3 min read
Subscriptions are perhaps the most reliable route to repeat custom and if it’s a model that makes sense for your business, it’s definitely one to consider. It is, however, a model that requires a slightly different approach when it comes to organising your finances.
If you run a subscription-based business and want to get a more accurate and relevant overall picture of your finances, accurately calculating your Monthly Recurring Revenue (MRR) is of paramount importance as that is your bread and butter.
Today, we’ll be diving into the intricacies involved in calculating your subscription revenue (or MRR); how to model it, recognise it and calculate it accurately and reliably.
What is subscription revenue?
A subscription model generates income on a recurring basis, typically by offering a monthly service to its customer for a recurring fee. This provides a steady and predictable revenue stream and could represent the backbone of many businesses. Indeed, for some, it could represent their sole source of revenue.
For businesses that rely on this model, the consistency is what makes it so appealing. It also allows the business to cultivate long-term customer relationships. However, fully understanding subscription revenue is crucial when assessing the financial stability and growth potential of a subscription business.
How to model subscription revenue
To model subscription revenue accurately, businesses must consider various factors that impact revenue generation.
Determine the pricing model for your subscriptions. For example, are you going to be keeping it simple with flat-rate pricing? Or perhaps you have a more complex offering and want to introduce tiered pricing or usage-based pricing? Each model affects how revenue is generated and needs to be calculated.
Create different subscription plans with varying features and price points to cater to different customers with varying needs and budgets. This gives a sense of agency to your customers and allows them to scale up their subscription ‘package’ when they have the desire or means to do so.
Customer acquisition and retention
Plan and implement effective strategies to attract new customers. This should be no different to acquiring customers in a traditional business model, however, as what you’re selling is a commitment above all else, marketing efforts should reflect this, where possible. When it comes to retention, investing in customer service and offering value to all customers (not just new ones) should be your priority. Study your customers and their needs and do everything in your power to meet them.
How to recognise subscription revenue
Recognising subscription revenue involves properly accounting for and reporting revenue generated from subscriptions.
Revenue recognition methods
Choose an appropriate revenue recognition method, such as recognising revenue evenly over the subscription period (known as straight-line recognition) or recognising revenue upfront (deferred recognition). This will impact your analytics and should reflect your business model. For example, deferred recognition might make sense in some situations but could serve to overly complicate others.
Determine the subscription period (monthly, quarterly, annually) to allocate revenue across the specified time frame. Monthly is generally considered the most practical choice as it hits a good balance between consistency and affordability for many customers, most of whom organise their finances on a monthly basis anyway. It’s worth noting that, if your subscription model operates on an annual basis, you’ll also need to consider your Annual Recurring Revenue (ARR).
Churn and renewal
Always account for customer churn (cancellations) and renewal rates when recognising revenue. Churned subscribers shouldn’t be included in revenue calculations, whereas renewed subscriptions should be.
Subscription revenue calculator
To calculate MRR effectively, follow these step-by-step instructions.
Gather necessary data
Take a specific period – a year is generally the preferred option – and collect data on your active subscribers and their fees for that period. This can typically be done automatically from within your financial planning software as long as you have at least a year’s worth of data to work with.
Exclude non-recurring revenue
Exclude all one-time fees, setup charges, or any other non-recurring payments from your calculation. MRR focuses solely on recurring revenue and these other numbers will only lead to complications further down the line for your accounting team.
Calculate active MRR
Multiply the number of active subscribers by their monthly subscription fees. This will provide you with the Active MRR for the given period.
Continuously monitor changes in Active MRR over time to assess growth, identify trends, and gain insights into customer behaviour. You can utilise subscription management platforms such as FastSpring, Moxo and ChargeBee to achieve this with minimal fuss.
We can help
GoCardless has emerged as a prominent player in the realm of subscription-based businesses, offering streamlined solutions for recurring payments that are practical, elegant and foolproof.
We can automate your recurring payment collection, cutting out the tedious and costly manual process often associated with subscription businesses. We also collect up to 97.3% of all payments successfully the first time and the vast majority that fail the first time will be able to use our payment intelligence management service Success+ to significantly reduce payment failures.
We give businesses a simple and convenient way to collect payments directly via bank accounts, circumventing expensive card networks entirely and allowing businesses to benefit from more affordable fees, easy automation and enhanced anti-fraud intelligence.