Some entrepreneurs think that what matters most is a disruptive product with a big potential market and that investors don’t care much about revenue streams. While it’s true that many investors look at future potential, they also care about your current performance. In fact, your current revenues are a good predictor of your future revenue potential.
Unlike one-time deals or one-off services rendered to clients, recurring revenue — such as revenue derived from subscriptions — are especially interesting to investors and lenders. This is because they can point to sticky future income streams and are a baseline for future revenue growth.
In the guide below, you’ll learn how to demonstrate revenue potential to investors. We’ll show you how to calculate and track three key SaaS metrics that show potential revenue, which investors use to determine whether your business is a good investment.
What SaaS Metrics Demonstrate Revenue Potential?
There are a lot of acronyms and buzzwords about how to demonstrate revenue potential of a new startup these days, especially for software as a service (SaaS) companies.
The reality is there are many ways to track the health of your tech business, and there are various points of view on which indicators are the most meaningful and why. While there may be different views on which metrics to track, one thing is certain: you need have some indicators that show your business is healthy and growing for potential investors, employees and other partners.
Investors and lenders will not only want to review your financial reporting, they’ll want to see how your company is performing based on key SaaS metrics.
These SaaS metrics include:
Monthly Recurring Revenue (MRR)
Committed Monthly Recurring Revenue (CMRR)
Average Revenue per Customer (ARPC)
Investors use this data — MMR, CMRR, and ARPC — to see if your company is a good investment. What makes these indicators so important to investors and how do you calculate each metric, you might ask?
Let’s start our journey with an overview of MRR, how to calculate it, and why it matters.
What is Monthly Recurring Revenue (MRR)?
Monthly Recurring Revenue (MRR) measures the monthly amount of total revenue that’s subscription-based or recurring in nature and highly likely to continue into the future. This number excludes all one-time, non-recurring payments, such as implementation or professional service fees, hardware, and discounts.
On an annualized basis, this metric is known as Annual Recurring Revenue (ARR).
How to Calculate MRR
To calculate MRR, start by taking all of your current customers and align them with their monthly subscription values. If you have customers that are on multi-month subscriptions, simply take those contract values and divide by the number of months in the subscription period. Lastly, add up all of the subscription values to determine your current MRR.
The formula to calculate monthly recurring revenue is as follows:
MRR = (Average monthly subscription value per customer) × (Number of customers)
All the data you need to calculate your MRR should have been tracked in your accounting software. To calculate your MRR, you need to make sure you track your recurring and non-recurring revenue separately.
Further reading: How to Calculate Monthly Recurring Revenue (MRR)
Monthly Recurring Revenue Formula (Example)
For our example monthly recurring revenue formula, let’s assume the name SaaS Company.
SaaS Company, an online social networking platform for SaaS entrepreneurs, has 2,000 customers with half on its basic plan priced at $10/month and the other half on its premium plan at $180/year that pays all upfront. To calculate its MRR, SaaS Company would take the 1,000 customers on the monthly plan and add it to the 1,000 customers on the annual plan (dividing the cost of the annual plan by 12):
(1,000 x $10) + (1,000 x $180/12) = $25,000
Next month, if they added 500 customers with the same 50/50 split and lost no customers, the MRR would be $31,250:
$25,000 + (250*10) + (250*180/12)
The company’s total revenue for that month may have been significantly different if it has any non-recurring payments, such as one-time installation fees for new customers or additional charges on top of the monthly contract value for usage or data overages. That’s because MRR is not trying to measure cash flow or receipts, but how quickly and efficiently you’re growing your top line. In this case at 25 percent month-over-month.
Why MRR Matters
There’s a reason MRR is one of the biggest buzzwords in the SaaS startup world — and why it’s tracked so closely. While growth in bookings is the revenue performance standard for traditional industry, using bookings to measure growth in SaaS businesses is misleading and easily manipulated. This is because subscription terms can vary wildly — from month-to-month contracts to multi-year contracts. And once you factor in upgrades, downgrades, and renewals over a contract term, it becomes pretty difficult to understand the true performance of a company using just bookings.
What MRR does is normalize that recurring revenue into one time period, providing an accurate benchmark for your business momentum. Successful SaaS companies track their MRR to measure their growth and momentum, as well as for use in financial forecasting and planning.
As a key indicator for growth, measuring your MRR on a month-over-month basis is critical for understanding whether you’re gaining traction or starting to stall.
For financial planning purposes, MRR is particularly helpful since it’s relatively stable and predictable. Once you have a history of tracking your MRR, you can use it to model out estimates of where you’ll be in the coming months and can plan your business accordingly.
However, remember that MRR does not represent your actual cash flow. If you’re receiving all of your money upfront, you’ll still be incurring costs to service that contract over the rest of its term, without receiving any additional cash inflow.
Now let’s move on to CMRR, how to calculate it, and why it matters.
What is Committed Monthly Recurring Revenue (CMRR)?
Committed Monthly Recurring Revenue (CMRR) looks at current MRR, as defined as (New Business + Expansion – Contraction – Churn), and then adds in signed contracts going into production and subtracts out revenue that’s likely to churn within that period.
The terms included in the definition of CMRR are defined as:
New Business MRR: MRR associated with leads that convert to paid customers in a given time period.
Expansion MRR: Any increases in MRR from existing customers in a given time period. These could be the result of customers adding additional subscriptions, upgrading, etc.
Contraction MRR: Any decreases in MRR from existing customers in a given time period. These could be the result of downgrading to a lower plan, adding or increasing a discount, etc.
MRR Churn: MRR from customers who cancel or fail to renew their subscription in a given period. (Download our SaaS Metrics eBook to learn about MRR Churn.)
How to Calculate CMRR
Here’s a simple formula you can use to calculate committed monthly recurring revenue:
CMRR = MRR + Signed Contracts – Expected Churn
You can track MRR data in your accounting software, but the information on signed contracts and expected churn likely lives in your CRM. You may need to create a spreadsheet pulling from both sources to connect the two types of data, or invest in third-party software.
Further Reading: How to Calculate Committed MRR (CMRR)
MRR vs. CMRR
As you can see, taking into account signed contracts that are going into production and expected churn shows a different picture than just MRR. In this example, CMRR has a more positive outlook than MRR. However, if expected churn is much higher than new contracts entering production, CMRR can show a less favorable outlook.
Further Reading: 5 Ways to Reduce Customer Churn for Your SaaS Startup
Why CMRR Matters
Unlike MRR, which only yields insight into the current run rate of a company, CMRR incorporates potential future changes. Committed monthly recurring revenue provides a forecast for the company’s performance, based on what you know about your customers today.
Knowing your CMRR and how it’s trending over time can enable you to more accurately forecast revenues and provides a better picture of the financial standing of the company.
Last but not least, let’s dive into ARPC, how to calculate it, and why it matters.
What is Average Revenue per Customer (ARPC)?
Average Revenue per Customer (ARPC) is the average revenue generated from each customer per month (or per year). Sometimes the metric can be further broken down by customer segment or product type, such as the ARPC for enterprise-level customers, or the ARPC for Product A.
ARPC may Vary by Product Line
Resurfacing our previous example business, SaaS Company, let’s assume they offer a mix of products and services with the following ARPCs:
Product B is definitely the cash cow in terms of revenue generation. Assuming products A and B have similar expenses, the company should focus on growing the customer base of Product B.
In addition, knowing the ARPC of their different products and services helps SaaS businesses identify up-sell opportunities. Expanding on the previous example, we added a pricing column for the different products and services.
While Product A has an up-sell opportunity of $20/customer/month (from $50 to $70), Product B has an up-sell opportunity of $300! This means the company should be paying a lot of attention to up-sell opportunities for customers of Product B.
How to Calculate ARPC
You can calculate ARPC using the following formula:
ARPC = Total Revenue / Customer Count
Note that Total Revenue could be based on your customer segments or product types. Customer Count needs to match the breakdown of Total Revenue (i.e. Large Clients ARPC = Total Revenue from Large Clients/ Number of Large Clients, Product B ARPC = Total Revenue from Product B /number of Product B customers, etc.).
Why ARPC Matters
Knowing the ARPC of your different SaaS products or services will help you identify up-sell opportunities. A good business practice is to monitor the change in the ARPC over time.
To do this, set a certain time period for calculating changes in ARPC. For example, you could look at the ARPC of Product A in the last 6 months vs. ARPC of Product A in the last 12 months. This can help SaaS businesses to see how the revenue generated from Product A evolved over time.
Alternatively, you can set the time period for calculating changes in ARPC to certain events (such as shipment of a major upgrade of Product A, or completion of a major marketing campaign) to see how your customers react.
You can get the ARPC of your products and services from your accounting software or from third-party software.
How These Key SaaS Metrics Help Startups Accelerate Growth
Companies find that once they start tracking key SaaS metrics, they can use the data to make strategic decisions.
For example, Levi Morehouse, CEO and Founder of Ceterus, says his company uses Monthly Recurring Revenue (MRR) as their main performance indicator. The focus on MRR allows Ceterus to “develop valuable recurring solutions, sell these to the right prospects, and deliver value to customers.” Ceterus provides innovative financial reporting and bookkeeping for entrepreneurs.
Morehouse attributes much of his company’s recent growth and success to prioritizing recurring opportunities over non-recurring opportunities. This means frequently rejecting profitable leads that would make them larger in the short run, but would not grow MRR.
This is just one example of how SaaS companies are using metrics to make the right business decisions and accelerate their growth.
Keep Track of These Metrics
Along with all other key SaaS metrics, there is no one industry definition for measurement. As you begin to track these metrics, be sure to document how you’re calculating them — and remain consistent over time. Having thorough documentation will make it easier when you have to present these metrics to potential investors and lenders.
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Want More SaaS Metrics?
This guide explains the core metrics used to measure SaaS company success. Using simple examples, we’ll show you how to calculate each metric, and describe why specific indicators are important to investors.