SaaS Recurring Revenue, Monthly Recurring Revenue and Annual Recurring Revenue
SaaS businesses categorise Recurring revenue into MRR (monthly recurring revenue) and ARR (Annual recurring revenue).
Scaling a Software-as-a-Service business requires large capital expenditures, so they must continuously raise capital for a successful business expansion. Here’s where recurring revenue comes into play.
Recurring revenue enables SaaS businesses to scale smoothly by generating consistent month-over-month revenue.
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Why is recurring revenue significant for SaaS businesses?
There are a few key reasons why recurring revenue is so significant for SaaS businesses:
- It provides a more predictable and sustainable source of income.
- It allows businesses to invest more in customer acquisition and retention, as they know they can recoup their costs over time.
- It gives businesses a better understanding of their customer’s lifetime value, which can help them make better pricing and product development decisions.
- It helps businesses deal with hard economic times, as customers are less likely to cancel their subscriptions if they’re happy with the service.
- With subscription-based recurring revenue models, SaaS companies can quickly adjust their pricing and packaging to meet changing customer expectations.
Types of recurring revenue for SaaS businesses
SaaS businesses categorise Recurring revenue into MRR (monthly recurring revenue) and ARR (Annual recurring revenue).
Monthly Recurring Revenue (MRR)
Monthly recurring revenue (MRR) is a metric to track a SaaS company’s monthly income from its recurring revenue streams. For SaaS businesses, it is an important metric to follow because it provides insight into the company’s health and ability to generate revenue consistently.
MRR is a forward-looking metric that provides insights into the future growth of a business. It is a crucial metric for investors to track when considering investing in a subscription-based business.
How to calculate MRR?
There are a few different ways to calculate MRR, but here’s the most common method.
SaaS businesses can calculate MRR by adding up the recurring revenue generated by their customers for each month (period t).
MRR = Σ Recurring Revenue
In the example below, we have three customers and a monthly subscription rate of £300. Therefore, the MRR in January is calculated below.
January: 300 + 300 + 300 = £900 MRR
In February, a SaaS company gained another customer, which increased MRR:
February: 300 + 300 + 300 + 300 = £1200 MRR
This calculation method produces a monthly average of recurring revenue, which SaaS companies can use to compare against previous months or quarters to track growth.
MRR helps track the health of the customer base and identify any trends in customer behaviour.
By tracking MRR, SaaS companies can identify any trends in revenue and take steps to address any issues that may arise.
MRR Segmentation
SaaS businesses can further segment MRR into five types.
New MRR is the monthly recurring revenue from new customers acquired in a given month.
Reactivation MRR: MRR gained from regaining previously lost customers.
Upgrade MRR: Upgrade MRR measures the revenue from subscription plans upgraded from their original pricing to higher-cost plans.
Churn MRR: Revenue lost from subscription cancellations from month to month.
Expansion MRR: It is the increase in MRR from existing customers.
Benefits of Tracking MRR
There are numerous benefits of tracking MRR for a business,
- First and foremost, it provides a clear picture of the business’s health. If MRR grows, the company is on a path to sustainable growth.
- Second, MRR is a leading indicator of future growth. By tracking MRR, businesses can identify and invest in activities driving growth.
- Third, MRR is a crucial metric for understanding customer lifetime value. By understanding the MRR of a customer, businesses can make informed decisions about acquisition and retention strategies.
- Fourth, you can use MRR to benchmark the performance of a business against others in its industry. By understanding the average MRR of a business in its sector, SaaS businesses can set ambitious but achievable growth goals.
- Finally, MRR is a crucial metric for understanding the economics of a subscription business. As a result, companies can make informed decisions about pricing models and other vital aspects of the SaaS business.
Annual Recurring Revenue (ARR)
Annual recurring revenue (ARR) measures a company’s yearly subscription-based income. Similar to MRR, ARR helps track and predict future revenue growth.
How to calculate Annual Recurring Revenue (ARR)?
SaaS companies can calculate ARR by taking the company’s total recurring revenue for a given period and dividing it by the number of months (12 months).
Annual Recurring Revenue = Yearly revenue generated / 12 months
For example, if a company has a total recurring revenue of £120,000 for 12 months, therefore
ARR = £120,000 / 12
ARR = £10,000
However, many SaaS companies prefer breaking the total figure into several individual ARRs. As a result, ARR consists of the following components:
- New customer ARR
- Renewal revenue from existing customers
- Upgraded customers’ ARR
- ARR lost due to downgrades from current customers
- Churned customers’ ARR
It’s helpful to break down the total figure to identify the customer segments that contribute the most to the company’s ARR.
SaaS companies with higher ARR tend to grow at a faster rate.
To calculate ARR, companies need to understand their recurring revenue streams clearly, which means identifying all the recurring revenue on a monthly or yearly basis. It can be challenging for companies with complex subscription models, but it is essential for accurate ARR calculation.
Once a SaaS company has calculated its ARR, it can use this metric to track its performance over time and compare it to other companies in its industry.
Key Takeaways
MRR is an excellent metric for managing and understanding SaaS companies’ recurring revenue, whereas ARR is a perfect metric for managing a SaaS company’s overall revenue.
Businesses tend to focus on maximising their MRR (monthly recurring revenue) to ensure a consistent and predictable income stream. As a result, ARR (annual recurring revenue) is often seen as a secondary metric, though it can help predict long-term growth.
Both the metrics are crucial for your SaaS company’s growth.
