What are MRR and ARR and how are they calculated?
Some believe that to measure is to know.
Applying this concept to life would make it hard to live in some aspects, but there are a few areas that undeniably profit from this approach.
One of these areas is the SaaS industry—which needs constant management in order to grow.
How you ensure growth is up to you, but I can introduce you to two metrics that will surely help you along the way as long as you know how to put them to use.
That being so, I will present MRR and ARR to you and explain how you can calculate them to drive business growth.
What Is MRR?
MRR stands for monthly recurring revenue and is a measure of monthly income for the SaaS companies that operate on a subscription model.
To elaborate, it calculates the recurring revenue that businesses generate from subscriptions on a monthly basis. Thus, this is a key metric that you can utilize every single month to observe the ups and downs in revenue and make plausible predictions regarding the future of the business.
From a different viewpoint, it could be considered as the polar opposite of the customer churn rate—owing to the fact that monthly recurring revenue consists of the monthly revenues that the current customers bring in, and churn rate involves the percentage at which customers cancel their subscriptions, thus stop adding to monthly subscription revenue.
The calculation of monthly recurring revenue does not factor in non-recurring revenue, such as one-time charges and add-ons, because it is not paid on a regular basis—unlike predictable revenue.
What is more, MRR assures business owners that a roadmap concerning the health and longevity of the SaaS business can be prepared if the data obtained from the previous months are compared.
How is MRR calculated?
MRR is a vital metric with a simple formula that every company that adopts a subscription business model should acknowledge.
What you need to do is multiply the number of monthly subscribers by average revenue per user (ARPU)—whose formula requires dividing the total amount of revenue by the total number of customers you have in a given period of time.
Let's assume that you have five customers paying for a monthly plan that costs $200. Then, your MRR will be $1,000.
However, you need to modify the formula for annual subscriptions. In that case, you have to divide the annual plan price by 12 and then multiply the result by the number of customers on the annual plan.
What Is ARR?
ARR stands for annual recurring revenue and is a measure of annual income for the SaaS companies that use a subscription-based model.
Essentially, it calculates the recurring revenue that businesses generate from yearly subscriptions. Hence, this is a financial metric that you can use to monitor the changes over the years and decide which aspects you can invest in and plan to achieve profitability in the long term.
By studying the previous trends and data, annual recurring revenue allows you to forecast revenue—which could aid you on the path to profit as having a clear and accurate view of the future revenue would help the business organize priorities and make more effective plans down the line.
Just like MRR, ARR does not include non-recurring revenue, such as one-time purchases and one-time fees, since it is not charged on an ongoing basis.
Moreover, estimation of future revenue is not the only asset ARR has; it also reports growth rate based on long-term contracts. Additionally, it aligns well with the GAAP (Generally Accepted Accounting Principles) revenue, therefore making it easier to have an approximate calculation of GAAP revenue.
How is ARR calculated?
ARR is a metric for subscription businesses to measure the annual revenue from subscriptions.
To calculate your ARR, you must figure your MRR in advance - which is acquired by multiplying the number of monthly subscribers by average revenue per user (ARPU). Then, all you have to do is multiply your MRR by 12.
To put the ARR formula to use, let's assume that your MRR is $1,000. If you multiply it by 12, then you will get $12,000 as your ARR.
Is ARR 12 times MRR?
To simply put, it is.
There may be some changes in the metrics when more complicated items are added to their calculations. However, the simplest way to measure your ARR goes by calculating your MRR first and multiplying the result by 12.
Accordingly, every business owner who wants to receive insights into the health of the business, anticipate future revenue, and spot the issues regarding the subscription model should apply this formula.
What is a good ARR for SaaS?
Back in the day, it was said that achieving $1,000,000 ARR meant success for startups.
Some still follow this road to scale the business, however, it is no longer a valid milestone to pursue due to new buyer personas. Now that the potential customers are more willing to purchase SaaS products for a higher price, it does not take as long as it used to achieve this goal. Also, there are a lot of changes in the sales environment that speed up the whole process.
For this reason, it would be more logical to bring out a suggestion that applies to all scenarios instead of a standard that is acceptable for the time being. That brings us to a significant matter regarding your business: expenses.
For SaaS, a good ARR completely depends on your expenses. As long as the business is thriving despite all the expenses, such as the cost of revenue and sales and marketing, your ARR must be capable enough to allow you to be profitable and stick to the plan you made for the health of the business in the long term.
To be considered profitable in the SaaS industry, your total revenue must exceed the total operational costs, and your recurring revenue must be able to cover the customer acquisition costs. Given that you meet these requirements, there is one more thing you should pay attention to: growth.
There are two powerful concepts that cannot be ignored when it comes to growth: month over month (MoM) and year over year (YoY). Month over month compares the alterations in the value of a specific metric with the previous month's data of the same metric. Year over year, on the other hand, serves the same purpose but the duration shifts to a year.
These two terms can be applied to other metrics to measure growth—which induces the process of recording and reporting gradually less unchallenging. Each and every matter I have touched upon above should be taken into consideration when deciding on a good ARR for your business since ARR is a variable item that depends on many factors.
4 Revenue Metrics That Are Inseperable from MRR and ARR
Explaining MRR and ARR without mentioning the metrics that complement them would be a mistake.
Therefore, here are the four revenue metrics that go hand in hand with MRR and ARR:
1- Customer Acquisition Cost (CAC)
Customer acquisition cost concerns the amount of money you spend on acquiring new customers. To find it out, you must add every item that you pay out to win new customers over a specific period of time. These items include marketing, sales, and even salaries.
The next step is figuring out how many customers you acquire during that period. Then, all you need to do is divide the first variable by the second one. Supposing that you spent $1,000 on attracting new customers last month and were able to incorporate 100 new customers thanks to your efforts, your CAC would be $10 for that month.
This metric comes in handy more than you can imagine when combined with customer lifetime value— which is our next stop.
2- Customer Lifetime Value (CLV, CLTV, or LTV)
Customer lifetime value deals with the amount of money your customers bring into your business during the time they actively work with you. Simply put, it represents how much an average customer is worth to your business. It is composed of three parts:
👉Divide the number 1 by your customer churn rate to find your customer lifetime rate.
👉 Find your ARPA (average revenue per account) by dividing your total revenue by the total number of customers.
👉 Divide your customer lifetime rate by your ARPA to figure your customer lifetime value.
After recognizing your CLV, you can plan the future ahead and take action regarding the maximization of profitability—for better results, try applying this metric per customer segment.
3- CAC-to-CLV Ratio
CAC-to-CLV ratio presents the two metrics above in a single metric; it compares the amount of money you spend to acquire new customers to the amount of money these customers bring to you.
Hence, this metric can be utilized to see whether your current marketing strategies are working effortlessly for your business or not. Depending upon the result, you might invest in new programs instead of employing those that do not work in your favor—if your CLV is at least three times greater than your CAC, your business is considered healthy.
4- Average Revenue Per Account (ARPA)
Average revenue per account reveals the average revenue your business earns from your customers. To find out your ARPA, you can divide the total revenue of a specific period, mostly on a monthly or yearly basis, by the number of accounts within the same period.
Bear in mind that using ARPA and ARPU (average revenue per user) interchangeably is not a right practice as one customer may have several accounts with a company.
To sum up,
MRR and ARR are two metrics that every subscription-based SaaS company can use as a tool to pursue and plan growth and profit over the long haul.
The progress of business can be interpreted thanks to these metrics—which also provide a basis for mapping out new strategies and campaigns, thus sailing towards new opportunities regarding the health of the business.
Better yet, you could use the other key revenue metrics that I have provided above to take things to the next level when keeping track of revenue.
