Commonly used by subscription-based software-as-a-service (SaaS) companies, monthly recurring revenue (MRR) is a financial metric that shows the monthly amount of revenue you can expect to receive from customers for providing products or services. Although MRR is not recognized by accounting standards such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), nor does it need to be reported to tax authorities or government agencies, it is an important metric for investors. As well as for the company itself. Given the importance of this metric, most SaaS companies report it in their quarterly and annual reports.
When to Calculate Monthly Recurring Revenue vs. Annual Recurring Revenue
Basically, annual recurring revenue (ARR) is the annualized sum of your monthly recurring revenue, and many subscription-based companies calculate both. This helps to gain a long-term view of the business’ financial standing, as well as measure month-over-month MRR growth or decline. However, there are a couple of caveats. Although MRR and ARR go hand-in-hand to gauge financial health, large enterprise subscription-based companies that only offer annual contracts will use ARR. Alternatively, subscription-based SaaS businesses that provide subscribers with the option to cancel their subscription before the end of the term and small- and medium-size businesses (SMBs) will typically use MRR.
The Benefits and Pitfalls of Monthly Recurring Revenue
As with virtually everything, there are advantages and disadvantages, and monthly recurring revenue is no exception. Let’s start with the benefits an MRR business model provides.
Businesses built around monthly recurring revenue can count on more predictable growth. It’s a key metric for investors and venture capitalists who analyze both short-term averages and longer-term trends. The advantages of MRR include:
- Appeals to investors because:
- Products or services are sold on an ongoing basis, providing cash flow certainty.
- Predictability of the business’ scalability.
- Accurate expense management and the ability to increase or decrease spend in near real time.
- Minimized risk due to recurring revenue streams.
- Flexibility for customers to change plans, which helps reduce churn.
- Realistic revenue projections month-to-month and annually.
- When MRR goals (aka MRR quota) are used to incentivize sales teams, sales performance is enhanced.
- Provides a better understanding of business performance, which enables executives to make better decisions and optimize profitability.
Receiving monthly recurring revenue sounds like an easy road to long-term profitability, but there are some problems that can crop up. Ones that, if not handled, can lead to business failure. Key issues include:
Knowing your customers’ value
Do you know the lifetime value (LTV) of your customers? If you’ve been in business a while, you may have a pretty good idea. However, if you’re just starting out, estimating this figure can be difficult, which means you need to do everything possible to keep customers engaged by offering incentives, perks, or other rewards. Whether your business has longevity, or you’ve just opened your doors, you need to quickly understand the LTV of your customers. Underestimating the potential LTV of customers means you are also limiting the investments made to retain and grow your customer base, which could result in losing a significant portion of your business’ value.
Measuring the company’s financial health
Although it sounds counterintuitive, you may see revenue growth even though the business is in financial decline. For example, let’s assume that since you launched the business 2 years ago you only had one sale. We’ll also assume that the sale was finalized in June of the first year. For 6 months of year one, you’ll receive 6 monthly payments, and for the first 6 months of your second year in business you’ll receive monthly payments. This means that the first 6 months of revenue will be a full 12 months of revenue in the second year, creating an inaccurate perception of financial growth. MRR revenue is considered a lagging metric. For a more precise measure of your company’s financial growth or decline, the focus needs to be on new sales, upgrades, features, etc. – basically, you need to track new MRR.
Knowing the cost to acquire a customer
Growing your business is, of course, a key goal. But what happens in a MRR business model when the company grows too fast? Acquiring new customers costs money and with an MRR business model, revenue is spread over the contract months. This means that if you’re spending cash that you don’t yet have to acquire customers, you’ll run the risk of depleting the cash you have. To determine your cost to acquire a customer (CAC), take the total amount spent to acquire customers for a single month and divide by the number of net new customers – this is your CAC. The next step is to determine the CAC payback period. This is simply accomplished by figuring out the length of time it takes each customer to pay back (revenues received/will receive) the CAC.
How to Calculate Monthly Recurring Revenue
There are a few ways to calculate your recurring monthly subscription revenue. The formulas you choose will depend on the metrics you desire. Let’s look at some of the most common MRR calculations.
If you have 20 subscribers each paying $200 per month, your monthly recurring revenue would be $4,000 (20 x $200 = $4,000).
Let’s now assume that in addition to the 20 subscribers paying $200 per month, you also have 10 subscribers paying $150 per month. Your monthly recurring revenue for the 30 subscribers would be $5,500 (10 x $150 = $1,500 + $4,000 = $5,500).
Net New MRR
This metric consists of revenues collected from new subscribers and upgrades, as well as revenue lost due to downgrades or churn/cancellations. For example, during the month you gained 5 new subscribers paying $100 each per month, and 10 current subscribers upgraded their plans from $100 per month to $200 per month. However, 3 subscribers that were paying $200 per month churned. Your net new monthly recurring revenue for that month would be $900 (New subscribers + upgrades – churn).
This simple calculation determines the amount of revenue lost due to subscriber cancellation. If you started the month with $20,000 in revenue, but lost $1,000 due to churn, your churn rate would be 5% (lost revenue / total revenue x 100).
When a customer cancels a subscription, but at some point returns, you can quickly calculate your reactivation monthly recurring revenue. For example, let’s assume 6 subscribers returned each purchasing subscriptions for $100 per month. Your reactivation monthly recurring revenue would be $600 (6 x $100 = $600).
These calculations provide a baseline to help you understand the sustainability of your SaaS company, determine achievable goals, and measure the business’ growth or decline. However, you may decide that other metrics are needed to provide a more in-depth view of your business’ financial health.
Avoid Monthly Recurring Revenue Calculation Mistakes
As a critical financial metric, it’s imperative that your monthly recurring revenue figures are accurate. Let’s look at the 5 most common mistakes made when calculating MRR.
- Including non-recurring payments: Revenue received on a non-recurring basis, such as a one-time payment for an event you’re hosting shouldn’t be included in your MRR calculations.
- Including revenue at full value: If the full subscription payment is received in advance, you can only use the monthly figure when calculating MRR. For example, if a subscriber purchased CRM software for a 12-month period and paid $12,000 for the year, your MRR calculations should consist of $1,000 for each month of the contract.
- Including free trials: By including the expected value of non-revenue generating trials in your calculations, your MRR will be skewed. This is because you’ll show an increase of net new subscribers one month and a higher-than-normal level of customer churn in subsequent months.
- Including fees and charges: Whether transaction fees or payment delinquency charges, including expenses of this nature results in inaccurate and misleading MRR figures.
- Not subtracting promotions: When providing subscribers with a promotion, the amount of the promotion needs to be subtracted from the actual subscription price for the duration of the promotion. Say you’re offering a discount of $25 on a $100 per month plan for the first quarter of the year. For the months of January, February, and March, your MRR calculation would reflect $75 per subscriber instead of $100.
As you can see, calculating monthly recurring revenue can quickly become complex and open to miscalculations. It’s also time-consuming – especially if your finance team is manually handling monthly recurring revenue processes.
Considerations Beyond Calculations
While all subscription-based companies have one thing in common (receiving revenue on a recurring basis), their pricing strategies may vary greatly which adds another layer of complexity in calculating monthly recurring revenue. Add in various promotional initiatives such as trials, vouchers, coupons, and discounts; tracking what initially appeared to be simple metrics can quickly become complicated.
In an industry that’s experiencing exponential growth, SaaS companies need to evolve and address emerging market needs to remain competitive. This typically means the addition or retirement of products, services, and bundles, as well as pricing schemes.
Unlike one-off sales revenue models focused on acquiring a constant stream of new customers, subscription-based companies rely on customer retention. Delivering the experiences that drive long-term customer loyalty takes flawless account management, timely and accurate billing and invoicing, and empowering customers to serve themselves.
Grow Monthly Recurring Revenue
You need a clear and accurate understanding of your financial standing and shouldn’t leave anything to chance. This means avoiding costly errors and time-consuming manual tasks. BillingPlatform delivers an all-in-one solution that automates the entire quote-to-cash processes, allowing you to calculate monthly recurring revenue with precision and speed – providing you with the time needed to improve MRR.
You can improve MRR through several tactics. The most obvious is acquiring new customers, continually building the sales pipeline, and providing customers with the experiences they expect. Other strategies include expansions such as upsells, cross-sell, add-ons, and win-back campaigns; updating your SaaS pricing models to ensure customers are receiving value for money spent; and lowering the churn rate by understanding the reason(s) for voluntary churn and then putting proactive mitigation strategies in place.
Calculating and understanding all the dimensions of MRR isn’t always easy. However, this point-in-time metric provides the information needed to gain detailed financial insights to keep your subscription-based SaaS company profitable over the long term. If you’re ready, our team of experts is here to help you learn more as well as maximize your billing operations.