The Fundamentals of Subscription Finance
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ARR / MRR
Annual Recurring Revenue, or ARR (Monthly Recurring Revenue / MRR), is the amount of revenue you expect to repeat. It’s that simple. Note that this does not include one time revenue, it only includes revenues that recur. And with that said, ARR is different from revenue. Revenue is a backwards looking number while ARR is a forward looking number — emphasis on “Recurring” in ARR.
The problem? Well, your traditional financial statements only show revenue for a past period and have no concept of recurring, forward looking revenue. But for Subscription Economy companies, because of ARR, they can actually start each fiscal year knowing what their revenues are going to be for that year. In the formula above, we call this Starting ARRn.
Annual Contract Value (or ACV) is your new revenue brought in by new customers or customers upgrading or renewing their existing contract. You invest in sales and marketing to drive new revenue, because ultimately this increases your ARR.
If you add up all of these metrics, you not only have a complete financial picture of your subscription business, but you also have your recurring revenue for next year or your ending ARR.
So, by now you get the subscription business model. ARRn – Churn + ACV = ARRn+1, right? But how do the ERP financial systems you have in place today support a new model based on fostering and monetizing relationships?
But tracking recurring revenue is a forward-looking process. So, when it comes to tracking metrics for subscription businesses, traditional systems just can’t account for the whole picture. Sure, financial metrics like bookings, billings, cash and revenue were tracked in the old world of commerce, but they were backwards-looking and focused on one-time transactions. Let’s look into some of their limitations.
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