monthly recurring revenue explained

Running a recurring revenue business can be very lucrative.

You acquire customers, and they keep paying you every month. Business is much more predictable. There is less effort involved in maintaining a recurring revenue stream than it is to get new sales each month. Once a customer is acquired, that’s a bunch of revenue gained not only at the moment of purchase, but for many months (or years) after.

That’s why running a subscription/SaaS business is such an appealing prospect.

To track this recurring revenue, the traditional “revenue” metric (used by accountants) isn’t going to cut it. You need a special metric that is tailored for subscription businesses. This metric is called monthly recurring revenue (MRR).

Let’s look at how you measure it.

The basics of MRR

MRR is a normalized monthly measurement of revenue. It gives you the total monthly value of all the subscriptions in your business.

A quick example: A subscription business has 10 customers. Five are on a $25/month plan, and five are on a $50/month plan.

So the MRR is ($25×5)+($50×5) = $125+$250 = $375

Some complexity arises when you offer annual plans as well. It’s typical for many subscription businesses to offer an annual plan that gives subscribers two months free compared with the monthly plan. How do you calculate the MRR of a plan that is billed annually?

Here, we do something called normalization, which is really just a fancy word for division. To normalize revenue from annual plans, you simply divide the cost of the annual plan by twelve, which tells you the cost per month of an annual subscription.

A quick example: A subscription business has ten customers. Five are on a $240/year annual plan and five are on a $24/month plan. First we normalize revenue from the annual plan by dividing it by 12. 240 divided by 12 equals $20.

So the MRR is ($20×5) + ($24×5) = $100 + $120 = $220

That wasn’t so hard.

But what if you’re offering three-month or six-month plans? What about biennial plans? To calculate MRR for such billing periods, you simply divide the cost of the plan by the number of months in the billing period. To calculate MRR for a three-month plan, you divide by three. For a six-month plan, you divide by six. And for a biennial plan, you divide by twenty-four.

Tracking growth trends with MRR

One of the best uses of MRR is for tracking how fast your business is growing. Analyzing how your MRR changes from month to month helps you make crucial decisions that lead to more business growth.

The number that indicates how much your MRR has grown from one month to the next is called Net New MRR. This is the net amount of MRR that you add over a month. For example, if your MRR is $1,000 in January and $1,100 in February, the net increase in your MRR (or net new MRR) is $100. This number takes into account not only the MRR that you have added, but also the MRR you have lost from month to the other.

From a mathematical perspective, Net New MRR is calculated by putting together four different components:

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

What does this mean? Let’s break it down.

New MRR is the MRR gained from new customers acquired each month.

Expansion MRR is the MRR gained from existing customers each month. It comes from existing customers upgrading to a higher plan, purchasing premium add-ons, etc.

Contraction MRR is the MRR lost from existing customers downgrading to a lower plan, cancelling add-on subscriptions, etc.

Churned MRR is the MRR lost from existing customers leaving you each month. Even if you have the best product and customer service in the world, a few customers are always going to leave you.

If your Net New MRR is positive, it means your business is growing. If it’s negative, then your business is in decline, which is something you totally do not want, ever.

We can see how the MRR changes from one month to the next with this equation:

MRR(n) + Net New MRR = MRR(n+1)

Where n denotes the month.

For example, if we’re looking at MRR growth from January to February, MRR(n) would denote the MRR for January and MRR(n+1) would denote the MRR for February.

A quick example: A subscription business has 100 customers paying $10 per month in January. Thus MRR(n) is $1,000. Five of these customers leave, and the business gets ten new customers. Additionally, five of the existing customers upgrade to a $20/month plan.

New MRR = 10 new customers x $10 = $100
Expansion MRR = 5 upgrades x $10 = $50
Churned MRR = 5 cancellations x $10 = $50

Net New MRR = New MRR + Expansion MRR – Churned MRR
= $100 + $50 – $50
= $100

MRR(n+1) = MRR(n) + Net New MRR
= $1000 + $100
= $1100

Thus the business has grown to $1100 in MRR.

Achieving hyper MRR growth

This is the best situation you can find yourself in:

Expansion MRR > Churned MRR

This means you’re adding so much MRR from existing customers (from upgrades, add ons and what not) that it’s greater than the MRR you lose from customers leaving your service.

When this happens, it means you’ve achieved negative churn.

Negative churn is a sure sign of explosive growth for your subscription business. So go ahead! Move into the bigger office, buy that new phone, and throw that party.

Conclusion

MRR is a simple but powerful metric that gives you an accurate picture of the health of your subscription business. It’s important to check your MRR everyday to make sure it’s headed in the direction you’d like it to go.

That said, we have also created a free tool that allows you to forecast future MRR. All you have to do is enter your current MRR, churn rate and MRR growth rate, and it will tell you how much and how fast your business is going to grow into the future. Check it out and let us know what you think!

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  1. Dean Patino

    Good article on explaining the metrics for recurring revenue. This is the biggest trending financial model for businesses today.