types, here are the five most common.
- New MRR: Reflecting customer acquisition efforts, new MRR consists of revenue derived from new subscribers each month.
- Expansion MRR: Increased revenue from existing customers resulting from upgrades and/or the addition of services.
- Churned MRR: Lost revenue due to customer churn or downgrades.
- Reactivation MRR: Revenue acquired from customers who previously canceled their subscription and return.
- Reduced Revenue: Loss of revenue from subscribers transitioning from higher to lower pricing plans.
How to Calculate MRR
While MRR is a key financial metric, it’s often used in conjunction with others like: customer acquisition costs (CAC) which measures the expense of acquiring a new customer. Average revenue per user (ARPU) that helps in the understanding of the value each subscriber brings to the company. CLV which provides projected revenue from a customer over their subscription lifetime. Finally, net new MRR which assesses monthly revenue growth or decline.
Let’s look at a few MRR calculation scenarios.
Example 1:
A SaaS business has 20 subscribers, and they each pay $500 per month for a subscription: MRR = $10,000 (20 x $500).
Example 2:
A SaaS business has 20 subscribers paying $150 per month and 10 subscribers paying $100 per month: MRR = $4,000 (20 x $150) + (10 x $100).
While the above provides relatively basic examples, it’s important to note that MRR must account for annual or quarterly billing cycles. Failing to adjust for billing intervals can result in overstating revenue, impacting forecasts and budgeting. Additionally, usage-based fees can be included in MRR but consumption must be predictable.
ARR vs. MRR: Which to Use?
The Differences:
While the most significant difference between ARR and MRR is their timeframe, there are other differences.
ARR
- Annual revenue from subscriptions
- Reflects long-term business stability
- Provides insight into the annual financial outlook
MRR
- Monthly revenue from subscriptions
- Provides immediate financial health information
- Depicts detailed monthly trends
Which one to use:
ARR provides a long-term view of a SaaS business’s revenue for the entire year, whereas MRR offers a shorter-term view. One rule of thumb states that startup SaaS businesses should use MRR as it provides the ability to monitor cash flow on a granular level, however there are other considerations.
To start, the decision whether to use ARR or MRR depends on the company type and the type of customers the business attracts. For instance, if the business is an enterprise subscription-based SaaS and most of the subscribers are on an annual or multi-year contract, ARR would be the logical choice.
However, if the majority of subscribers pay on a monthly basis, MRR would be a more appropriate metric. That being said, both ARR and MRR provide valuable insights into the performance and financial health of the business and key metrics from both can be used.
Stay on Top of Your Recurring Revenue with Automation
ARR and MRR are critical metrics used to measure SaaS subscription revenue. Regardless which metric your company uses, automation is key to gaining a complete and accurate view of your business’s financial health.
Tracking recurring revenue metrics manually can result in errors, leading to an inaccurate view of the business’s revenue and profitability. This is why many subscription-based SaaS companies are swapping their manual processes and legacy billing solutions for an agile billing platform that leverages accurate reporting and proactive data analysis to monitor the financial health of a business.
With BillingPlatform’s cloud-based billing solution you’re able to gain new insights into your business. From business intelligence and dashboards to integrated reporting and artificial intelligence (AI)-powered natural language queries, you’re able to gain increased visibility into operational performance, easily understand customer behavior (ARR, MRR, usage, CLV, churn, etc.), and stay on top of your recurring revenue.
BillingPlatform is ready to help, reach out to our experts to take the next step.
