What is MRR? How Does It Decide The Growth Of Subscription Businesses?

Monthly Recurring Revenue (MRR) is a crucial financial metric for subscription-based businesses, particularly in the Software as a Service (SaaS) industry. It represents the predictable, recurring revenue a company can expect to receive on a monthly basis from its active subscriptions. Understanding MRR helps businesses forecast revenue, measure growth, and make informed strategic decisions. Below are the key headings necessary for an accountant to fully grasp the concept of MRR.

Importance of MRR

Monthly Recurring Revenue (MRR) does more than just tell you how much money is coming in each month. It provides crucial insights for financial forecasting, helps measure growth trends, and informs strategic decision-making. MRR also offers valuable data on customer behavior, aids in evaluating sales and marketing performance, and enhances investor appeal by demonstrating revenue stability and predictability.

Financial Forecasting and Planning

Financial Forecasting and Planning does more than just project future revenues and expenses. It provides a roadmap for strategic decision-making, helping businesses anticipate market changes and prepare for various scenarios. By using financial forecasts, companies can optimize resource allocation, plan for growth, and mitigate risks, ensuring long-term stability and success.

Measuring Growth and Momentum

Measuring growth and momentum involves tracking key metrics such as revenue growth, customer acquisition cost (CAC), customer lifetime value (CLTV), churn rate, and conversion rate. These metrics provide insights into a company’s financial health, customer behavior, and the effectiveness of sales and marketing strategies. 

Understanding momentum includes assessing the relevance of the product, the agility of the business, and the strategic direction. This helps businesses set clear goals, develop robust strategies, maintain consistent effort, and adapt to market changes for sustained growth and success.

Investor Appeal

Investor appeal in the context of Monthly Recurring Revenue (MRR) refers to the attractiveness of a company to investors due to the predictability and stability of its revenue stream, demonstrated growth potential, financial health, scalability, and detailed insights into business performance. MRR indicates consistent income and effective business strategies, making the company a promising and reliable investment opportunity.

How to Calculate MRR

The basic formula for calculating MRR is:

MRR = Number of Active Accounts × Average Revenue Per Account ARPA 

MRR=Number of Active Accounts×Average Revenue Per Account ARPA 

For annual or quarterly subscriptions, the revenue should be normalized to a monthly basis by dividing by 12 or 3, respectively.

Example Calculation

If a company has 50 active accounts, each generating $2,000 per month, the MRR would be:

MRR = 50 × 2000 = $ 100,000

MRR=50×2000=$100,000

Types of MRR

New MRR

Revenue from new customers acquired during the month, often referred to as New MRR, represents the additional monthly recurring revenue generated from customers who signed up for the service within that specific month.

Example:

Suppose a SaaS company offers a subscription service at $100 per month. In July, the company acquires 10 new customers. The New MRR for July would be:

New MRR=10 new customers×$100 per month=$1,000

New MRR=10 new customers×$100 per month=$1,000

This $1,000 represents the new recurring revenue added to the company’s monthly income due to the acquisition of these new customers.

Expansion MRR

Additional revenue from existing customers through upsells, cross-sells, and add-ons, often referred to as Expansion MRR, represents the extra monthly recurring revenue generated from existing customers who upgrade their plans, purchase additional features, or subscribe to complementary products.

Example:

Suppose a SaaS company offers a base subscription at $100 per month. In August, 5 existing customers upgrade to a premium plan costing an additional $50 per month, and 3 customers purchase an add-on feature for $20 per month. The Expansion MRR for August would be:

Expansion MRR=(5 upgrades×$50)+(3 add ons×$20)=$250+$60=$310

Expansion MRR=(5 upgrades×$50)+(3 add ons×$20)=$250+$60=$310

This $310 represents the additional recurring revenue added to the company’s monthly income due to upsells and add-ons purchased by existing customers.

Contraction MRR

Contraction MRR represents the revenue lost due to existing customers downgrading their subscription plans or reducing their usage of services.

Example:

Suppose a SaaS company has customers on a $100 per month plan. In September, 4 customers downgrade to a $50 per month plan, and 2 customers reduced their add-on services by $20 per month each. The Contraction MRR for September would be:

Contraction MRR=(4 downgrades×$50)+(2 reductions×$20)=$200+$40=$240

Contraction MRR=(4 downgrades×$50)+(2 reductions×$20)=$200+$40=$240

This $240 represents the monthly recurring revenue lost due to customers opting for lower-priced plans or reducing their service usage.

Churned MRR

Churned MRR represents the revenue lost from customers who cancel their subscriptions entirely.

Example:

Suppose a SaaS company has customers on a $100 per month plan. In October, 3 customers cancel their subscriptions. The Churned MRR for October would be:

Churned MRR=3 cancellations×$100=$300

Churned MRR=3 cancellations×$100=$300

This $300 represents the monthly recurring revenue lost due to customers who have completely discontinued their subscriptions.

Net New MRR

Net New MRR represents the net change in Monthly Recurring Revenue by accounting for the revenue gained from new customers and expansions and subtracting the revenue lost due to downgrades and churn.

Example:

Suppose in November, a SaaS company gains $2,000 in New MRR from new customers, $1,000 in Expansion MRR from existing customers upgrading, loses $300 in Contraction MRR from downgrades, and $700 in Churned MRR from cancellations. The Net New MRR for November would be:

Net New MRR=$2,000 New MRR +$1,000 Expansion MRR −$300 Contraction MRR −$700 Churned MRR =$2,000

Net New MRR=$2,000 New MRR +$1,000 Expansion MRR −$300 Contraction MRR −$700 Churned MRR =$2,000

This $2,000 represents the net increase in the company’s monthly recurring revenue after accounting for all gains and losses.

Reactivation MRR

Reactivation MRR represents the monthly recurring revenue generated from previously churned customers who have re-subscribed to a paid plan.

Example:

Suppose a SaaS company has customers on a $100 per month plan. In November, 3 previously churned customers reactivated their subscriptions. The Reactivation MRR for November would be:

Reactivation MRR=3 reactivations×$100=$300

Reactivation MRR=3 reactivations×$100=$300

This $300 represents the additional monthly recurring revenue gained from customers who returned after previously canceling their subscriptions.

Common Mistakes in Calculating MRR

Calculating Monthly Recurring Revenue (MRR) accurately is crucial for financial forecasting and business planning. However, common mistakes can lead to incorrect MRR figures:

Including One-Time Fees

Including one-time fees in MRR calculations is a common mistake. Only recurring revenue should be included, excluding one-time payments and variable fees. This ensures that MRR accurately reflects the predictable, ongoing revenue from subscriptions, providing a true picture of financial health and growth potential.

Example:

If a SaaS company charges a $100 monthly subscription fee and also receives a $500 one-time setup fee from a new customer, only the $100 should be included in the MRR calculation. Including the $500 setup fee would inaccurately inflate the MRR. Thus, the correct MRR from this customer is:

MRR=$100

Incorrectly Normalizing Revenue

Incorrectly normalizing revenue is a common mistake in MRR calculations. Annual or quarterly payments should be divided by 12 or 3, respectively, to reflect their monthly value accurately. This ensures that MRR provides a true monthly revenue figure, avoiding overestimation or underestimation.

Example:

If a SaaS company receives an annual payment of $1,200 from a customer, this amount should be divided by 12 to determine the monthly value. Incorrectly treating the entire $1,200 as monthly revenue would significantly overstate the MRR. The correct MRR from this annual payment is:

MRR= $1200/12= $100

Including Free or Trial Users

Including free or trial users in MRR calculations is a common mistake. Only paying customers should be included in the MRR calculation to ensure it accurately reflects the actual recurring revenue generated by the business.

Example:

If a SaaS company has 50 paying customers each contributing $100 per month and 20 users on a free trial, only the revenue from the paying customers should be included. Including the free trial, users would inflate the MRR inaccurately. The correct MRR is:

MRR=50 paying customers×$100=$5,000

MRR=50 paying customers×$100=$5,000

Difference Between ARR and MRR

Annual Recurring Revenue (ARR) and Monthly Recurring Revenue (MRR) are both key metrics for subscription-based businesses, but they differ in their timeframes and applications.

ARR: Measures the predictable, recurring revenue a company expects to receive annually from its subscription services. It provides a long-term view of a company’s financial health and growth potential.

MRR: Measures the predictable, recurring revenue a company expects to receive monthly from its subscription services. It offers a short-term view, useful for tracking immediate business performance and making quick adjustments.

MRR vs. Accounting Revenue

Monthly Recurring Revenue (MRR) and Accounting Revenue are two critical financial metrics that offer different insights into a company’s performance.

MRR:

• Forward-looking metric measuring recurring revenue from subscription-based products or services.
• Predictable and scalable revenue stream.
• Closely related to Customer Lifetime Value (CLTV).

Accounting Revenue:

• Backward-looking metric measuring total revenue earned over a specific period.
• Includes both recurring and non-recurring revenue sources.
• Historical and subject to fluctuations due to non-recurring revenue streams and seasonal factors.

Differences

MRR (Monthly Recurring Revenue) focuses exclusively on the predictable, recurring subscription revenue a business generates each month, excluding one-time sales and variable fees.

Accounting Revenue includes all sources of income, such as one-time sales, services, and any other non-recurring revenue streams.

Example:

Suppose a SaaS company earns $5,000 from monthly subscriptions (MRR) and an additional $2,000 from one-time setup fees and consulting services in a month.

• MRR: $5,000 (only the recurring subscription revenue)

• Accounting Revenue: $7,000 ($5,000 recurring + $2,000 one-time fees and services)

This distinction ensures that MRR reflects the steady, ongoing revenue while accounting revenue provides a comprehensive view of all income sources.

Frequently Asked Questions about MRR

What is Monthly Recurring Revenue (MRR)?

MRR is a financial metric that measures the predictable, recurring revenue a company expects to receive each month from its subscription-based services.

How is MRR calculated?

MRR is calculated by multiplying the total number of paying customers by the average revenue per user (ARPU) per month. For example, if a company has 100 customers paying $50 per month, the MRR would be $5,000.

Why is MRR important for subscription-based businesses?

MRR is crucial because it helps businesses forecast future revenue, identify growth trends, and make strategic decisions. It provides a stable and predictable revenue stream, essential for financial planning and investor appeal.

What are the different types of MRR?

The different types of MRR include New MRR (revenue from new customers), Expansion MRR (additional revenue from existing customers through upsells and add-ons), Contraction MRR (revenue lost due to downgrades), Churned MRR (revenue lost from cancellations), and Reactivation MRR (revenue from previously churned customers who re-subscribe).

What are common mistakes in calculating MRR?

Common mistakes include including one-time fees, incorrectly normalizing revenue from annual or quarterly payments, and including free or trial users in the calculations. These errors can lead to inaccurate MRR figures and misinformed business decisions.

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