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MRR vs ARR (Which One Should You Use and How Do You Calculate It?) - YouTube
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- Peter Drucker famously said
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what gets measured gets managed.
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So, if you're growing your SaaS business,
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what you're probably
measuring very meticulously
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are your revenues and your revenue growth.
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When I was working in
toutapp, my SaaS business
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and I was working at
Marketo, the company
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that bought my SaaS business,
which was also SaaS business,
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revenues and how we measured revenues
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and how we thought about
revenues versus booking
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and MRR versus ARR, Oh man,
it was it was kind of crazy.
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And so, it's very often I
see SaaS founders getting
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a little confused about how to measure
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revenues the right way.
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And that's super important if you're
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actually driving growth.
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That's like the one
metric you want to nail
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and get right and be accurate about.
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So, in this episode, I'm going to walk you
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through the three principles
that you absolutely need
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to know when it comes to
measuring revenues the right way.
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Intro
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(upbeat music)
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What's everybody, welcome
to Unstoppable, I'm TK.
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On this channel, I help
SaaS founders like you
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navigate the path to
the next stage growth,
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navigate the path of product
market fit and beyond.
[62]
So if you are new to the channel, welcome,
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I drop an episode every
Sunday, Wednesday and Friday,
[68]
so be sure to hit the subscribe
button, and the bell icon,
[71]
so you get notified every
single time I drop an episode
[74]
like this with the TK Energy.
[76]
Also, if you're already part
of the community, welcome back.
[79]
Really excited to have you here.
[80]
So, on this episode, I'm going
to go through some things
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about measuring revenue
and all these metrics
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we talked about and in SaaS businesses,
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I'm wanna walk you through how to think
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about them the right way,
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because I don't know about you,
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but when I first started out in SaaS,
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which was, I don't know,
10 years ago, 15 years ago,
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it was kind of confusing.
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And back then it was also
a very nascent space,
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everyone was still trying to figure out
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how to do it the right way.
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But now, I think there's
some broadly accounted things
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that we agree on, on
how to measure revenue
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and what to focus on
between MRR, ARR, ACV, TCV.
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So, I'm gonna walk you
through my three principles.
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If you're excited to get
started, smash that like button
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and let's dig right into it.
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So, the first thing You got
to get your head around,
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especially when you're
like, just focus on revenues
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and thinking about scaling
is you got to start thinking
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differently between
bookings versus revenues,
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bookings versus revenues.
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I made this mistake where I
was talking about bookings,
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but I meant revenues and
we should have been focused
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on revenues and not
bookings, because cash flow
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is different between those.
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So, this is where I take a deep breath,
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let's dig into it,
bookings versus revenues.
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Bookings are essentially
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how much the customer
has committed to pay you.
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Revenue, on the other hand,
is how much the customer
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is paying you for this period of service,
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this next period of service.
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So, for example, let's just
say you bring on a customer
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that has committed to a three year deal,
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they said, Look, we'll sign
with you for three years
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or the best system of record
for my particular industry.
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Three years I'm all in is going
to be a giant transformation
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is super strategic and only 300K.
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So, did you book 300K, is that your ARR,
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is that your MRR, is that your TCV?
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Like there's some nuances here.
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And if you really want to nail this,
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especially as you measure your business,
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as you think about cash flow, as you think
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about fundraising, and how to communicate
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your business growth and revenue growth
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and your bookings growth,
you got to nail all this.
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So, the first thing you want
to understand is, you booked
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that three year deal, but
you need to only recognize
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the revenue for this current period.
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And just because you booked
that three year deal,
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doesn't mean that 300K is going
to be in your bank account.
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They could be paying on
for only for this year,
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and then they'll pay next year,
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and then they'll pay the following year,
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even though they're contractually
obligated for three years.
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If they are actually
paying on a yearly basis
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or monthly basis, they'll also impact
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how you think about your cash flows.
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This is why, investors
really wanna understand
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not so much bookings all the
time, but they really wanna
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understand revenue, and what
your revenue run rate is
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versus your bookings rate.
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Because it tends to Office
gate a lot of things
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especially on the health of the business,
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the cash flowing into the
business and all that.
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So, basically, lesson number
one, there's difference
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between bookings and revenues.
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Revenues are more important
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because that's the most impactful
thing to your bottom line
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and your cash flow versus bookings.
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Bookings are great too, three
year deals are fantastic,
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but you want to think about revenues
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because it's more present.
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The second thing you wanna understand,
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is whether you think about
Monthly Recurring Revenue,
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or Annual Recurring Revenue.
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This one I learned a
little bit on the hard way
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coz I always thought ARR,
or Annual Recurring Revenue,
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even when I talk to SaaS
founders, they're applying
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to my Go-to-Market-Program
in the little forum
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where you apply to join,
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I was asked what's your ARR not your MRR.
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There's a reason for this,
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toutapp originally started
as a self service business
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and people signed up, they activated,
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the swipe their credit card,
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and then we made a certain
amount of money every month.
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And that was kind of like,
chapter one of the business.
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But chapter two, through
chapter 10 of the business,
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we actually turned on
an inside sales team.
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We actually de emphasize
the self service visits
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and focus a lot more on bigger deals
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and going after the enterprise
and the upper mid market.
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And so, we always did one year
deals or three year deals.
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And so, we always thought in terms of ARR,
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even when Marketo, there
was no way you could sign up
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for a trial, you have to pay for the year,
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you have to do a one
year contract minimum.
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In some cases, we made
exceptions both toutapp
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and our Marketo that, okay, you can do
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at least a one year deal,
but you can pay quarterly
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but you're still contractually obligated
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for the full year and will come after
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if you don't pay every quarter,
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we can break up the payments
for smaller companies,
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but it was always Annual
Recurring Revenue.
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Now not every besides business
thinks about an annual deal.
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There are lots of SaaS businesses,
even people in my program
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that actually think more in
terms of monthly revenue.
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Because they're only paying every month
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and they charge a credit card every month,
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and any given month,
the customer can decide
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they're going to leave.
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So, the first thing to ask
yourself is, do you wanna
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think for yourself an MRR
cadence or ARR cadence?
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I'm biased here, I actually
think that every SaaS business
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should try to go for yearly deals.
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But that's not true for
every market, right?
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In certain markets,
just the most you can do
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is on a monthly basis, on an MRR basis.
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So, the first thing you
want to figure out is,
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is your business thinking in
terms of charging customers
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on a monthly basis, or
can you actually move up
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to doing it on a yearly basis
and then a multi year basis?
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Obviously, the more of an
important and urgent problem
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that you're solving, the
more likely the customers
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are gonna be to prepay
for the year sign up
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for the year or even do multi year deals.
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So, you want to push for that.
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I actually think you should
try to be on the ARR level
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and charge for the year all the time.
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But, that may not be the
case that may not be feasible
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or you may not have grown into it yet.
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So, first choose whether you're on
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the MRR cadence or the ARR cadence.
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Now, how do you measure
MRR, or ARR for that matter?
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It's essentially any new business,
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plus upgrades, plus cross sells,
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minus downgrades, minus cancellations.
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That's essentially your MRR,
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and simply put that MRR
times 12 is your ARR.
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If you're always charging
on an annual basis,
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then you start with your ARR calculation,
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and you can divide it by 12
for your MRR calculation.
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There's this extra thing that you get into
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and I'm not going to go
into it in this video,
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but this is something to talk about
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with their finance person, it's
around Revenue Recognition.
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Revenue recognition is like
the underbelly of SaaS,
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finance and SaaS revenues
and how do you measure it?
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Rev Rec, there's like this
ugly spreadsheet that's hidden
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in every SaaS business, and
it's usually by the controller
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or the accountant or the
part time CFO or the CFO,
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where they're trying to
do Rev Rec the right way,
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and there's almost
certainly bugs in there.
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Revenue Recognition comes
into if someone pays you
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for a three year deal
upfront, they pay the 300K,
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but they're on a monthly basis,
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like they're using the
service every month,
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when you recognize that 300K,
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and what do you do with that cash,
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and how do you manage that cash?
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That's revenue recognition.
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I won't go into that, for
the purposes of this video,
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just know the difference
between MRR and ARR,
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and whether you should be on
an ARR level or an MRR level.
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If you are truly on a monthly
cadence, then stick with MRR.
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If you are charging doing one year deals,
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and that's your baseline,
you don't do business
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unless they sign up for a one year deal,
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which is where you want to
get to with the SaaS business
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in my opinion, then you want to do ARR.
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Now, can you go into ARR right
away in the early stages?
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No, we didn't, we started with
MRR and then we grew in ARR,
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and then we were doing three year deals.
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So, that's that's how
you can think about that.
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But know that number one
bookings versus revenues.
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And then when you get into revenues,
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think about MRR versus ARR.
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And also talk to your
friendly finance person
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about Revenue Recognition and make sure
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that they're doing that properly,
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otherwise, they'll screw you over.
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The other thing I'll mention,
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I have one more on this
and I'll get to that.
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But before I get to that, let
me pause here for a second.
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There's this one time at tout,
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this was like super early days,
we were just in that chasm,
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we were moving from doing
the the self service business
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to the inside sales business
and we were starting to book
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these one year deals and they were like,
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they start with 20K deals,
and 30K deals, and 50K deals
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and they were coming in,
coming in coming in, coming in.
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And we hadn't even raised our series A yet
[549]
we were we had only raised
about a million like 970K
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in seed money, we were
getting to a million ARR,
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we were almost like, we were
basically cashflow positive,
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and we were thinking our next
run, but then all of a sudden,
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like I log in, to our bank account.
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And by the way, we've been killing it,
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we had our best sales month.
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And I logged into our bank
account and we were like,
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We weren't gonna make
payroll, forget like,
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we weren't gonna be able to make payroll.
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We had like seven employees at the time,
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reaching a million ARR, but we
also wouldn't be able to pay
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our like Engine Yard bill,
we were using Engine Yard.
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And I'm like, I don't
understand, like what's going on?
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We booked all this business,
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but we don't have the money in here,
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like what the hell is going on?
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And that was my rude
awakening to this entire mess
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of bookings versus revenues.
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In that just because we booked a deal
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doesn't mean the cash
is in the bank account.
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There's also this thing around DSO,
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which is just essentially how much
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your customers owe you
but haven't paid yet.
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Like, we booked the deals,
we put them in the platform.
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They're like sounds
good, checks in the mail.
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But it turns out even
for large corporations
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unless you have a series
of processes, hey,
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you owe us money, you need to
pay it, it's due in 30 days,
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need invoice you, and they
had to ship you the check,
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because you can't put
$50,000 on a credit card.
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We essentially, were at
a point where we booked,
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like we booked a whole bunch
of deals, but essentially,
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our Rev Rec was zero and even more so,
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Rev Rec was okay, but our
cash collected was negative.
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And therefore we were like, out of money.
[637]
And like I had literally had to call up
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one of our investors, I'm like, listen,
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we're out of money, but we're
not really out of money.
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But we're out of money and
we need you to wire us 25K
[648]
so that we can pay our
bills, but I promise you,
[650]
like, there's a whole bunch
of money coming our way.
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And that's when I really learned like,
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you got to think differently
between bookings and revenue
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and you got to think
differently between MRR and ARR.
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You also think differently about Rev Rec
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and cash collections.
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These are all important
pieces that, like I wanna
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build great product, I wanna to market it,
[667]
I wanna to get more people,
wanna to serve them.
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Yes, but you also have to
think about this finance piece.
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So I wanted to do this
episode, so was crazy story,
[673]
we're like out of money
but not out of money.
[675]
And like our investors
just laughed coz he's like,
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I get this all the time, like
you get your stuff together.
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Like I know, I know, we're
hiring a part time CFO.
[683]
And when we got our series
A we actually brought
[685]
on the firm to be our part time CFO.
[687]
So, this is why this is so important.
[689]
If you're seeing why this is so important,
[690]
you gotta embrace this stuff.
[692]
You don't know the
difference between bookings
[693]
and revenues, MRR versus ARR,
[695]
can I just get a yes in the comments below
[696]
and also smash that like button,
for the YouTube algorithm.
[700]
Also, if you're thinking about
growing your SaaS business,
[702]
I'm a five point star strategy guide,
[704]
I'll tell you more about it,
[705]
but let's wrap up on the third principle.
[708]
The third principle is knowing
[709]
the difference between ACV and TCV.
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So, we talked about bookings and revenues.
[715]
We talked about MRR versus ARR.
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The last piece you just need to know
[719]
in this slide PhD for SaaS financial terms
[722]
that are related to
revenue, ACV verses TCV.
[726]
ACV is your Annual Contract Value,
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TCV is your Total Contract Value.
[730]
This is the league you want to get to.
[731]
If you're building a
substantial SaaS business,
[733]
you want to get out of this, like swipe
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a credit card every month,
[736]
like that's good to get started in.
[738]
But in the larger, larger
scales, you want to get
[740]
into annual deals, you want
to get into multi year deals,
[743]
that's when it gets super
interesting, it gets super fun.
[746]
And so let's just say Acme Inc,
[749]
signed a three year
deal, with a TCV of 300K.
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If it's a TCV, TCV is
Total Contract Value.
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Total Contract Value of three years 300K,
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that means your ACV, your
Annual Contract Value is 100K.
[763]
It also means that, if this
is your first customer,
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your ARR annual recurring
revenue is now 100K.
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But it also means, that your
MRR is now 8.3K, roughly.
[775]
I think I did the math right,
yeah, that sounds right.
[778]
And so, that's how all of
these connect together,
[780]
but also remember, there are nuances
[782]
here if you've been paying attention,
[784]
like just because you booked
the 300K deal doesn't mean
[787]
you have 300K in the bank,
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just because, your payment terms matter
[791]
your collection matters, and
all of these tie together
[794]
to actually paint the true revenue picture
[797]
of your SaaS business.
[798]
There's also this thing of like,
[799]
just because someone
signed a three year deal
[801]
doesn't mean they're
always going to honor it.
[802]
If it's a tiny company,
they might give you the wink
[805]
and a nod and say that they're
doing a three year deal
[807]
but they've got a business,
some money in the bank.
[809]
This is why all these nuances matter.
[811]
So, to recap, know the difference
[813]
between bookings and revenues.
[816]
Pick whether you're on the MRR
cadence or the ARR cadence,
[819]
and also, do multi year
deals, those are the best
[823]
but just know ACV versus TCV.
[826]
Those are the three principles
I wanted to walk you through
[828]
and the story I wanted to share
about SaaS revenue metrics,
[831]
what gets measured gets
managed, so be sure to measure
[833]
your SaaS revenues properly,
as you drive to growth.
[837]
If you got value from this video,
[838]
please be sure to smash that like button
[840]
Also, if you're new, be sure
to hit the subscribe button
[843]
and that bell icon if you haven't already,
[845]
so you get notified when
I bring you another video
[847]
like this on how to
grow your SaaS business.
[850]
Speaking of which, if you are
growing your SaaS business,
[852]
be sure to check out my five
point startup strategy guide.
[856]
And so my start strategy guide,
I go into much more detail
[858]
on the key things you need to understand
[860]
are on your SaaS business to
drive growth the right way.
[863]
So, you get it's completely free,
[864]
just go to getunstoppable.com/strategy,
[867]
or just follow the link below.
[869]
And lastly, I bring an
episode every Sunday,
[872]
Wednesday and Friday, so,
be sure to let me know
[875]
what topics what future
topics you'd like me to cover,
[877]
because we're putting
out a lot of content.
[879]
We do a lot of research around
these complicated topics
[882]
and we want to bring in the
best relevant topics to you.
[884]
So, put that in the comments or hit me up
[886]
on Twitter if you like.
[887]
My username is over here.
[888]
That's pretty much it.
[889]
I really appreciate watching this video.
[891]
And remember, everyone needs a strategy
[893]
for their life and their business,
[894]
but when you are with us,
yours, its gonna be unstoppable.
[898]
I'm TK and I'll see you
in the next episode.
[900]
(upbeat music)
[907]
I think I did the math right,
yeah, that sounds right.
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