on July 27, 2018 Financial Metrics

MRR Should Really be Called 'MRRR' Due to GAAP Accounting Rules

Blog Home Page

Most people in the SaaS world know MRR stands for "monthly recurring revenue." What many do not know is that despite having the word "revenue" in it, MRR is not actually revenue.

MRR could be more accurately described as "MRRR" or monthly recurring revenue representation. MRR is a normalized number that provides a good representation of your monthly recurring revenues, but it is not actual revenues that you can legitimately recognize under GAAP.

Because SaaSOptics provides both GAAP-compliant revenue recognition (which includes reportable revenue for recurring and non-recurring revenues) and subscription metrics (which include MRR and its many uses in reports like MRR momentumâ„¢, cohorts, customer lifetime value, and more), we frequently have the need to clarify for prospects and users that MRR is not reportable revenue. You should not use your MRR to create financial statements, and neither should you use reportable revenue as your MRR number to create metrics. 

The danger of using reportable revenue as MRR is the potential volatility inherent in reportable revenue numbers.

This volatility can make it look like your business has changed when the only thing at work is accounting rules around the timing of when you can recognize revenue. Below is an example that may help illustrate this.

A customer signs a one-year agreement for $1,200. In our example, an implementation is required, and the customer doesn't go live until May 1. Under current GAAP revenue recognition rules, you then start recognizing revenue on May 1. That means your reportable revenue for January to April is $0 per month ($0/4 months). Then from May to December, it is $150 per month ($1,200/8 months).

For creating your GAAP financial statements, this is great. For the subscription metrics that you need to help understand your customer behavior and make business decisions, this is trouble.

And it is exactly where MRR comes to the rescue. MRR is a normalized number not subject to accounting rules that you can use to represent your customer's financial behavior. This customer is NOT worth approximately $150/month to your business; it is worth approximately $100/month. The customer's behavior relative to your business (committing to a $1200 contract for 1 year) is much more closely represented by the MRR schedule below than by the reportable revenue schedule. If you use the reportable revenue numbers as your MRR, it looks like a customer that signed up for an eight-month contract for approximately $150/month.

MRR should be called MRRR

It gets even more misleading at renewal time! One year from now, the customer renews. For reportable revenue purposes, because there is no implementation required (they are already live), you can keep recognizing revenue. But, now for the second term, the $1,200 is spread over all 12 months. So, instead of $150/month in recognized revenue, it is $100/month. If you were to use the reportable revenue numbers in your metrics, it would look like the customer downgraded from 150/month to 100/month! By contrast, the MRR schedule is giving us exactly what we need for our metrics: Representation of customer/contract behavior.

This customer did NOT downgrade, they renewed. We have a positive event that could easily be misinterpreted if the wrong building blocks are used for your metrics.

MRR (and the metrics built from the foundation MRR provides) are about representing customer/contract behavior to enable business decisions. Reportable revenue is about GAAP accounting rules, timing, and creating financial statements. Using one for the other will lead to misconceptions, faulty decisions, or incorrect financial statements.

The above can be difficult to keep straight conceptually and even more difficult to report on, especially if you're trying to do it in spreadsheets. So, contact us if you want help, or just remember 'MRR' should really be called 'MRRR' (monthly recurring revenue representation).

View our encyclopedia of articles on MRR here.