July 29, 2022
Explainer

Monthly recurring revenue: a guide to a crucial metric for understanding your company’s performance

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Monthly recurring revenue (MRR) is a metric that tracks a company’s normalized, predictable, monthly revenues from subscriptions to software as a service (SaaS) products. You can think of it as the amount of revenue a company makes from monetizing its active subscriber base.

While it is not used in US GAAP or non-US IFRS reporting, it has become a crucial performance metric for company executives and investment analysts alike, because changes in MRR reflect changes in the momentum of a company’s growth over time.

This basic definition of MRR hides a wealth of subtle insights that can be gleaned from variants of the metric, which we will explore in this article. MRR isn’t a crystal ball, and many businesses calculate it incorrectly.

But if done correctly, you will find that MRR is key to:

  • Evaluating the success of new and existing business strategies, including pricing plans and subscription models.
  • Making accurate forecasts of how much cash flow your company will have to invest in growth opportunities, or to retain or distribute as earnings, over time.
  • Effectively tracking the value of accounts receivable, a current asset that must be reported on your company’s balance sheet.

The growing importance of MRR

Before the dotcom era, understanding the monetization of subscriptions was a task mainly performed by newspapers, magazines, cable companies, and other media businesses. That changed dramatically with the advent and rapid growth of the SaaS business model during the early 2000s.

Heavyweight B2B market data vendors like Bloomberg and Thomson adopted the model early, since it allowed them to keep their massive and fast-changing databases in house, rather than forcing them to laboriously install updates at clients.

But B2B and B2C software vendors saw the cost and efficiency advantages of the SaaS model, and today most software is delivered via SaaS on a subscription basis. This has made MRR a crucial metric throughout the technology world.

 

The widespread use of SaaS makes it important to understand just what MRR is, how it is calculated, and what it can and cannot do. We turn to that next.

What is monthly recurring revenue?

MRR helps companies and outside analysts assess a SaaS businesses long-term prospects. It allows managers to change course and adjust strategies that fail to perform as expected, or fail to respond well to changing business conditions, in a timely fashion.

 

Types of MRR

There are several sub-types of MRR that add to this key metric’s usefulness:

New MRR

This is monthly revenue from new customer acquisition. This does not include trial lists, and needs to be adjusted to account for new-subscriber discounts.

Expansion MRR

This is new revenue from existing customers. It is usually acquired through upselling packages or cross-selling products.

Downgrade MRR

This is the opposite of Expansion MRR—it is the loss of revenue from subscribers that move to a cheaper plan.

Reactivation MRR

This is new revenue from former subscribers who resubscribe and become new customers.

Churn MRR

This is the loss of revenue from subscribers who drop out altogether. Churn is one of the key problems for SaaS companies.

  • A high customer churn rate reduces the monthly revenue growth rate, since the company has to replace the subscribers it loses. Capturing new subscribers typically costs more than convincing existing subscribers to renew.
  • A volatile MRR churn rate makes MRR less reliable as a forecasting SaaS metric.

Contraction MRR

This is the sum of downgrade and churn MRRs. 

The MRR formula

Broadly speaking, the top-line equation for MRR is:

Breaking it down by sub-type, however, gives insight into the sources of revenues and their relative importance. The equation becomes:

What do the results of my MRR calculations mean?

Here’s an example of how a company might calculate its MRR, and what the results might mean. Table one below shows the company’s MRR and growth rate, calculated by adding the subcategories. Graph one shows the growth rate over time.

This is a small company that starts out with $500,000 in existing total MRR in January 2022. Its downgrade and churn MRRs are relatively modest and are more than offset by new and expansion MRRs. In fact, the only fly in the ointment occurred in May, when its new MRR figure fell off somewhat, causing its overall MRR growth rate to drop below trend.

From the MRR growth rate graph, assuming there was no seasonal factor involved, management and the sales team probably concluded that a change to sales practices, monthly subscription model, monthly fee, or product offerings in March or April was unsuccessful, leading to the drop in the MRR growth rate in May. It reversed course and the rate returned to its previous trajectory.

Using the same data set, the company created a forecast for the final three months of the year. Graph two shows the results—a continued upward sloping rate of growth, even if the company only achieves a level equivalent to the lower confidence bound. Management could use this stable outlook to choose whether to work with venture capital investors (thereby experience dilution) or whether it had enough cash flow on the horizon to fund its expansion plans out of its subscription revenues.

Table one: MRR data and calculation example

Graph one: month over month MRR growth

 

Graph two: MRR forecast

 

 

Mistakes to avoid 

There are a number of common mistakes financial managers make when calculating MRR.

  • Including quarterly or annual contracts in one month’s calculation: This will skew the results. These payments need to be divided into monthly installments before being added to the calculation.
  • Including trial lists: Only subscribers that pay for the product should be included.
  • Not accounting for discounts: If you give a discount for subscribers who pay annually rather than monthly, that has to be factored in when you divide the total into monthly installments.
  • Including one-time, non-subscription revenues: These include set-up costs, consulting services, professional services fees and other revenues that are not recurring.

Problems with MRR

While very useful, MRR is not a panacea. Here are a few concerns to keep in mind.

  • Hybrid revenues: The last mistake listed above illustrates one serious problem with MRR—it does not account for all types of revenues, and for hybrid companies with large one-time revenue sources alongside SaaS payment streams, it can make resource allocation decisions somewhat confusing.

    For example, a SaaS software company that also sells consulting services might find the two divisions disagreeing over decisions strongly influenced by the MRR metric. This could be a concern for a company like Apple, which makes a lot of its revenues from one-time sales of hardware, but which is moving aggressively into subscription services like Apple Music.
  • Revenue heterogeneity: Another issue is that most MRR approaches assume revenues are homogeneous. This isn’t necessarily the case. It costs more to acquire a new client than to re-acquire a former one, and that costs more than keeping an existing one.

    So, to get the clearest view of business performance, some businesses discount each type of MRR category differently, with new acquisitions getting the biggest haircut. This starts to bring costs into the mix, however, and MRR is supposed to be a revenue metric, so experts differ on the subject.
  • Intra-period timing issues: Recurring revenues are not homogeneous in their timing either. But companies often simply dump all subscriptions that start in a particular month, despite having starting days that can be four weeks apart, into the same month.

    Many legacy subscription management systems cannot manage daily reporting, although that would be an ideal level of data granularity for diagnosing some issues. A big decline in revenue between July 25 and August 5, triggered by fraud or some other issue, could be masked by strong performance in late August.

Managing SaaS revenues

MRR is only one indicator of a company’s health. How it manages the expenses it must fund out of its MRR will bear on its gross profit and its net earnings. And a company’s value is usually calculated as some multiple of its earnings.

 

The expenses that directly support revenues are called the Cost of Goods Sold (COGS), and in SaaS companies tend to be lower than in, say, manufacturers. That’s because SaaS subscriptions are scalable—once the technology is in place, adding a subscriber usually involves little more than giving them access to the system. By contrast, although there are economies of scale, manufacturers bear the cost of materials and labor for each item they sell. Subtracting monthly COGS from MRR gives you monthly gross profit and net profit margin.

 

It becomes more important for SaaS companies to manage expenses further down the income statement, where items such as these should be watched carefully:

  • taxes
  • interest payments
  • rent
  • marketing
  • accounting
  • litigation
  • travel and entertainment
  • compensation

 

These expenses impinge on the all-important earnings number—the bottom line—which is what shareholders watch most closely. Early stage companies rarely have positive earnings because their expenses are greater than their revenues. These “cash-flow negative” companies have to rely on funding from venture capital firms or other sources.

The rapidity with which they spend this funding is called their “burn rate,” and needs to be managed carefully to avoid running out of funds prematurely. MRR-based forecasting helps determine how much additional revenue can be expected over time and is crucial to attempts to successfully calculate the burn rate.

 

Simplify your business finances with Ramp

Ramp helps startups manage these expenses and grow earnings. There are two important ways to do this, both of which we support.

1. Use effective payroll software for startups: Here are the important elements to look for in a solution:

  • Easy to use
  • Runs payroll automatically
  • Provides employee benefits
  • Offers tax support for full-time, part-time, remote, and contract workers
  • Integrates with your finance and HR stack

 

Ramp doesn’t offer payroll software, but our financial management software integrates with top providers to help streamline your finance and HR processes.

 

2. Track and manage expenses with a corporate credit card: Ramp offers a market leading product, which provides key benefits:

  • Features to reduce the time needed to file and manage expenses
  • Advanced spend control features
  • Automated savings insights
  • Real-time expense reporting

If you want to see how Ramp could help your organization streamline expenses, take a tour of our software today.

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FAQs
What are examples of recurring revenue?

Recurring revenues are normalized, predictable revenues from subscriptions to Software as a Service (SaaS) products. In MRR calculations, they are received monthly. Prominent examples include B2C products like Microsoft Office 360, Apple Music, PayPal, and Amazon Prime. B2B examples include Shopify, Slack, and Salesforce.

What is the difference between recurring revenue and non-recurring revenue?

Recurring revenue comes from normalized, predictable payments received in each time period – in MRR calculations, it is received each month. Non-recurring revenue consists of one-off payments for goods or services, such as equipment or consulting services.

How do you calculate monthly revenue?

The general equation for calculating overall monthly revenue is:

MRR = Number of Active Accounts x Average Revenue Per Account

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