Understanding Everything about Monthly Recurring Revenue (MRR)

For the company's success and profit, organizations must understand various financial denominations. It must comprehend and calculate financial margins, as well as take appropriate steps for growth. One such term to be familiar with is recurring revenue. This is the amount of money you can expect to make consistently. Recurring revenue can be calculated monthly or annually (e.g., MRR: monthly recurring revenue, ARR: annual recurring revenue).

 

Monthly Recurring Revenue, or MRR, is a financial metric that depicts the revenue that a company expects to receive from customers every month in exchange for providing products or services. MRR is a metric that calculates a company's normalized monthly revenue. It is, in fact, the most important metric in the subscription business. 

 

In this article, we will learn the definition, meaning, and calculation of MRR. 

 

 

What do you understand about MRR?

 

The predictable total revenue generated by your business from all active subscriptions in a given month is known as Monthly Recurring Revenue (MRR). One-time fees are excluded, but recurring charges from discounts, coupons, and recurring add-ons are included.

 

It is, as previously stated, the most important metric in the subscription business. In a subscription business, new customers will always sign up, and some existing customers will churn out. Your revenue will be constantly fluctuating as a result of this. This movement is captured by MRR, which shows whether your revenue is increasing or decreasing, and by what percentage.

 

A monthly revenue calculation ignores annual subscriptions and subscription plan changes, giving an inaccurate picture of your company's financial health. MRR makes it easier to accurately forecast future revenue, allowing you to make informed budgeting, investing, and scaling decisions.

 

A rise in MRR indicates that customer acquisition, plan upgrades, or both have increased. Increased downgrades, cancellations, and churn indicate a decrease in MRR. To understand the specific reasons for MRR's rise and fall, you'll need to track the various factors that influence this metric separately. When you break down the MRR into more specific types, you'll find that each one provides unique insights into revenue, customer behavior, and company health.

 

 

What are the types of MRR?

 

Here are the types of MRRs that one needs to analyze:

 

1. New MRR:

 

The additional revenue generated from new customers acquired during a month is referred to as new MRR. For example, if your company adds ten new subscriptions to the $100/month plan, the new MRR will be 10 * $100 = $1000.

 

 

2. Upgrade MRR:

 

Over a month, upgrade MRR is the amount of additional revenue generated from subscriptions that move from existing pricing plans to higher plans. When calculating Upgrade MRR, the add-ons associated with the subscriptions are also taken into account. If a customer upgrades from a $100 plan to a $150 plan with $20 in monthly add-ons, the upgrade MRR is $150-$100+$20= $70.

 

 

3. Downgrade MRR:

 

Downgrade MRR is the monthly revenue from subscriptions that have been downgraded from their current plan to a lower plan. The downgrade MRR will be $100-$50= $50 if the customer downgraded from a $100 plan to a $50 plan.

 

 

4. Expansion MRR:

 

The additional revenue gained from existing customers in a given month compared to the previous month is known as expansion MRR. Expansion MRR generates additional revenue through add-ons, upselling, and cross-selling. 

 

Expansion MRR that is positive means you were able to keep your customers by gaining their satisfaction and loyalty. This is great for the bottom line because these sales to existing customers have no Customer Acquisition Cost (CAC). We can also calculate the expansion MRR rate of growth for a month by the following calculation:

 

Growth rate = (Expansion MRR in that month / Total MRR at the beginning of the month) * 100

 

 

5. Reactivation MRR:

 

The monthly revenue generated by previously churned customers returning to a paid plan is known as reactivation MRR. It denotes the profit made by regaining lost customers. For example, if five of your churned customers reactivated their accounts in the same month, each on a $50/month plan, your Reactivation MRR for the month is $250.

 

 

6. Contraction MRR:

 

The amount your business loses due to subscription cancellations and downgrades during a given month is known as contraction MRR. If a customer cancels their subscription, downgrades to a lower-priced plan, pauses their subscription, uses credits, receives a discount, or stops a recurring add-on, you'll have Contraction MRR. 

 

Although some contraction MRR is due to downgrades, contraction MRR differs from downgrade MRR in that other factors play a role. For example, let's say you've decided to reward 50 of your long-term customers with a $30 discount for a specific month. The MRR for your Contraction will be 50 * $30 = $150.
 

 

7. Churn MRR:

 

The total amount your business loses due to subscription cancellations over a given month is referred to as churn MRR. For example, if five of your $500/month customers cancel their subscriptions in the same month, your churn MRR for that month is $2500.

 

 

8. Net New MRR:

 

Net The new MRR shows how much your revenue increased (or decreased) in the last month compared to the previous month. You can calculate this using this formula:

 

Net New MRR = New MRR + Expansion MRR – Churned MRR.

 

You have lost revenue if your Net New MRR is negative. If your Net New MRR is positive, you've made a profit.

 

Also Read | What is Deferred Revenue? Examples and Importance

 

How to analyze and calculate MRR?

 

While MRR appears to be a simple metric, it is quite complex and can provide you with a valuable picture of how your subscription business is progressing. The simplest way to calculate MRR is to take your monthly Average Revenue per User (ARPU) and multiply it by the total number of users in that month. MRR is calculated using the following formula:

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Sourced from baremetrics.com

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Here are a few steps that you can follow to calculate the MRR:

 

• Put all of your existing customers in a spreadsheet with a column for their account ID for a given month. Put their subscription value in the next column, dividing the contract value by the number of months for any multi-month subscriptions.

 

• After that, simply add up the subscription column. This is the total monthly recurring revenue for that month.

 

• The top-level data is useful, but you'll want to break things down further by pricing plans, cohorts, and so on. Simply repeat the process above, but only include data from the segments that interest you.

 

• You'll want to know your MRR growth once you know your MRR. This can be accomplished by grouping the above sections into cohorts such as "New MRR," "Upgrade MRR" and "Churn MRR." Finally, determine the New Net MRR.

 

Mistakes while calculating MRR:

 

When calculating it, business owners should be aware of some common blunders. Here are a few examples:

 

1. Incorporating full-value quarterly, semi-annual, or annual contracts in a single month:

 

Even if someone pays you in full upfront, their subscription value should be divided by the intended subscription length in MRR calculations. This is due to one of the most common uses of monthly recurring revenue: momentum measurement. You're not trying to figure out how much money you have. You want to know how quickly and efficiently you're expanding. Many of your other metrics, such as customer churn rate, customer count, customer lifetime value, and so on, will be thrown off if you include everything at once.

 

 

2. After deducting transaction fees and late fees

 

To be more conservative and accurate when calculating their metrics, founders may be tempted to subtract transaction fees and delinquent charges from their MRR totals. While the intentions are good, the result is incorrect and misleading. 

 

Delinquent charges fall somewhere between churn and active, particularly if you recover failed credit card charges quickly. However, because you didn't collect the monthly subscription from the customer, a delinquent charge is technically gone in an end-of-month (EOM) calculation schema. Instead, you should separate your delinquent charges into their category.

 

This type of grouping enables you to precisely measure and reduce the amount of revenue lost each month as a result of failed or expired credit cards. 

 

Furthermore, including transaction fees does not give you enough credit and hides a potential optimization opportunity. Sure, you'll never get that transaction fee to 0%, but you can easily optimize costs by switching billing systems, spinning up your solution, and so on.

 

 

3. One-time payments are included.

 

One-time sales and payments aren't considered "recurring," so they aren't included in Monthly "Recurring" Revenue. Because you don't anticipate receiving them regularly, including them in your MRR calculations will overstate your revenue expectations and skew your financial model.

 

 

4. Taking Trial cases into Account in Their Calculations

 

Including trials and their expected subscription value before they convert to a customer is perhaps the most egregious SaaS sin. Because we all know that 100% of trials don't convert, doing this essentially gives you a consistently high list of "net new" customers and "churned" customers.

 

 

5. Discounts are not included.

 

Another egregious and deceptive mistake is failing to include discounts in calculations.

 

Also Read | What is Customer Lifetime Value (CLV)?

 

Why is tracking MRR important?

 

MRR provides insights into what leaps you can take to grow your business by providing an accurate picture of how much revenue potential your company has. Here are some reasons why tracking MRR is critical for your company.

 

1. Performance monitoring:

 

A month is thought to be a reasonable period for measuring the growth of a subscription business because a week is too short and a year is too long. 

 

Furthermore, unlike one-time sales, where full payment is made at the time of purchase, revenue for a given customer is trickled in in small amounts every month in the subscription model. To build a sustainable business, you must measure your business performance similarly, ensuring that you will have a consistent cash flow every month.

 

That's where MRR comes in handy. It keeps track of month-to-month trends and provides short-term insights into your company's financial performance, allowing you to see how close you are to meeting your revenue targets for the year. You can also use your finances to help you set realistic future goals by looking back on the previous year.

 

2. Revenue forecasting:

 

MRR is thought to be necessary for making accurate sales projections and planning for both short- and long-term business expansion. You can forecast next month's revenue and decide what changes you need to make in your sales efforts to increase revenue by analyzing your monthly financial performance.

 

 

3. Budgeting:

 

MRR forecasts the amount of money that will flow into the company each month. When you combine this revenue with the company's expenses, you get an accurate picture of the resources you'll have available to reinvest in the company. This is how MRR assists you in making reliable decisions and budgeting for business expansion with confidence. Aside from that, MRR projections can help you figure out where you need to spend more and where you can save money.

 

MRR vs GAAP revenue:

 

MRR is a normalized recurring revenue metric that is most commonly calculated using a constant value for each month of the subscription period. GAAP revenue is best calculated using a daily recognition model, in which revenue is recognized pro-rata each day between the subscription's start and end dates. GAAP revenue recognition is calculated using a daily computation, which is the most widely used (and least error-prone) method of revenue recognition.

 

When reporting on subscription growth and business momentum, one of the primary purposes of MRR as a normalized measurement is to remove the noise or jitter associated with real GAAP revenue. If you used the GAAP revenue figure, your momentum reporting would show significant month-to-month fluctuations.

 

A monthly subscription business, that is, a subscription with a one-month term, has a difference between GAAP revenue and MRR (monthly service paid in advance). While it is common practice to recognize monthly subscription revenue on the date of invoicing or billing, proper GAAP accounting would still result in revenue recognition over the subscription period, which in this case is a month.

 

Bottom line:

 

The right metrics can tell you how well your company is doing and can help you grow. For any subscription business, MRR is an important metric. It's essential for obtaining a real-time financial picture of your company and developing viable expansion strategies. The concept of Monthly Recurring Revenue has been discussed in-depth in this article.