ARR & MRR are important figures that every SaaS business needs to know and understand.
What is ARR & MRR
ARR (Annual Recurring Revenue) and MRR (Monthly Recurring Revenue) are measures of the revenue coming into the business from your subscribed customers, either every year or every month.
Neither ARR or MRR are Generally Accepted Accounting Principles (GAAP), however they are the revenue equivalent used by every SaaS organisation.
How to calculate ARR & MRR
On the face of it, ARR and MRR seem relatively straightforward to calculate.
For MRR, simply add up the amount of revenue your subscribed clients pay each month. It is the income that they pay each and every month in order to use your software. Note that it doesn’t include any one-off payments, for example onboarding or consultancy fees.
If you have ten clients each paying £1000 per month, then your MRR is £10,000.
ARR is simply the expected annualised amount. If you’ve got 10 customers that pay £1000 per month, then your ARR is £120,000
Pretty easy? Well it seems so, but the complexities come in when you start using MRR and ARR to forecast your future finances.
In forecasting you need to consider the following adjustments.
Expected new MRR
How many new clients do we expect to sell to each month, and what is the resulting MRR?
If you offer a tiered service, then it’s likely that some of your clients will increase their subscriptions. Indeed, this should be a targeted figure where you look to increase X% of your client database by a certain figure each month. If you’re gathering the right data, you should be able to get a benchmark of how many of your customers upgrade each month.
For example, let’s say 10% of your clients are expected to upgrade from £1000 per month to your £2,000 per month service by month three. Therefore, using the same example as above, your expanded MRR would be £10,000 for months 1 and 2 but in months 3 onwards it would be 9*£1000 +1*£2000=£11,000
It’s a fact that your customers won’t be with you forever. So it’s good practice to know and understand your churn rate. Then when you’re forecasting your MRR, you can make the necessary adjustments. Let’s say you lose 10% of your customer base every 2 months, then your MRR forecast can be adjusted either by averaging out the reduction each month. In the example that we’ve been using, we could do one of the following calculations
Renewals and lapses
Depending upon your terms of service, you may have a fixed duration contract or it may be that your clients are free to leave at any time. If it’s a fixed contract, how many of them renew and how many will lapse? Have you included the lapses in the churn rate that we looked at above? It’s fine to either include them in your churn rate, just make sure you don’t double count the reduction.
So, you can see how things can get a little more complex here. But really as long as you plan it out you and monitor your numbers you should be able to put together a relatively robust forecast.
Once you’ve calculated your monthly recurring revenue forecast you can work out our ARR. As per MRR, calculating ARR seems straightforward, but you’ll need to factor in elements such as whether you have annual contracts or whether people are free to leave with no notice. If it’s the former, then you can use the contractual value to work this out. Adjust for churn and non payers which, unfortunately, is a fact of life.
In month one you sign five contracts at £1,000 per month, and your contract term is 12 months.
Therefore you have 5*£1000*12= £60,000 ARR
In month two you sign another five at the same level. So now your ARR is 5*£1000*11=£55,000 + 5*£1000*12=£115,000
You’ll want to gather your data and monitor your renewal rate so that you can forecast from months 13 onwards. So, if you know that three out of five renew after 12 months, then you can factor those figures into your forecast.
Why is knowing your ARR & MRR important
As with any business, knowing your figures is crucial to making decisions. For example, can you afford to bring in a new hire? Invest in a new marketing channel or new equipment for the office.
It’ll also help you work out your sales targets and allow you to target and plan for profit. By understanding your expected overheads, expenditure and desired profit, and by calculating your average MRR or ARR per customer, you can then target and remunerate your sales team by the amount of new MRR that they bring in.
Having a firm grasp of your business numbers is a fundamental skill that all business owners should have and ARR/MRR is only one of the numbers.
If you would like to explore your numbers a bit more, book a growth strategy call with one of our consultants and we'll run through these with you.