ARR vs MRR: which metric for your company?

Why is it important to follow the MRR or ARR?

Monitoring of the company's regular income

The subscription business model has the advantage of securing regular income over the lifetime of the customer. This is particularly useful for planning the future of one's business and reassuring investors. Monitoring the MRR or ARR is therefore essential to forecasting your company's future revenues. 

ARR and MRR are good measures of the health of your business. As ARR / MRR is the amount of revenue a company expects to recur, it is a good measure of the company's progress and predicts future growth. It is also a useful indicator for measuring momentum in areas such as new sales, renewals and upgrades, as well as slowdowns due to downgrades and customer loss.

The usefulness of monitoring MRR and ARR metrics

These metrics are particularly useful for: 

• Clarify the health of the business: they measure the company's performance in specific areas, showing where revenues are increasing or decreasing, and why. Knowing your ARR / MRR can help you make better decisions about employee evaluation, compensation, operational planning, and financing to improve the bottom line and help increase business efficiency.
• Increase revenue: Tracking relationships helps to know what customers want and need. It also helps promote cross-selling and up-selling, which leads to increased revenue.
• Forecast revenue: Planning the duration and cost of different subscriptions helps forecast revenue from potential customers. Tracking the value of renewals and the cost of lost customers, or churn, helps companies manage expenses more accurately and maintain cash resources.
• Retain top talent: Tracking them encourages a company to focus on individual sales areas to determine what is working and what needs to be changed. Paying commensurate with productive work performance reduces turnover and training costs for new employees.
• Attracting Investors: Investors prefer contractual revenues, predictable sales models, and accurate revenue forecasts from the subscription economy to one-time sales. Subscription businesses with MRR / ARR tracking can thrive because executives can sell in a predictable and systematic way.

What is the RRA? 

Definition of the RRA

Annual recurring revenue (ARR ) is the value of your fixed-term subscription revenues , normalized over a one-year period. For most companies, ARR is the sum of all new subscriptions and upgrades (sometimes called expansions), minus downgrades (or contractions) and cancelled subscriptions. 

While this is not a generally accepted accounting principles (GAAP) value, it is the equivalent of revenue used by all SaaS companies.

Calculation of the ARR

There are two prerequisites for calculating the ARR: 

• Sell subscriptions with a minimum one-year commitment
• Exclude non-recurring revenues as well as expenses and charges.

Once these two conditions are met, the calculation of the ARR is rather simple: 

ARR = annual subscription revenue + other revenue* - losses due to unsubscriptions - ARR = #customers x annual subscription cost + other revenue* - losses due to unsubscriptions and downgrades

*recurring additional sales, subscriptions to a higher subscription level...

Example

Let's take the example of a ComptaBill company selling SaaS accounting software with an annual subscription.

It deals with 127 users who pay an annual subscription of €940. During the year 30 of the 127 users decided to add options to the subscription costing them an extra 60e per year. During the year 7 decided to stop the subscription and 10 new users took a subscription. 

ARR = 127*940 + 10*940 + 30*60 - 7*940 

ARR = 119 380 + 9 400 + 1 800 - 6 580

ARR = €124,000

ComptaBill therefore has an ARR of 124 000€. 

Advantages and disadvantages

The ARR model is an attractive solution for a SaaS. Your customers pay an annual upfront subscription, which maximises your cash flow. Payments that you can put back into acquisition, for example. In other words, you can finance yourself through your customers.

The upfront payment therefore gives visibility and makes it easier to look ahead. More than that, it reduces the fear of churn. Your customers are here to stay (at least for a year) and it is also easier for you to organize targeted actions as their renewal approaches to ensure the renewal of the contract. 

Finally, the predictability of your revenue curve is also an advantage when seeking financing, as your investors naturally seek to minimize their risk.

Nevertheless, ARR is not a must for all business models. Very rare in B2C or for VSEs/SMEs, your customers may find it difficult to take the plunge and invest a potentially large sum of money at once, especially if they are not always sure of the use and usefulness of your tool over time. This leads to the question of product development. 

Given the price tag, you need to make sure you are offering solid and useful features to your customers. This can represent a significant upfront investment to develop the product. Finally, in order to convince your customers to subscribe to your solution on a yearly basis, you may have to offer discounts or deals for a long term contract. This can reduce your profitability.

Fortunately, solutions exist to counteract these drawbacks and to optimize your MRR. To do so, you can take out an MRR loan through Revenue Based Financing (RBF) companies such as Karmen (more on this later). 

What is the MRS?

Definition of MRO

Monthly Recurring Income (MRI) is an indicator that measures your total income normalized into a monthly amount. MRI is different from the total income received at the end of the month. Rather, it is the regular payments that come in each month (regardless of one-time sales or expenses). 

Calculation of the MRR

The MRS formula is also quite simple, it is : 

MRR = total revenue from monthly subscriptions + new monthly subscriptions + revenue from upgrades and add-ons - loss of revenue due to unsubscribes or downgrades

Example

Let's go back to our example of ComptaBill. For another software that it sells as a monthly subscription, it has 25 users paying a monthly subscription of 40€. During the month of January, 2 of the 25 users decided to add options to the subscription costing them an extra €12 per month. 1 of the 25 users stopped the subscription and 3 new users took a subscription.

MRR = 25*40 + 3*40 + 2*12 - 1*40 

MRR = 1000 + 120 + 24 - 40 

MRR = €1,104

ComptaBill therefore has a recurring MRR of €1,104 per month. 

Advantages and disadvantages of MRS

Unlike ARR, MRR offers both a certain flexibility due to the absence of commitment and a more advantageous pricing than ARR. This pricing allows you to generate a higher profitability on your software.

However, monthly commitments reduce long-term visibility. This can be a hindrance for costly development projects and make it difficult to manage the attrition rate. 

However, new financing solutions, such as those offered by Karmen, can smooth out the disadvantages of MRO through FBR. 

ARR or MRR: should you choose?

The right model for your business

While ARR and MRR are important metrics for businesses, it can be difficult to know which metric to choose based on your business. Such a choice involves considering 5 overarching factors: 

The duration of the subscription

Whether you offer subscriptions longer or shorter than one year is an indicator of what measure may be right for your SaaS business. For ARR, the recommended minimum contract size is one year. While it is possible to extrapolate ARR by multiplying MRR by 12, such a shortcut may skew your metric (especially if your business operates on seasonal revenues). 

The complexity of the business model

As a SaaS business grows, it is common to see increasingly complex subscription models. While the MRR and ARR calculations focus on revenue, the ARR overview allows for the evaluation of other factors in addition to revenue and provides useful forecasts that MRR cannot always provide.

The size of the company

In case the above points did not suggest it, ARR is commonly used by companies. 

Investor interest

If your business is looking for investors, it's good to know that they advocate RWA as a metric. The valuation of your business is often based on annual revenues, not monthly.

The intention

Finally, and perhaps most importantly, the choice between ARR and MRR is a matter of intent. ARR is a useful tool for forecasting long-term growth and visualizing the size of your business. Conversely, MRO is ideal for short-term planning, evaluating the success of recent deployments or strategies, and tracking seasonal fluctuations.

How does Karmen base its funding on ARR and MRR?

If your business is based more on an MRR model, it is possible to smooth out its drawbacks with RBF. Revenue Based Financing is a new financing scheme that allows digital companies to finance their growth in a non-dilutive way and in less than 48 hours at Karmen! 

Indeed, RBF can give you greater visibility into your cash management forecast and turn future monthly revenues into immediate cash flow. If the company is eligible for Revenue Based Financing, investors convert the MRR, "Monthly Recurrent Revenue", into immediate cash flow. 

Karmen finances companies generating a minimum of €300,000 in sales. As your MRR increases, so does your financing envelope. You can draw down additional financing on a monthly or quarterly basis, depending on your growth and needs.

To conclude

5 essential points to understand everything about MRA and MRS:

• ARR (Annual Recurring Revenue) and MRR (Monthly Recurring Revenue) are measures of revenue from your subscriber customers, either per year or per month.
• For ARR to be relevant to your business, your term subscriptions must last at least one year, or most of your customers must have one-year or multi-year contracts.
• Note that ARR and MRR should only take into account long-term, or recurring, revenue. This does not include one-time projects or add-ons you provide to customers or consumer fees because, by definition, they are not recurring.  
• With the MRS approach, you receive regular cash flow, but your immediate cash flow is less.
• With the ARR approach, you get a considerable upfront payment, but with often lower profitability. 

Ultimately, each SaaS company is unique and must make decisions based on that uniqueness. Some companies charge monthly rates and likely track seasonal changes through the MRR to inform decision makers. Smaller companies may offer annual contracts with monthly pricing based on usage. Both measures are useful in their own way; which one you choose to focus on will depend on what is right for your company.