Recurring revenue: what is it & how does it work?

Recurring revenue represents the stable, predictable and regular segment of a business’ revenue. This is in contrast to one-off sales as the gist of a recurring revenue is that certain sales are guaranteed at specific intervals.  

Introduction to Recurring income

A company’s total revenues―gross income―directly determines its net income. This is because taxes and expenses are typically deducted from these revenues to arrive at the profit/net income for the time under review.

Companies and organisations have several methods of generating revenues. These revenues could be from predictable sales at consistent intervals or one-off transactions. Recurring revenue comprises the former―those stable, predictable and regular sales. These revenues always come in at regular intervals and so can be expected with some degree of assurance.  

A company running a recurring revenue model primarily generates its revenues from such recurring sales. In this case, customers pay for a certain service regularly, for instance, monthly or annually. Of course, this model helps companies and businesses a lot, due to its predictability.

Forecasting annual recurring revenue is possible. It may be achieved using user growth rate, churn rate, customer retention data and other such metrics.

It’s worth remembering however, that recurring revenues may stop at any time despite its typical regularity.

Recurring revenue formula

The recurring revenue formula can be used to calculate monthly recurring revenue as well as annual recurring revenue. The most crucial point here is to use the corresponding data for the period (a month, quarter or year) under review.

Recurring revenue is equal to the product of the overall number of paying users and average revenue per user (ARPU). The formula looks like this:

Recurring revenue model examples

Running a recurring revenue model differs in reality from industry to industry, but the underlying principle is the same. Here are some recurring revenue model examples:

• Long-term Deals: This comprises monthly or annual payments companies receive from customers in fulfilment of contractual obligations that run beyond the present accounting period. In this type of contract, customers pay a company or organisation for continuous service over a long time. Such contracts could be for two or five years.

• Automatic Renewal Subscription: Streaming services such as Netflix and Spotify run a subscription-based model whereby customers are charged monthly until they cancel their subscription. This subscription-based model allows businesses to earn guaranteed recurring revenue throughout a customer’s lifetime. Gyms and clubs also use this model.

• Supplementary Products: Some companies produce certain supplementary products to go with some of their products. In this case, customers can’t use product A (e.g. a high-end phone) without product B (e.g. a customised charger). Therefore, the company can make recurring revenues from the sales of product B.

Benefits of recurring revenues

Having recurring revenues helps a company or organisation in many ways. Among the benefits of recurring revenues are the following:

Predictability: Having recurring revenues assures a company that its current paying customers will likely continue to patronise them in the immediate future. The subscription-based revenue model, for example, affords high revenue predictability.

Stability: Recurring revenue affords a company some level of stability. A company generating recurring revenue enjoys a higher degree of stability in terms of finances and operation.

Such companies can easily estimate their business value and plan better, thanks to the availability of stable metrics. This way, they become more attractive to investors, especially because their projections are considered reliable. After all, investors know that severe changes are less likely in such a company’s performance on a monthly or annual basis.   

Today, more and more companies such as Adobe are transitioning to a recurring revenue model. Those who cannot are finding ways to use the model for certain aspects of their business e.g. Amazon Prime. It’s not hard to see why ― recurring revenue significantly boosts a company’s stability and sustainability. 

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