You calculate the MRR incorrectly, and here's why
The life or death of a SaaS business is determined by subscription revenue. To measure the growth or decrease of this indicator, you probably focus on the omnipotent MRR (Monthly Recurring Revenue).
In preparing the article, we looked at examples of calculations of this metric for 50 SaaS services. It turned out that every fifth company does not take into account individual cost items in the equation; two out of five include expected income from users of free or trial versions in their calculations; the vast majority incorrectly considers income from customers who bought a quarterly or annual subscription.
Let's look at what MRR is, consider the errors and determine why the correct calculation of the indicator is important for business.
What is MRR?
MRR shows the planned amount of monthly income. Successful SaaS companies track MRR levels for two reasons:
a) Financial forecasting and planning . Thanks to the subscription, MRR is relatively stable and predictable. Knowing the recurring income over a long period, you can easily model the state of the business, make financial forecasts and make realistic plans for the development of the company.
b) Measurement of growth . It doesn’t matter whether investors support you or a company develops on its own - the growth of MRR from month to month is very important. This is a key indicator of the success of the SaaS business, which makes it clear: you have already taken off or have not yet taken off the ground.
How to calculate MRR?
Calculating the metric seems like a daunting task, so we split the process into three easy steps.
- Take the customers of the analyzed month and place them in the first column of the table, each under a personal identifier (number, login).
- In the second column, enter the cost of the monthly subscription. If the customer has paid an annual or quarterly plan, first divide the amount by the number of months paid.
- Sum the digits of the last column - this is MRR.
An example . You have 10 customers who paid $ 10 / month and 10 people who bought the pro version for $ 15 / month. Therefore, MRR = (10 x 10) + (10 x 15) = $ 250.
It is more difficult to calculate the MRR taking into account the remaining metrics: the outflow or the appearance of new customers, the transition of users to expensive or cheap tariffs, etc. However, in its original form, the calculation of MRR looks exactly as shown above.
Five mistakes that replace reality
1) Accounting for the full cost of annual, semi-annual, quarterly subscriptions when calculating the metric for the month
Even if the client paid the full amount for a long subscription, divide it by the number of paid months.
Reason: MRR is primarily used to measure growth rates. You do not calculate the total income, but calculate how quickly and efficiently your business grows. In addition, such an error immediately discards the effect of other metrics on MRR.
2) Subtraction of late payments and transaction fees
For founders, it may be tempting to deduct these amounts - they believe that this will positively affect the accuracy of the calculations. However, the road to hell is paved with good intentions: such actions distort the true value of the indicator.
The fact is that late payments are in the "gray" zone. They "float" between losses resulting from the outflow of customers and income from active subscriptions. The problem manifests itself at the end of the month, when the calculations show that the client exists, but there is no payment. What to do? Select overdue payments in a separate group. So you accurately measure and reduce the amount of income that you lose every month because of this problem.
Subtracting transaction fees prevents you from getting reliable data and hides the potential for optimization. Of course, you are unlikely to achieve a 0% commission, but try replacing the payment aggregator or connecting payment services directly.
3) Inclusion in the calculations of one-time payments
Such income (for example, payment of consultations or improvements) are not repeated and are not taken into account when calculating MRR. Otherwise, one-time payments inflate the indicator and distort the overall financial picture.
4) Accounting for the expected income from trial users
Doing this before customers upgrade to a paid version of the product is the biggest sin in calculating metrics in the SaaS business. By doing so, you are fooling yourself: we all know that 100% conversion does not happen.
5) Ignoring discounts. A
glaring mistake - do not include discounts provided. If the tariff plan costs $ 100, and the client receives a 50% discount, take into account only $ 50. When you subsequently cancel the discount, the MRR will increase to $ 100.
What to do to improve MRR?
Make sure your calculations are correct . If you use a service to calculate metrics, check that the calculations are correct. Some platforms (for example, Recurrly and Zuora) have these errors.
Graphic goal setting . MRR is a growth rate metric. It’s better to track it on a graph where you can clearly see the daily change in the indicator both in the current and in the past months. For completeness, display the planned growth.
Take a few minutes every working day. Then at the end of the month you will not be disappointed, and the sales department will have an emergency mode of operation.
Although the MRR is not part of GAAP (Generally Accepted Accounting Principles), IFRS (International Financial Reporting Standards - International Financial Reporting Standards), incorrect calculation of this indicator means that you are lying to investors or, even worse, you are in a situation when an erroneous development assessment becomes the basis of planning.