Monthly Recurring Revenue (and its annual equivalent ARR) is a well-known financial aggregate in the world of cloud-based SaaS companies, a sort of holy grail in most subscription-based software valuation models. Though a lot has been said about its definition(s), in this article, we share our views on some of the underlying subtlelties that we have noticed during our manifold audit and advisory engagements over the past few years. As the list below is not intended to be exhaustive, our aim is to provide a helpful methodology and draw your attention to the main pitfalls, with a view to better understanding the MRR framework, through a classification in ascending order.
Traditionally, an initial distinction is made between “MRR” and “Committed MRR (CMRR)”, with the difference for the latter being mainly the inclusion of forthcoming signed contracts and other known expected variances. Both categories of definitions will be addressed separately.
Monthly Recurring Revenue (MRR):
1. Billed MRR with non-recurring discounts:
In some leading SaaS subscription management tools, MRR misleadingly includes discounts according to billing, without any consideration as to their temporary nature. In our opinion, when accounting for discounts, one should consider whether they can be regarded as recurring or not. If they are not recurring, we recommend removing them from MRR. In the following definitions, we assume that discounts are addressed appropriately.
2. Billed MRR with new contracts/projects not being recognised on a full-month basis:
This is an underestimated calculation that we notably see in some early stages companies. It entails aligning MRR with the monthly recurring revenue recognised as per accounting (in the latter method, if a new contract starts in the middle of the month, only half of the monthly recurring revenue is recognised), rather than taking into consideration the additional revenue generated on a 30 (or 31) days basis.
3. “Standard” billed MRR:
This is the most common standard definition of MRR (especially in dedicated SaaS subscription management tools), corresponding to the monthly recurring billing – expressed on a full-month basis (or annual/quarterly billing divided by the number of corresponding monthly periods, respectively 4 or 12 in the present case). This MRR is also the most well suited to analysing its dynamics over time (new, churn, upsell, downsell etc.).
4. Billed and unbilled MRR:
Though recurring revenue is essentially regularly billed, part of it can still be invoiced post the time of the analysis, either because (i) the customer, while still enjoying the service, has not been billed (for whatever reason) and no contract termination or non-renewal is to be considered, or (ii) the billing related to a newly implemented contract has not yet started. As this definition includes all recurring revenue, not only those billed, it can be considered more relevant, though MRR is then less easy to monitor on a regular basis.
5. Billed and unbilled MRR + POC (proofs of concept):
Proofs of concept are not included in MRR, as they are supposed to be non-recurring revenues. Still, when they are spread over a certain period of time, and subject to a contract formalisation that is closer to subscription fees, the line between it and pure MRR may narrow.
As a continuation of the previous definitions of MRR, CMRR extends the view into the near future by taking into account the expected secured MRR, which is all the more important in the context of strong growth.
Committed MRR (CMRR):
6. CMRR accounting for signed contracts and expected net upsell/churn:
In our view, this is the most relevant definition of CMRR, as it takes into consideration secured new contracts that will start in the coming weeks or months, while also encompassing the known evolution of existing contracts, both in terms of expected churn or expected net upsell.
7. CMRR accounting for signed contracts only:
This definition is also widespread, especially in early stage companies and/or when net upsell and churn on existing contracts are difficult to estimate.
8. CMRR accounting for signed contracts and pipeline:
This aggregate takes into account expected “probabilized” non-signed contracts in the pipeline. We consider this definition to be relatively aggressive.
In summary, we consider definitions #3 and #4 to be preferable in terms of MRR, with #4 being the most relevant on a static basis, while #3 (often quite close, if not comparable, in terms of amounts) is more practical to follow on a regular and dynamic basis. As for CMRR, #6 proves to be the most relevant, and is particularly useful when valuing a company.