Most business owners know what a gross margin is. It’s the percentage of revenue that your company doesn’t have to pay out in expenses before it actually makes a profit. However, you might not be aware that there is another important indicator closely related to gross margin called MRR or Monthly Recurring Revenue . In this article I will define MRR and show you how to calculate it.
MRR vs Gross Margin
Let’s start by comparing MRR and gross margin. While both of them are closely related, there is a key difference between these two indicators: the way they’re calculated. The gross margin simply represents the percentage of revenue that your company doesn’t have to pay out in expenses, while MRR measures the amount of revenue that is recurring each month.
The reason why MRR is so important is because it can give you a better idea of your company’s long-term stability. A high gross margin might look good on paper, but if most of your sales are one-time transactions, then your company is less likely to be profitable in the long run.
MRR Calculation – The Basic Formula
The calculation for MRR is quite simple. It combines three factors: your monthly recurring revenue, the average unit economics of each customer (or client) and how many clients you’re actively servicing (also known as your churn rate). If you’re not sure how to calculate any of these factors, don’t worry, I’ll go over them in more detail later in this article.
For now, let’s use a hypothetical example to see how MRR is calculated. Say your company sells a software product that costs $100 per month. You have 100 customers and each of them pays you $100 per month. Do some simple math and you’ll get your MRR – 100 x 100 = 10,000 .
However, this figure is a bit misleading because it doesn’t take into account that 20 clients have canceled their subscriptions in the last month (i.e., your churn rate is actually 20%). Therefore, if we factor this in, we get 100 x 100 – 20 = 8080 .
Calculating MRR Using the Average Client Economics Formula
The average client economics formula is a more accurate way of calculating your company’s MRR. It takes into account the fact that not every customer is equal and some bring in much more profit than others.
If you’re not sure how to calculate your average client economics, the table below should help.
Number of customers x Average revenue per customer = Average Client Economics
Let’s take another look at our previous example. This time we will use the more accurate formula for calculating MRR: 100 x $100 = 10000 . But this figure is misleading because ten of your customers generate twice as much revenue (i.e., they have an average client economics of $200). So, if we factor in this information, we get 100 x $100 – 10 = 9000 .
Calculating MRR Using the Churn Rate Formula
The last way to calculate MRR is by using your churn rate. This is the percentage of your customers who cancel their subscriptions each month.
If we go back to our previous example, and say that your churn rate is actually 20%, then we would calculate MRR as follows: 100 x $100 – (20% of 100) = 8000 .
MRR vs Annual Revenue
Now that we know how to calculate MRR, let’s take a look at how it compares to annual revenue.
Annual revenue is simply the total amount of revenue your company generates in a year. To calculate it, you simply multiply your monthly recurring revenue by 12 (or 13 if you include January, which is typically a slow month for most businesses).
Using our previous example, if we multiply 10,000 by 12 we get 120,000 , which is the annual revenue generated by our software product.
Now let’s compare this figure to our company’s annual revenue. If we look at our hypothetical company’s balance sheet, we can see that their annual revenue is actually 150,000 .
If we divide 150,000 by 120,000 , we get the answer 1.25 which means that our software company is generating 25% more revenue per year than they are monthly recurring revenue.