Recurring revenue models are commonly associated with subscription-based businesses, where customers subscribe to a product or service and make regular payments over a specified period. Examples of recurring revenue models include subscription-based software, streaming services, membership programs, and maintenance contracts. There are different types of recurring revenue:
Recurring revenue is highly desirable for businesses because it provides stability and predictability. It can help companies build long-term relationships with customers, improve cash flow, and create a more sustainable business model. For investors, recurring revenue is often viewed positively as it indicates the potential for consistent and reliable income streams.
Bookings drive recurring revenues in a SaaS business, but one must understand the mechanics behind it. Bookings typically refer to the total value of contracts or agreements signed with customers during a specific period, often on an annual or multi-year basis. It represents the revenue that the company expects to recognize over the term of those contracts. Bookings may include both new customers and existing customers who renew or expand their subscriptions. On the other hand, recurring revenues represent the portion of the bookings that the company recognizes as revenue on an ongoing basis over the duration of the customer contracts. This revenue is typically recognized over the course of the subscription term in equal instalments or based on the company’s revenue recognition policy. Here are the key points about how bookings and recurring revenues are interrelated:
Committed Annual Recurring Revenue (ARR) refers to the total value of recurring revenue that a SaaS business has contracted with its customers over a specific period. It represents the committed and predictable revenue that the company expects to receive from its customers in the upcoming year based on the existing contracts or subscriptions in place.
Committed ARR takes into account the contracted value of recurring revenue from both new customer acquisitions and existing customer renewals, including any upsells or expansions. It provides a forward-looking view of the company’s revenue stream and serves as a key financial metric for SaaS businesses. It is important to note that committed ARR is not the same as ARR, the latter being calculated by taking into account future anticipated growth in net bookings (see section below that explains this further).
To calculate committed ARR (Annual Recurring Revenue), you need to consider the contracted recurring revenue from both new customer acquisitions and existing customer renewals over a specific period. Here’s a step-by-step approach to calculating committed ARR:
Net Bookings in ($) = Bookings Additions ($) – Bookings Contractions ($)
It’s important to note that committed ARR can change over time as contracts expire, new contracts are acquired, and existing contracts are renewed or modified. Regularly updating (at least on a monthly basis) and tracking committed ARR allows you to assess your revenue growth and make informed business decisions.
Booking Committed Annual Recurring Revenue (CARR) involves recognizing the revenue associated with these contracts in the company’s financial records. Here’s how it is typically done:
It’s worth noting that the specific accounting practices may vary depending on the company’s revenue recognition policies and the applicable accounting standards (e.g., generally accepted accounting principles, or GAAP). SaaS businesses may seek guidance from professional accountants or consult the appropriate accounting standards to ensure accurate and compliant revenue recognition for CARR.
Committed Annual Recurring Revenue (CARR) is often mistakenly used to describe the Annual Recurring Revenue (ARR) of a SaaS business. And while these are very similar metrics, the former is calculated without reference to expected future new net bookings and focuses exclusively on existing contracts. Put differently, CARR is just a snapshot of revenues at a single point in the life of a SaaS business. Annual Recurring Revenue, on the other hand, is a forward-looking metric, and we will explain it now in a bit more detail, along with its sister metric, Monthly Recurring Revenue (MRR), which is the foundation of ARR calculation.
MRR (Monthly Recurring Revenue) and ARR (Annual Recurring Revenue) are two significant metrics used in the SaaS business model to measure the recurring revenue generated (or to be generated) by a company’s subscription-based services. While they both represent recurring revenue, they differ in terms of the time frame over which they are measured.
Monthly Recurring Revenue (MRR) represents the total revenue generated by a SaaS company from its subscriptions on a monthly basis. It takes into account the regular, recurring payments made by customers for their subscriptions within a single month. MRR provides a snapshot of the revenue generated in a specific month and is typically used for short-term analysis, tracking growth, and monitoring revenue trends on a monthly basis.
Calculating MRR involves summing up the monthly subscription fees from all active customers during a given month. It includes both new customer subscriptions and recurring payments from existing customers.
Annual Recurring Revenue (ARR) represents the total revenue generated (or to be generated) by a SaaS company from its subscriptions on an annual basis. It represents the sum of the recurring revenue from customer subscriptions for a full year. ARR provides a longer-term view of the company’s revenue and is often used for financial forecasting, budgeting, and valuation purposes.
Calculating ARR involves multiplying the MRR by 12 (also called annualization), as it represents the total revenue expected to be generated from the current subscription base over a year. ARR accounts for both the revenue from existing customers and the revenue expected from new customer acquisitions throughout the year. The expected customer acquisitions are not always easy to calculate as they rely on a set of assumptions and sources, such as sales funnel analysis, historical data analysis, market analysis, growth goals and projections, among other things. However, it is possible to model out these assumptions and estimate ARR, with MRR being the starting point of it.
As must be evident by now, the key difference between MRR and ARR lies in the time frame they cover. MRR focuses on the revenue generated within a single month, providing insights into short-term revenue performance and trends. ARR, on the other hand, represents the annualized revenue, giving a broader view of the company’s revenue and facilitating long-term planning and analysis. Lastly, ARR is not the same as CARR as has been explained earlier.
Both MRR and ARR are aboslutely essential metrics for SaaS businesses as they provide insights into the recurring revenue stream, customer retention, growth, and financial performance. They are often used together to assess revenue stability, evaluate growth strategies, and communicate the company’s financial health to stakeholders, investors, and potential acquirers.
It is important to point out that not all the revenue in a SaaS business is recurring. In fact, some SaaS businesses have substantial non-recurring sources of revenue, so it is critical to realize this and reflect it when tracking bookings and Committed ARR.
Let’s first understand what non-recurring revenue is. Most plainly, it is the revenue generated from one-time or irregular sources that do not fall under the category of recurring revenue. Unlike recurring revenue, which is predictable and generated through ongoing subscriptions or contracts, non-recurring revenue is typically derived from specific events, products, or services that are not part of the regular subscription or contract terms. Here are some common examples of non-recurring revenue in a SaaS business:
Non-recurring revenue is important for SaaS businesses as it provides additional sources of income and can contribute to short-term revenue spikes. However, it is typically less predictable and can fluctuate from one period to another, unlike the steady and predictable nature of recurring revenue. It’s essential for SaaS companies to monitor and manage their non-recurring revenue alongside recurring revenue to assess overall revenue performance and plan for long-term sustainability.
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