SaaS - Monthly Recurring Revenue
Monthly Recurring Revenue (MRR) is a normalized measure of predictable recurring revenue expected to be earned.
In the most simplistic version, a business would multiply total customers by the monthly subscription amount to come up with revenue.
However, the key point in the definition to MRR is the term ‘normalized’. There are certain factors that must be accounted for in the MRR formula.
Revenue Recognition – Historical Background
The Financial Accounting Standards Board (FASB) established the new revenue recognition model in 2016 effective for all companies as of 2019. The model established five main criteria to be able to recognize revenue. The ironic part of the model is its similarity to the original model set up for software industry back in the late 1990s. The current ‘new’ revenue recognition model was designed to put all industries on the same method. Fortunately for the SaaS companies, most were already recognizing revenue prior to this new requirement.
The MRR formula takes the beginning of the month MRR plus the Net New to come up with the end of the month balance. The Net New formula, which is New MRR plus expansion less churn, is what normalizes the calculation. The formula adjusts for new, additional, and lost revenue. The formula can be viewed as:
Types of MRR
- New – New monthly recurring revenue from customers new to the company.
- Expansion – Expansion represents existing customers who have obtained additional services or have upgraded their account.
- Churn – Churn is revenue that has been lost due to customers canceling or downgrading their account. For simplicity of this article we will disregard the chance to win the customer back before their subscription ends.
- Net new MRR – Net new is truly the activity for the month. This, added to the beginning of the month, equals the companies end of the month MRR.
Common Mistakes in Calculating MRR
The key for calculating the monthly recurring revenue to properly bring in the ‘recurring’ revenue. Common mistakes that happen is when SaaS CFOs incorrectly include one-time charges to this calculation.
Charges such as on-boarding, non-recurring add-ons, and one-time charges should not be part of this calculation.
For example, if the company got a new client and charged $300 for on-boarding and $2,000 monthly for SEO services, the monthly revenue would be $2,000.
The $300 on-boarding is a one-time charge and the company won’t be charging that to the client in the subsequent months. If one-time charges are included, then the MRR will be skewed too high and cause a ripple effect in the budgets, forecast, and more.
The Overall Importance to Understanding MRR
Tracking Performance and Growth
Tracking the company’s MRR is important. The company needs to understand how large the deals are and what was done to impact the sales cycle.
- Are salespeople meeting their quotas?
- What is the conversion rate on new sales?
Being able to track these items allows sales staff to modify their approach sales approach. This information also allows management to project a more accurate pipeline report. The measurement of MRR indicates how a company’s revenue will be building or deteriorating over time.
Tracking the performance will give important insights to the overall health of future revenue.
By understanding the MRR management can plan for growth or changes in the short-term and long-term.
If MRR is falling behind, then a focus can be made on marketing or sales. If MRR is gaining momentum, then hiring could be an option to keep the momentum going. It all comes down to meeting the budgeted expectation, not only for the sales staff by for the company.
The company should develop budgets at the production level for each employee. From there the budgets should roll up into the overall department and company budgets. The budgets show where the company wants to wind up.
It is the destination. The MRR budgets help identify troubling trends or can be used as a key metric to determine growth.
The MRR budgets are a valuable tool for utilizing the financial levers of the company. Being able to adjust a budget by 1 hour per week can have a significant ripple effect on the year end projections.
As the customer Lifetime Value (LTV) increases the customer satisfaction increase. Increases in LTV will tend to have an increase in high-priced tiers or even add-ons. The Net Promoter Score (NPS) will help indicate what customers do or don’t like about a product.
The company can react to this direct information and help drive and increase in LTV and MRR. Ultimately, the company wants to reduce or eliminate churn. Utilizing non-financial metrics when analyzing MRR will help management control what can be controlled and increase profits.
Tips and Recommendations:
- Understand how to calculate MRR and how to exclude one-time charges, such as on-boarding and one-time add-ons.
- Utilize the MRR to track the progress and growth of the company.
- Complete budgets at the production level and utilize them for the guide to where the company wants to go financially.
- Incorporate the MRR to the forecast to be able to maneuver and keep the company on track to meet budgeted goals.
- Utilize non-financial metrics to improve the new net MRR and reduce churn.
Monthly recurring revenue is the best measurement of revenue in a SaaS business. Understanding, tracking, and analyzing the MRR can mean the difference between a profitable year and a loss year.