For most subscription-based businesses, calculating the Monthly Recurring Revenue (or MRR) is undeniably a must for understanding the overall profitability of a company and its cash flow. If you’re just starting out in the field or if you were looking for more info about this, you found the right article! With our complete guide, you’ll know how to calculate the MRR with a subscription business model.
What’s a Monthly Recurring Revenue (MRR)?
Before talking about the MRR, first, you have to know how a subscription-based business works. The core of this model is to allow customers to subscribe to goods or services they want and pay a recurring fee (usually once a month) to prolong the access to that product/service. As a result, the company will gain a predictable “recurring revenue”.
Now that’s out of the way, here’s the meat of the bone. The monthly recurring revenue, hereinafter referred to as MRR, is a way to measure expected recurring revenues from a product or service provided by a subscription-based business.
Why is the MRR calculation/optimization important?
The MRR is a useful tool that can give you a lot of information about your business. Here we listed all the benefits one can gain by learning and using MRR:
- The MRR determines whether your sales and marketing are effective or not.
- This metric allows you to know what are your sales’ strengths and opportunities.
- Since this calculation can accurately forecast financial outcomes, it indeed helps you to determine the budget as well as to prepare your next year’s business plan accordingly.
- The MRR is also an important key indicator of business growth.
- With the MRR’s result, you will be able to make better decisions and lead the business in the right direction.
How to calculate the MRR?
There are 2 formulas to calculate the MRR:
Formula 1: MRR = SUM (the amount of monthly fee paid by customers)
The simple way to find the MRR is to sum the monthly subscription fee paid by each customer. For example, if customer A bought a $100 monthly program and customer B bought a $300 one, in that month, your MRR would be $400 in total.
Formula 2: MRR = ARPA * Total # of Customers
The second formula for MRR calculation is to use the average revenue per account/user (ARPA). You can simply multiply the total number of your active customers by the average amount, all of those customers are paying per month.
Supposing that you have 5 paying customers and the average amount paid per customer is $200 monthly, so your MRR would be $1,000 (5 person x $200 fee). To know your ARPA, you could just take your monthly or annual revenues total and divide it by the amount of customers/accounts.
How to calculate precisely your MRR growth?
Many people think that the MRR growth is generally related to the number of customers. In principle, this is correct, but it is only one of the factors you should consider. In fact, to properly analyze the MRR growth, we have to consider the 3 different types of MRR as follows:
1. The New MRR is your basic MRR calculation, or in other words, the revenues from acquiring new customers. See above for the formulas.
2. The MRR Churn is the loss of revenues caused by customer cancellation or downgradings. As an example, 2 customers canceled their $100 monthly subscription plans and another customer downgraded his/her plan from $200 to $100. Your MRR Churn of that month would be $300 ($200 + $100).
3. Expansion MRR refers to an upgraded subscription plan from one or more existing customers. This happens when they upgrade their existing subscription (which is called “upselling”) or when they buy new additional products (which we call “cross-selling).
After measuring all of the above, you can now calculate your MRR growth by following this formula: “New MRR + Expansion MRR – Churn MRR = New New MRR”
BONUS TIP: How to compute the MRR for annual plans?
In case your company offers annual plans for customers, you can still measure the MRR by converting the revenues into monthly incomes.
Let’s say you sell a $2,400 yearly plan. So, just divide by 12, and then you will easily have the result which is $200 per month. Also, for quarter billing you simply divide the yearly plan by 4, and so on.
What are common mistakes that you should be wary of when calculating MMR?
As the MRR metric is significantly important for subscription businesses, you should be wary of some of the most common mistakes that business owners make:
Forgetting to convert the quarterly, semi-annual, or yearly plans into monthly plans.
Accidently includes one-time payments which are not “recurring” income. This error will inflate the revenue forecast and negatively affect your financial model later on.
Forgetting the customer acquisition’s costs (CAC), which include the transaction fees from their MRR calculation.
Last but not least, forgetting the exclusions of the discounts in the final results. Let’s say you only got 1 customer with a $200 monthly plan this month, and you gave a 50% discount on that account, your MRR would be $100 only, not $200.
Now you know how to calculate your monthly recurring revenue which is one of the most important indicators of business success. We hope the formulas in this article will be helpful for you in the near future.