ARR and MRR are two of the most important metrics every SaaS company needs to correctly measure and track. When properly calculated, ARR and MRR offer insights into current and projected subscription revenue to help guide strategic decisions, reveal the financial health of the business, and provide investors with data on future income.
In this article, you’ll learn everything you need to know to start working with ARR and MRR, including the key differences compared to other metrics, a calculation formula, and how startups can use these metrics to grow their business.
What are ARR and MRR?
Monthly recurring revenue (MRR) is the sum of recurring revenue a business recognizes in a given month. In many ways, the recurring nature of subscription business models offers some predictability of revenue, making it easier to track and forecast revenue.
For most SaaS business models, MRR is mainly revenue from software license subscriptions. In addition to reflecting the total value of ongoing subscriptions, the total MRR figure takes into account any variance in recurring revenue during the month, including any new subscriptions, cancellations or customer churn.
Annual recurring revenue (ARR) is the sum of recurring revenue a business receives over 12 months, based on the MRR figures. The practice of regularly tracking and calculating ARR is a helpful exercise to predict long term growth of your business.
How are ARR and MRR used?
ARR and MRR are metrics that provide valuable insights into the health of your business. This data can be used to forecast the momentum of revenue your business is building (or losing) over time, and allow you to plan accordingly.
To properly use ARR and MRR, it’s crucial to understand the concept of recurring revenue and how it’s different from total revenue, bookings, and billings. These are all ways of measuring the amount of money a business makes in a given period; however, each of these metrics looks at the income from a different perspective:
- Recurring revenue is the portion of income a business has earned and expects to continue earning based on customer contracts.
- Revenue is the total income a business has earned. This includes both recurring revenue and one-off payments that the business does not expect to continue earning.
- Bookings are the total contract value of customers that have signed and committed to pay, including contracts that have not yet been invoiced or paid.
- Billings are the invoiced amount of customers’ money you are to collect in payment for customer contracts.
If your business uses accrual accounting, you cannot recognize the payments you receive from customers as revenue until the business earns it by providing the contracted service—until this point, you must record it as deferred revenue. In the case of software subscriptions, the business delivers the service throughout the duration of the customer contract terms and so earns the income throughout the contracts as well. You can recognize an equal portion of the total subscription fee each month as recurring revenue, which then contributes to your MRR and ARR.
For example: A company secures two new customer contracts in January, each consisting of an annual software subscription of $12,000, plus a one-off setup fee of $1,000. The company receives payment for one contract in January and payment for the second contract in February. In February, both customers received their first full month of software access and their setup service. At the end of these two contracts, the company will have earned a total of $26,000, but the bookings, billings, revenue, and recurring revenue from the first three months would be as follows:
Learn more: How To Manage SaaS Revenue Recognition For Your Startup
Calculating ARR And MRR
How is MRR calculated?
To calculate monthly recurring revenue, SaaS companies need to take several types of recurring revenue into account:
- New MRR—The recurring revenue received from all new customers in a given month. This also includes revenue received from customers who reactivate a lapsed or canceled subscription in a given month.
- Upgrade MRR—The additional recurring revenue received from existing customers in a given month. This is generated by cross-selling or upselling, and includes subscription renewals at a higher price. Upgrade MRR is also known as expansion MRR.
- Downgrade MRR—The recurring revenue lost through existing customers downgrading to a lower-value subscription in a given month, including customers renewing their subscription at a lower price.
- Churn MRR—The recurring revenue lost through existing customers ending or cancelling their subscription and leaving the service in a given month.
- Existing MRR—The recurring revenue from existing customers who have not reactivated, upgraded, or downgraded their subscription in a given month. If a customer renews their current subscription without switching to a more or less expensive plan, the revenue recognized from this renewed subscription is included as existing MRR.
You can use the following MRR formula and five types of MRR detailed above to calculate the net monthly recurring revenue:
Total MRR each month =
Existing MRR + New MRR + Upgrade MRR - Downgrade MRR - Churn MRR
When calculating monthly recurring revenue, a common mistake by SaaS companies is including one-off payments, variable fees for add-on services, or forgetting to subtract discounts. Including these charges or omitting discounts falsely inflates the expected MRR growth rates, which can mislead investors and misinform strategic business decisions.
For example, a company might offer a subscription for five hours of customer support each month and charge for any assistance in excess of this allotted time period at an hourly rate. The subscription value is considered to be recurring revenue. However, if customers incur and pay for additional hours in a given month, you cannot count on these one-time fees to recur, so they should not be included in the MRR calculations.
How is ARR calculated?
ARR is the value of the recurrent revenue components of your business’s term subscriptions normalized to a one year period. There are multiple ways to calculate ARR. One of the easiest ways to determine how much revenue your business can expect over a one-year period is to follow this simple annual recurring revenue formula:
ARR = Total MRR x 12
In comparison to MRR, the ARR calculation is less exact because it extrapolates the data from a single month across an entire year. In reality, the rate of growth may increase or decrease throughout the year, and factors such as contract length: whether you have annual contracts or customers can opt-out at any time. But, generally speaking, ARR shows the amount of revenue the business can rely on generating.
How SaaS Businesses Use ARR And MRR
If your business accounts follow Generally Accepted Accounting Principles (GAAP), your financial reporting will reflect the business’s total revenue, including non-recurring income that you can’t count on to grow your business. Because ARR and MRR only express recurring revenue, they allow SaaS startups to determine if an increase in revenue is an anomaly driven by one-time purchases or sustainable growth of reliable income.
As a result, using MRR rather than total revenue to build financial projections and forecasting produces a more accurate picture of the income the business will consistently generate in the future. Monitoring the fluctuations in MRR and any correlation to changes in the service allows you to identify trends and make predictions for how specific scenarios will impact MRR. Plus, by identifying any marketing activities or product updates that correlate with growth in MRR, you can see which were beneficial and actually increased the number or value of subscriptions. Based on this information, your startup can invest more in marketing and development activities that have driven up MRR and reduce investment in unsuccessful strategies.
The Key To Getting Accurate SaaS Metrics
To deliver these kinds of valuable insights, your calculations for ARR, MRR, revenue, bookings and billings need to be based on accurate bookkeeping. For example, to correctly calculate MRR and ARR, SaaS companies need to have a proper revenue recognition schedule and granular records that reveal the source of each dollar of income.
The Zeni finance team experts have been working with software and subscription companies for decades, so we have a solid understanding of what it takes for SaaS startup finances to run smoothly—including proper revenue recognition and MRR calculations for your subscription model. Zeni is a full-service finance firm that can handle all your company’s bookkeeping, accounting, tax, and CFO functions. We combine AI and human expertise to maintain GAAP-compliant financial records that are meticulously detailed and always up to date.
Plus, with the Zeni Dashboard, you have a 24/7 resource to review your company performance at a glance with instant access to your monthly financial statements and key metrics, including burn rate, runway, monthly revenue, OPEX, cash flow, and more—all for a flat monthly fee.
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