How to Calculate MRR in a Term Subscription Business

How to calculate MRR for a Term Subscription Business

Need to know how to calculate MRR in your business? Let’s start with the basics:

MRR or Monthly Recurring Revenue is neither a FASB nor a GAAP defined term, and therefore there are neither rules nor findings to help you define the calculations for the various MRR components needed to report on business momentum:

  • Monthly Recurring Revenue from renewals
  • Monthly Recurring Revenue from new sales
  • Monthly Recurring Revenue from upgrades
  • Monthly Recurring Revenue from losses or downgrades, commonly referred to as¬†revenue churn

Whether you use a tool like SaaSOptics or an Excel file, your report will look something like the image below. Variations might include a list of the customer names, or simply a summary without the detailed category line items.

calculate mrr

Tired of reading and just want to quick and dirty version of this article? Check out the video below:

 

 

 

If you run your financials on QuickBooks or another packaged accounting system, you likely maintain your revenues on a spreadsheet. If your financial system has a revenue recognition capability (Intacct, Netsuite, Softrax, SAP, Oracle, and others), you have likely become comfortable turning to that system or the data from that system for revenue calculations.

News Flash Рyou cannot get Monthly Recurring Revenue calculations from ANY financial reporting system!

Why?

  1. Finance systems don’t typically differentiate revenues from new transactions versus those from renewal transactions
  2. Finance systems don’t typically track lost revenues from canceled contracts or non-renewed contracts
  3. Finance systems don’t always make it easy to track or calculate net changes (net upgrade/net downgrade values)
  4. Finance systems that have revenue recognition functionality report GAAP revenue in actual calendar months, which as we will see, is not an MRR component

Points 1, 2, and 3 are self-evident for most after an hour or two of report writing.¬† What’s harder to understand is the concept that none of the components of Monthly Recurring Revenue can really be gathered from your revenue recognition schedule. That is true whether your revenue system of record is Excel or a true finance system.

Two issues shed light on the core problem using financial or “reported revenues”:

  1. If you use a daily revenue recognition schedule, you will see a monthly 3%+ variation in revenues due simply to the number of days per month (1/30, 1/31, and 1/28)
  2. Unless you start all revenue recognition on the first day of the month, you will have partial month revenue streams

If you use an Excel file for revenue calculations/reporting today, you probably won’t have issue #1, but likely will have issue #2. If you have a sophisticated financial system, you could have both issues.

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MRR Measurement is largely an exercise exception management

A PowerPoint presentation with simple formulas can lead you to believe that MRR calculations are easy. In fact, most are. As in most things in life and business, the exceptions are the time consumers. The higher the value of your transactions, the more exceptions you are likely to experience, and therefore the more effort required to define the rules. Some practical examples shed further light on how in practice it can be complicated to calculate the various monthly recurring revenue components and why clear definitions are critical.

MRR Calculation Examples

Example 1 РHow to Calculate MRR for First and End of Month Start Dates 

Scenario: A new $120,000 annual contract starts on May 1, 202o, and ends on April 30, 2021. The contract does not renew in 2021.

Question: How much Monthly Recurring Revenue was added and when?
Answer: $10,000 in May 2020, specifically May 1, 2020

Question: How much Monthly Recurring Revenue was lost and when?
Answer: $10,000 was lost, but in what month? We would suggest May 2021, which is when the contract should have renewed (specifically May 1, 2021). Unless clearly defined, someone could easily decide to put the loss on April 30, 2021, the last day of the term. But doing so, you both gain and lose $10K within a single 12-month period.

Example 2 РHow to Calculate MRR for Mid-Month Start Dates 

Scenario: A new $120,000 annual contract starts on May 15, 2020, and ends on May 14, 2021. The contract does not renew in 2021.

Question: How much Monthly Recurring Revenue was added and when?
Answer: $10,000 in May 2020, specifically on May 15, 2020

Question: How much Monthly Recurring Revenue was lost and when?
Answer: $10,000 in May 2021, specifically on May 15, 2021, when it did not renew

Example 3 РHow to Calculate MRR for Gaps in Contracts 

Scenario: A new $120,000 annual contract starts on May 15, 2020, and ends on May 14, 2021. After a gap due to contract negotiations, the contract renews for $120,000 on June 26, 2021, for a new term through June 25, 2022.

Question: How much new Monthly Recurring Revenue was added and when?
Answer: $10,000 on May 15, 2020.

Question: How much Monthly Recurring Revenue was renewed and when?
Answer: In fact, there is no “right answer,” there is only how you decide to calculate it. Options include considering it a non-renewal in May 2021 and a renewal in June 2021, placing it into a bucket of “open renewals” in May, simply renewing it in June 2021 or renewing it effective May 15, 2021, at $9,230 MRR, effectively discounting it by considering it a 13-month term.

Another option is to simply not worry about it. The not worry option is an extremely difficult one for finance people whose culture is rooted in mathematical purity and the concept of tying. But, it is important to remember that MRR calculations are metrics that are used to report on progress, but most importantly to make business decisions. If the exception scenario is rare or is not material to the calculations, simply ignore it or footnote it!

Example 4 – How to Calculate MRR for Early Renewal Upgrades

Scenario: A new $120,000 annual contract starts on May 15, 2020, and ends on May 14, 2021. The customer orders an upgrade on December 31 that goes into effect January 15, with the new End date September 18, 2024, and for an additional $247,000.

Question: How much new Monthly Recurring Revenue was added and when?
Answer: That one is still easy – $10,000 on May 15, 2020.

Question: How much Monthly Recurring Revenue was renewed or upgraded and when?
Answer:¬†It’s up to you! Define the Monthly Recurring Revenue rules as best you can and record the transactions as consistently as possible. Be sure the rules are defined and described in English, so everyone on the team can understand them.

And remember, unless each contract has the same duration, you have to normalize the contracts somehow in order to perform the simple mathematical calculations of addition and subtraction.

Interested in seeing how your company stacks up to its peers? Check out OpenView’s SaaS benchmarks.¬†

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