Best Guide To Monthly Recurring Revenue in SaaS

The new companies that deliver Software as a Service (SaaS) do not use conventional financial metrics to track progress. It’s because such metrics are inadequate and are often misleading. Why?

Traditionally, products sold by technology companies primarily comprised equipment or Software. Almost all the firms generated revenue by securing purchase orders, with a small portion of revenue coming from annual maintenance contracts. 

But today, there is an expansion of always-connected computing devices. And this has resulted in an increasing number of startups delivering technology through perpetually-renewable automated services.

These subscription services do not deliver any upfront value to the end-users, regardless of when the cash is collected for such services. Consequently, GAAP reasonably recognizes the revenues of such businesses over time, month by month. In other words, the revenues of SaaS businesses are recurring and not ‘one-time’.

Therefore, key revenue-based metrics like MRR, ARR, and ACV are used to determine the potential growth in the revenues of SaaS businesses. 

This article will discuss Monthly Recurring Revenue, its meaning, and MRR calculation to evaluate SaaS and similar recurring revenue businesses.

Monthly Recurring Revenue Meaning

MRR stands for Monthly Recurring Revenue. It is a growth metric that enables SaaS or subscription-based companies to forecast their expected revenue for a given month. 

In other words, ​​MRR measures how much revenue a business generates from the monthly subscription payments that subscribers or customers pay.

MRR includes a business’ total recurring revenues generated from its offerings, pricing plans, and monthly billing periods. 

Thus, a business’s total or aggregate MRR represents the contracted monthly recurring revenues from all the customers at a given time. 

However, MRR for each customer represents the monthly subscription price that a SaaS business charges from its customers.

Remember, MRR is the single most important metric for evaluating revenue growth for SaaS companies or businesses with a subscription-based model. That’s because it measures the revenue momentum and projects the revenue growth of a SaaS business.

Further, this growth metric provides a consistent and predictable source of revenue for subscription-based business models. Hence, it is used by SaaS businesses to track and measure not only revenue performance but also company team and individual performance.

Besides helping to determine the overall performance, the changes in MRR trends also indicate the implications of such changes across the business. This is regardless of the fact whether the changes are positive or negative. As a result, businesses that evaluate MRR accurately and its metrics can also be an indicator for areas of the business; MRR also helps a SaaS business evaluate Annual Recurring Revenue (ARR) and other important metrics.

MRR Revenue Components

MRR Revenue and its components help SaaS businesses determine their health and performance. 

Further, these MRR components help subscription-based businesses identify growth opportunities, threats, and any challenges that may arise shortly. Provided such components are measured and tracked consistently and accurately. 

The following are the various components of MRR of a SaaS business

• New MRR

New MRR refers to the new sales of your subscription-based products or services to new customers in a month. It covers the recurring revenues generated from onboarding new customers in a specific month.

• Expansion MRR

Expansion MRR refers to the recurring revenues generated due to additional sales to existing customers in a month—a performance metric that measures revenue growth from existing customer upgrades or added services. The formula for Expansion MRR is the difference between the value of the old plan and the upgraded plan.

• Contraction MRR

Contraction MRR represents the decrease in the monthly recurring revenues of a SaaS business. The decline in MRR happens when the existing customers renounce or reduce the scope of their current subscription or service in a given month. Thus, Contraction MRR is a performance metric that measures revenue change from existing customers downgrading or applying discounts. The formula for Contraction MRR is the difference between the value of the old plan and the downgraded plan.

• Cancelled MRR

Cancelled MRR refers to the monthly recurring revenues lost due to the existing customers giving up on their product or service subscription. It may include non-renewals, cancellation of customer subscriptions, etc. Thus, Canceled MRR is a performance metric that measures the change between MRR lost due to downgrades, and MRR added from expansion revenue. This is important in understanding the areas where a business can improve despite having an MRR.

Thus, the Net MRR of a SaaS business represents the new MRR, Churned MRR, Expansion ARR, and Canceled ARR. 

Components to be Excluded in MRR Calculation

MRR is only related to recurring revenue or expected earned income. It is a forecasting metric that can be used to calculate future revenues. This means it does not represent the past revenues of a SaaS business. Most importantly, MRR does not include any revenue that is not recurring. Accordingly, the following components would not form a part of MRR:

• One-time fees
• Usage-based overage fees
• Other non-recurring add-ons

What is Committed Recurring Monthly Revenue?

Committed Monthly Recurring Revenue (CMRR) is a performance metric that SaaS businesses use to measure the expected revenue relative to MRR accurately. 

There is no standard definition for CMRR as each business has its metric to measure data. Typically, the CMRR of a subscription-based business incorporates recognized MRR, new MRR,  Churn MRR, and Expansion MRR. However, it does not include non-recurring items like a one-time installation fee.

Recognized MRR is based on the Principle of Revenue Recognition, one of the fundamental accounting principles. As per this accounting principle, a person or a business must completely deliver goods or services to recognize the payment received as revenue in its books of accounts.

Let’s consider the same example as above to understand this CMRR formula.

Say, ‘Zootin’ has $100,000 as MRR at the start of the month. In other words, it has an ARR of $1,200,000. The following are the changes that took place during the month:

• MRR lost due to subscription cancellations: $10,000
• MRR lost due to subscription downgrades: $5,000
• Expansion in MRR: $15,000
• MRR gained from new signups: $20,000
• New bookings: $25,000

Here’s how you will calculate the MRR for the said month:

CMRR for the month = Beginning MRR +New Bookings + MRR Expansion + New MRR – MRR Contraction – MRR Cancellation 

Net New MRR for the month = $10,000 + $15,000 + $20,000 – $5,000 – $10,000 = $30,000

MRR Formula

As mentioned above, MRR is a forward-looking metric that evaluates the expected revenue that a SaaS business may generate from all its active subscriptions in a particular month. As a result, it may cover recurring charges from discounts, coupons, and recurring add-ons. However, MRR may exclude one-time fees.

1. MRR Calculation Using ARPU

ARPU stands for Average Revenue Per User. It is the average revenue per user of the income that a SaaS business receives through offering subscription services to each customer per unit of time.

Let’s understand this with the help of an example. For instance, ‘Zootin’ is a web streaming app with 1000 customers, and the ARPU per month is $200. Thus, the total MRR of ‘Zootin’ is $200,000.

The MRR formula used in the above example is:

MRR = ARPU x Number of Customers

2. MRR Calculation Using MRR Components

The MRR of a SaaS business highlights the subscription behaviour of the end-users. Accordingly, an increase in a company’s MRR indicates either an increase in customer acquisition, plan upgrades, or both. On the contrary, a decrease in a company’s MRR indicates increased churn rates, cancellations, or downgrades in subscriptions.

Therefore, a SaaS business needs to keep track of each MRR component to know the real cause behind changes in the Net MRR.

When a SaaS business wants to track the fluctuations in different MRR components, it needs to use the following formula for MRR Calculation:

MRR = New MRR + Expansion MRR – Cancelation MRR – Churned MRR

Let’s consider the same example as above to understand this MRR formula. Suppose ‘Zootin’ has $100,000 as MRR at the start of the month. In other words, it has an ARR of $1,200,000. The following are the changes that took place during the month:

• MRR lost due to subscription cancellations: $10,000
• MRR lost due to subscription downgrades: $5,000
• Expansion in MRR: $15,000
• MRR gained from new signups: $20,000

Here’s how you will calculate the MRR for the said month:

Net New MRR for the month = Beginning MRR + MRR Expansion + New MRR – MRR Contraction – MRR Cancellation 

Net New MRR for the month = $10,000 + $15,000 + $20,000 – $5,000 – $10,000 = $30,000

Conclusion

MRR and related metrics give valuable insights regarding a SaaS business’s overall health and performance. Besides, it helps forecast customer retention and expansion, new customer acquisition, pricing, hiring and staffing decisions. SaaS businesses that do not use complete data as inputs for the MRR formula cannot accurately calculate MRR or related metrics.