The new class of companies that deliver Software as a Service (SaaS) does not use the conventional financial metrics for tracking the business 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 in the form of 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’ in nature.

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

In this article, we will talk about 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 is a measure of how much revenue a business generates from the subscription payments that subscribers or customers pay each month.

Note that MRR includes a business’ total recurring revenues generated from its offerings, pricing plans, and billing periods each month. 

Thus, the total or aggregate MRR of a business represents the contracted monthly recurring revenues from all the customers at a given point in 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 in the case of SaaS companies or businesses having 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 the metrics related to it are able to use it as an indicator for areas of the business as well.

Finally, MRR also helps a SaaS business in evaluating Annual Recurring Revenue (ARR) and other important metrics.

MRR Revenue Components

MRR Revenue and its components help SaaS businesses in determining their overall health and performance. 

Further, these MRR components help subscription-based businesses in identifying growth opportunities, threats, as well as any challenges that may arise in the near future. 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 given month. It covers the recurring revenues generated as a result of onboarding new customers in a specific month.

• Expansion MRR

Expansion MRR refers to the recurring revenues generated as a result of additional sales to the existing customers in a given month. It is 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.

• Canceled MRR

Canceled MRR refers to the monthly recurring revenues lost as a result of the existing customers giving up on their product or service subscription altogether. It may include non-renewals, cancelation 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 an important figure 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 over a given period. It  is a forecasting metric that can be used to calculate future revenues. This means it does not represent  past revenues of a SaaS business. Most importantly, MRR does not include any  type of revenues that are 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 Monthly Recurring Revenue?

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

There is no standard definition for CMRR as each business has its own metricto measure data. Typically, 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 one-time installation fee.

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

Let’s consider the same example as above in order 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. Say, for instance, ‘Zootin’ is a web streaming app that has 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 behavior of the end-users. Accordingly, an increase in a company’s MRR indicates either an increase in customer acquisition, or plan upgrades, or both. On the contrary, a decrease in a company’s MRR indicates there is an increase in churn rates, cancelations, or downgrades in subscriptions.

Therefore, a SaaS business needs to keep a track of each of the MRR components so that it knows 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 in order 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 the overall health and performance of a SaaS business. Besides, it also helps in forecasting, 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 are not able to accurately calculate MRR or any related metrics.