Numbers don't lie.
As a SaaS owner, you are always looking at the numbers to make decisions.
Two of the most important numbers for any subscription business are ARR and MRR. But what are they, and what do they mean for your company?
In today's guide, we'll define ARR and MRR, explain how they're measured, and show you why they're so important.
We'll also dispel some of the common myths about both terms.
By the end of this guide, you'll understand these two metrics like a pro.
What Is ARR?
ARR, or annual recurring revenue, is the total value of all contracts that are set to automatically renew within a 12-month period.
In other words, it's all of the revenue that your company can expect to receive in a year, from contracts that have already been signed and are set to renew.
ARR is a key metric for subscription businesses, because it shows the true value of your recurring revenue stream.
It's also a helpful metric for forecasting future growth.
What Is MRR?
MRR, or Monthly Recurring Revenue, is an estimation of how much revenue your company will earn in a month, minus any one-time or non-recurring charges.
It's a more granular look at your recurring revenue stream.
MRR is helpful for tracking month-over-month growth, and can be a leading indicator of future ARR growth.
Why Is Tracking ARR Important?
When you buy a pair of shoes, you pay for them once and that's it.
The same goes for most one-time products or services.
But with a subscription, you're paying for something that will continue to renew each month or year.
This creates a recurring revenue stream for the business.
As a SaaS owner, it's important to track the size and growth of this stream.
This is where ARR comes in.
ARR gives you a snapshot of your recurring revenue stream, and can be used to predict future growth.
It's also helpful for benchmarking your business against others in your industry.
For example, if the average ARR for a SaaS company in your industry is $10 million, you can use that as a goal to aim for.
When you know your ARR, you can make more informed decisions about where to allocate your resources.
You can also use it to negotiate better terms with investors and partners.
For instance, if you're looking for a loan, you can show the lender your ARR and prove that your business is sustainable.
Some other benefits of tracking ARR include:
- Understanding the health of your business: A growing ARR means that your business is adding more customers and growing. Conversely, a shrinking ARR could mean that you're losing customers.
- Tracking your progress: ARR can help you track your progress over time. This can be especially helpful if you're trying to hit a specific goal, like that $10 million average ARR.
- Planning for the future: ARR is a helpful metric for forecasting future growth. This information can help you make decisions about where to allocate your resources, and how to grow your business.
Why Is MRR Important?
Much like annual recurring revenue, ARR is a helpful metric for understanding the health of your business and tracking your progress over time.
But MRR is particularly useful for tracking month-over-month growth.
This information can be helpful for making decisions about where to allocate your resources in the short term.
Some other benefits of tracking MRR include:
- Spotting trends: MRR can help you spot trends in your business. For example, if you see a sudden drop in MRR, it could indicate that something is wrong.
- Increased control: With MRR, you have a more granular view of your recurring revenue. This can help you make better decisions and have more control over your business.
How Do You Calculate ARR and MRR?
Now that you know what ARR and MRR are, and why they're important, you might be wondering how to calculate them.
Fortunately, it's not too difficult.
To calculate your ARR, you simply need to take your total contract value and divide it by the number of active years.
For example, if your business has nine 5-year contracts, with each contract worth $50,000, your ARR is $90,000 (9 x $50,000 / 5 years).
To calculate your MRR, you need to take your total contract value and divide it by the number of months in each contract.
For example, if you have 10 contracts, each worth $100 per month, your MRR is $1,000 (10 x $100).
You can also calculate MRR by dividing your annual contract value by 12.
For example, if you have 10 contracts, each worth $1,200 per year, your MRR is also $1,000 (10 x $1,200 / 12).
Common Misconceptions About ARR and MRR
At this point, you already have a pretty good understanding of ARR and MRR.
But there are still some common misconceptions about these metrics that we want to clear up.
1. ARR and MRR Are Not a Measure of Profitability
Just because your ARR or MRR are high, doesn't mean that your business is profitable.
There are a lot of other factors that go into profitability, including expenses, overhead, and taxes.
A business with an ARR of $1 million could be profitable, while a business with an ARR of $10 million could be losing money.
Never judge the profitability of a business based on its ARR or MRR alone.
These metrics should always be looked at in addition to other data, such as gross margin and operating expenses.
2. MRR and MRR Are Not a Measure of Sustainability
Sustainability means being able to maintain a certain level of revenue over time.
MRR and ARR are just one part of this equation.
You also need to look at things like customer churn, average revenue per customer, and gross margin.
A business with a high MRR/ARR but a high churn rate is not sustainable because it is losing more money than it is bringing in.
At the end of the day, these metrics are just one factor to determine a company's sustainability.
3. ARR and MRR Can Be Misleading
ARR and MRR can be misleading because they don't consider the churn rate.
For example, let's say you have a business with an ARR of $1 million but a churn rate of 30%.
This means that you're losing $300,000 per year.
While your ARR is high, your business is actually not very sustainable.
Always be sure to take the churn rate into account when measuring ARR and MRR.
4. MRR and ARR Don't Equal Growth
Just because your MRR or ARR are growing, doesn't mean that your business is also growing.
Growth can be measured in many ways, including customer acquisition, revenue, and profit.
MRR and ARR are just two pieces of the puzzle.
You could grow your ARR by 100%, but if your churn and expenses also grow by 100%, your business is not actually growing.
To get a true picture of growth, you need to look at MRR, ARR, churn rate, and other metrics as well.
In other words, you need to look at all of the data.
ARR vs. MRR: Which Metric Is Best?
To be honest, there's no one “best” metric.
Both ARR and MRR have their own benefits and drawbacks.
ARR is a good metric for understanding the overall health of your business, but MRR is more helpful for short term sustainability.
The best thing you can do is to track both metrics and use them in conjunction with each other.
This will give you the most complete picture of your business.