What is ARR & MRR and how should you calculate it?

What is ARR & MRR and how should you calculate it?

7 minute read

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Annual recurring revenue (ARR) & monthly recurring revenue (MRR) are important figures that every SaaS business needs to know and understand.

They're metrics that can be used to measure the health of your business, estimating future revenue and identifying issues with your subscription model, business model or product.

In this blog we're going to be looking at the key questions:

  1. What is ARR and MRR?
  2. How to calculate ARR and MRR?
  3. What if I want to increase my MRR?
  4. Why both metrics are important for SaaS

 

What is annual recurring revenue (ARR) & monthly recurring revenue (MRR)?

If you're a SaaS business or operate with a business model with fixed-term subscriptions, you need to understand your ARR and MRR.

ARR (Annual Recurring Revenue) and MRR (Monthly Recurring Revenue) are measures of the revenue coming into the business from your subscribed customers, either per year or per month.

For ARR to be relevant to your business, your term subscriptions must last for at least one year, or most of your customers should be on one year or multi-year contracts.

Note that both ARR and MRR should only take into account long term, or recurring, revenue. This doesn't include one time projects or add ons that you deliver for customers or consumption fees as, by definition, this is not recurring. Bear in mind that MRR can vary significantly from GAAP revenue due to the variation in the number of days in each month.

Neither ARR nor 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, annual recurring revenue and monthly recurring revenue 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 SaaS product. If you have ten clients each paying £1000 per month, then your MRR is £10,000.

To calculate ARR, the formula is simply the expected annualised amount. If you’ve got 10 customers that pay £1000 per month, then your ARR is £120,000

Think MRR and ARR calculations seem pretty easy?

Well, it seems so, but the complexities come in when you start to use ARR and MRR to forecast your future finances.

In forecasting, you need to consider the following adjustments.

Expected new MRR

How many new customers do we expect to sell to each month, how much do you expect those companies to spend with you, and what is the total resulting MRR?

Expanded MRR and expansion revenue

If you offer a tiered service, then it’s likely that some of your customers will increase their subscriptions before their current contract comes to an end.

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 £2,000 per month by month three.

Therefore, using the same example as above, the calculation for your expanded MRR would be £10,000 for month 1 and 2, but in month 3 onwards it would be 9*£1000 +1*£2000=£11,000

You could use the same formula for working out your MRR based on the number of users you expect to reduce their investment with you before the end of their contract (assuming you allow for that), as long as you have the data to project that figure.

Churn rate

It’s a fact that your customers won’t be with you forever, and that unfortunately, you'll experience revenue churn over time.

with this in mind, it’s good practice to know and understand your churn rate. Armed with this figure, when you’re forecasting your MRR you can make the necessary adjustments.

Let’s say you lose 10% of your customer base every two months. Your MRR forecast can be adjusted either by averaging out the reduction each month.

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 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 and monitor your numbers, you should be able to put together a relatively robust cash flow and net profit 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.

For example:

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.

 

What if I want to increase my ARR or MRR?

Increasing ARR and MRR is simply a case of increasing the number of customers paying you every month - but there's more than one way you can go about this.

Increase traffic

Assuming your website is generating leads for you already, increasing traffic will also increase leads and, ultimately, more customers. Or at least it should do.

Let's look at an example:

Your website receives 1,000 monthly visits. You convert 5% into leads, and 20% of those leads into new customers.

Therefore, if you increase monthly traffic from 1,000 to 1,500, total new monthly customers should increase from 10 to 15.

Of course, this depends on you retaining the same conversion rates at each stage, but, as long as you continue to drive the right sort of traffic, the numbers should remain mostly the same.

Developing an SEO strategy to increase organic search traffic or increasing your paid media budget are the main routes for increasing total website sessions.

In a survey conducted by Databox, 70% of respondents said that SEO is better than PPC for generating sales. (Databox, 2019)

First things first, you need to develop a strategy, including identifying your target buyer personas and planning the content you need. An Inbound Marketing Gameplan can deliver higher ROI, and is great for SaaS companies that want to scale in terms of volume and profitability.

 

Improve visitor-to-lead conversion rate

If you don't have the budget to increase your paid media spend, or you can't afford to wait for your SEO efforts to bear fruit, then improving visitor-to-lead conversion rate will help you get more from the traffic you already get.

Do you have clear calls-to-action on your highest traffic pages? Are they easy to find or buried in the footer? You also need to look at what these CTAs are for. Are they going to help to generate new customers or all geared towards top of funnel content downloads?

Identify opportunities for capturing leads, particularly on pages where there is a clear purchase intent. For subscription businesses and SaaS companies, this should include free trials and demos, as well as detailed product information like brochures and data sheets.

 

Improve lead-to-customer conversion rate

Generating leads is only half the battle. It doesn't matter how many new contacts you're adding to your CRM if you're failing to convert them into a paid subscription.

There will be a few different stages you need to look at.

Are you nurturing top and middle of funnel leads into free trialists or demo requests?

Are free trial and demo leads becoming customers?

No two sales processes are the same, but you should map out the different stages and look for where there seems to be an issue converting leads to the next stage. This should be as detailed as possible, right down to individual emails within a nurture sequence.

 

Why is knowing your ARR & MRR important

As with any business, knowing your figures is crucial for effective decision making, but it's particularly true for a subscription company. 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 to work out your sales targets and allow you to target and plan for profit and growth in the long term. By understanding your expected overheads, expenditure and desired profit, as well as by calculating your average monthly recurring revenue or annual recurring revenue per customer, you can then target and remunerate your sales team by the amount of new MRR that they bring in.

If, after you calculate ARR and MRR for your SaaS business, you'd 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.

Having a firm grasp of your business numbers is a fundamental skill that all company owners should master, and ARR/MRR are only two of the numbers to measure. Understanding the numbers behind your ARR and MRR, as well as each stage of the sales process, will ensure you identify genuine insights for increasing revenue.

Last year we helped our SaaS clients grow by increasing their website traffic and increasing their conversion rate, on average by 40% compared to the start of 2020.

What would an increase of 40% in conversion rate mean for your business?


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