MRR Should Really be Called ‘MRRR’ Due to GAAP Accounting Rules
This post was originally published on July 27, 2018.
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 MRRR and its many uses in reports like MRR momentum™, cohorts, customer lifetime value, and more). We frequently clarify for prospects and users that MRRR, like the name change suggests, is not reportable revenue. You should not use your MRRR to create financial statements, and neither should you use reportable revenue as your MRRR number to create metrics. Using reportable revenue as MRR is dangerous because of the potential volatility inherent in reportable revenue numbers.
This volatility can make it look like your business has changed when the only thing that has really changed are the accounting rules around the timing of recognizing revenue. Here’s an example that may help illustrate this concept.
Say a customer signs a one-year agreement for $1,200. In this example, an implementation is required, and the customer doesn’t go live until May 1st. Thus, under current GAAP revenue recognition rules, you’ll start recognizing revenue on May 1st. That means your reportable revenue for January to April is $0 per month ($0/4 months). Then from May to December, revenue is reported as $150 per month ($1,200/8 months).
This is a great process for creating your GAAP financial statements. However, it spells trouble for the subscription metrics that you need to understand your customer behavior and make business decisions.
This is when MRRR comes to the rescue. MRRR is a normalized number not subject to accounting rules that you can use to represent your customer’s financial behavior. If you use the GAAP-compliant reportable revenue numbers as your MRRR, it looks like a customer that signed up for an eight-month contract for approximately $150/month. But this customer isn’t worth $150/month to your business. When taking into account the implementation process, they’re actually worth $100/month. The customer’s behavior relative to your business is much more closely represented by the MRRR schedule below rather than by the GAAP-compliant reportable revenue schedule.
GAAP-compliant MRR reporting gets even more misleading at renewal time. For reportable revenue purposes, because there’s no implementation required upon contract renewal (they’re already live), you can keep recognizing revenue. But, now for the second term, the same $1,200 is spread across all 12 months. So, instead of $150/month your recognized revenue is $100/month. If you were to use the reportable revenue numbers in your metrics, it would look like the customer downgraded from $150 to $100 per month. By contrast, the MRRR schedule is giving us exactly what we need for our metrics: accurate representation of customer/contract behavior.
This customer didn’t downgrade, they renewed. This is a positive event that could easily be misinterpreted if the wrong building blocks are used for your internal metrics.
MRRR (and the metrics built from the foundation it provides) is about representing customer/contract behavior to enable wise business decisions. Reportable revenue is about GAAP accounting rules, timing, and creating financial statements. Using a single metric for both purposes will lead to misconceptions, faulty decisions, or incorrect financial statements.
We know keeping MRR, MRRR, and all the other metrics required for a full understanding of your business can be difficult to keep straight—and even more difficult to report on. (Especially if you’re trying to do it in spreadsheets.) So, if you want help, just reach out to one of our Solutions Consultants. We can help you eliminate the spreadsheet shuffle and automate your financial operations for streamlined, accurate, and compliant financial reporting.
If you want to keep learning about all the financial metrics you should be reporting on, check out SaaSpedia—our comprehensive encyclopedia of articles designed to support your SaaS business growth.