How to calculate Monthly Recurring Revenue for a Monthly Subscription Business
There are significant difference in how Monthly Recurring Revenue is calculated for a monthly subscription business versus a term subscription business.
With a term subscription model, MRR growth is calculated using a monthly value derived by normalizing a contract transaction. For instance, a $1,200 annual subscription has a monthly value of $100. This normalized value is not typically derived from actual revenue schedules, which include "noise" due to revenue recognition rules and methods employed. This normalized value is just a representation of the monthly value of a contract element during the life of the subscription. Unfortunately, you can't simply pull it from your finance system. You have to calculate it.
In a monthly subscription model, you use actual billed, invoiced, or paid fees in your MRR calculation, which means you can use actual transactions from your finance system or even raw transactions from a credit card processor.
While the data sources differ significantly, the MRR growth report format is the same. To communicate important information about performance, MRR growth is reported in distinct buckets:
As you can see, the MRR from actual transactions is report by:
- MRR gained from New Accounts (new)
- MRR gained from Upsells/Upgrades/Increases (net positive)
- MRR Lost from Downgrades/Downsells (net negative)
- MRR Lost from Cancellations/Non-renewals (loss)
(MRR Lost from #3 and #4 is typically referred to as "Revenue Churn." Monthly subscription businesses do not typically have a high frequency of #3.)
If the MRR report were simply a display of revenue by period, you could produce and use a basic income statement. Unfortunately, it is the need to segment the sources of gains and losses that creates the significant problems in calculating MRR growth for monthly subscription businesses. Financial management and transaction management systems do not typically relate transactions to each other, only to the customer. It is the interrelationship of a customer's monthly transactions that enables the measurement of net positive and net negative changes. Furthermore, traditional finance systems neither identify "new" transactions in a subscription stream, nor do they indicate or store the presence of a cancellation. If even captured, it is typically done so within the administration and provisioning module of your application or subscription system not the finance system.
Some additional notes.
- Because you do not have contracts that obligate customers beyond the present month, Monthly Recurring Revenue is neither committed nor contracted. Your Monthly Recurring Revenue is simply the historical record of revenue transactions.
- If your model includes variable, usage or "consumption" fees, calculation of MRR growth is significantly more complicated and requires objective proof of predicable usage.
- To project Monthly Recurring Revenue, you estimate by applying a defendable renewal rate or churn rate to the actual historic numbers. Naturally, you will want to layer in your projected new sales, however the revenue components for renewals and new sales should be presented as individual line items.
Contracted Monthly Recurring Revenue
Committed Monthly Recurring Revenue
How to Calculate Monthly Recurring Revenue - Term Subscriptions
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