The subscription economy, according to Forbes, is expected to reach $1.5 trillion in revenue for businesses. With the potential likely realized this year, it's vital to understand how it is tracked – and more importantly, how it's able to be tracked on a separate basis.
Also known as net dollar retention (NDR), this metric calculates the proportion of recurring revenue kept from present clients, including upsells and churn, during a defined time frame. Net revenue retention (NRR) evaluates a business's potential to keep and increase sales from their present clients.
It looks at how well a company leverages existing customer relationships to increase sales through add-ons, complimentary services, etc. It focuses on the long-term growth of recurring revenue from these relationships. It's calculated as follows:
NRR = (Starting MRR + Expansion MRR - Churn MRR) ÷ Starting MRR
Based on the following assumptions:
Starting monthly recurring revenue: $200,000
Expansion monthly recurring revenue: $40,000
Churn monthly recurring revenue: $20,000
NRR = ($200,000 + $40,000 - $20,000) / $200,000 = 1.10 or 110%
Based on this result, the company is increasing its revenue from existing customers faster than it's failing to keep revenue from customer churn, an important metric showing growth.
The following factors impact the formula:
Starting MRR is also referred to as the baseline recurring revenue.
Expansion MRR refers to the added sales from newly added clients, upselling, upgrades, and additions to existing customers' services.
Churn MRR is the sales missed by customers who stopped or lowered their level and type of services with the company.
Defining a Healthy Revenue Retention Rate
Companies that have a score of more than 100 percent show they're bringing in more revenue from the existing customer base versus what the company is losing from customer churn. If, however, it's less than 100 percent, customer satisfaction might be lacking, and customers may either be lost or simply not interested in additional services. Since acquiring new customers is more expensive than keeping current ones, it can lead to reflection on how to improve retention rates.
Journal Entry for Recurring Revenue
Assuming there's a 12-month contract signed for monthly services, the journal entry would be as follows for a $1,000/monthly payment for a total of $12,000.
| Debit | Credit | |
|---|---|---|
| Cash | $12,000 | |
| Unearned Recurring Subscription Income | $12,000 |
Once the $1,000 subscription income has been earned, the following journal entry would be entered.
| Debit | Credit | |
|---|---|---|
| Unearned Recurring Subscription Income | $1,000 | |
| Earned Recurring Subscription Income | $1,000 |
While each industry and business are different, using this metric can help companies determine if there's a customer retention problem; then they can start the investigation on how to increase retention for the future.
Sources
https://www.forbes.com/councils/forbesfinancecouncil/2023/10/27/the-truth-about-recurring-revenue/
