What is recurring revenue?
Recurring revenue is defined as revenue that a company can reasonably expect to receive regularly, which could be daily, weekly, monthly, or annual. Recurring revenue is also sometimes called subscription revenue because it is often associated with companies that offer subscriptions to their products or services.
Unlike one-off sales, which fluctuate wildly from month to month, recurring revenue is much more predictable and therefore provides a solid foundation for businesses to grow. That’s why recurring revenue is so important—it gives businesses a predictable way to grow their top line.
Why is understanding or having recurring revenue important?
There are many reasons why recurring revenue is important, but perhaps the most important is that it gives businesses a more predictable stream of income. This makes it easier to forecast future earnings and plan for growth.
In addition, businesses with a recurring revenue model often have a higher customer lifetime value (CLV). This is because customers who are paying regularly are usually more satisfied with the product or service and are therefore less likely to churn.
How to calculate your monthly and annual recurring revenue?
There are a few different ways to calculate your recurring revenue, but the most common is to take your total number of paying customers and multiply it by the average amount they pay per month (or year).
For example, let's say you have 100 customers who each pay $10 per month, the monthly recurring revenue would be $1,000 ($10 x 100 customers), while the annual recurring revenue would be $12,000 ($10 x 100 customers x 12 months). Note: this assumes no churn or monthly topline growth.
What are the types of recurring revenue business models?
There are many types of recurring revenue business models, a few of the more common include:
- Hard contracts - businesses provide a service to customers over a specific period for a specified charge, e.g. mobile phone plans.
- Sunk money consumables - businesses sell a product to their customers at a loss, with the idea that they’ll make more money over time with consumable products, e.g. printers, razors, Keurig coffee brewers.
- Auto-renewal subscriptions - businesses collect revenue each month (or year) until the customer cancels their subscription, e.g. Amazon Prime, Netflix, Hulu.
- Usage billing - businesses charge their customers based on the total usage of the service during a specified period of time, e.g. cell phone plans with limited monthly text messages or minutes.
- User-based - businesses that charge their customers based on the number of seats they have, e.g. salesforce, Figma and Asana.
- Freemium - businesses provide a free version of their product or service with a limited set of features, and another paid version with all of the features, e.g. Canva, and Wistia.
How to increase my recurring revenue?
There are a few different ways to increase your recurring revenue, but some of the most common include:
- Offer complimentary products or services: If you have customers who are happy with your core product or service, they may be more likely to buy additional products or services from you.
- Increase prices: If you have room to increase your prices without losing customers, this can be a great way to boost your revenue.
- Pair new features with a tiered pricing model: Adding new features to your product or service can entice customers to pay more for your offering, especially when the features are exclusive to only one of the packages.
- Improve retention: Improving customer retention will also lead to increased revenue over time because a higher lifetime value is related to higher recurring revenues.
Impact of recurring revenue on valuation?
Recurring revenue is often seen as a key indicator of a company's health and growth potential, so it's not surprising that it can have a significant impact on a company's valuation.
Companies with high levels of recurring revenue are often valued at a higher multiple than companies with less predictable sources of income. This is because these revenue models provide a more stable foundation for future growth, and businesses with recurring streams are less risky compared to those without them, all things considered.
How to forecast recurring revenue?
Forecasting recurring revenue can be difficult because it is often based on historical data. However, there are a few methods that can help you get a more accurate picture of what to expect in the future:
- Look at customer churn: Customer churn is a measure of how many customers cancel or do not renew their subscriptions each month. By looking at customer churn, you can get a better idea of how many customers you can expect to lose in the future and adjust your forecast accordingly.
- Align pricing to market analysis: Many different market analysis techniques can help you understand what customers are willing to pay for your product or service. This information can then be used to adjust your forecast up or down.
- Utilize the NPS framework: Surveying your customer base to determine your net promoter score (NPS) can help understand the areas of improvement, so you can minimize your churn and inform your product roadmap.
Can you provide an example of recurring revenue businesses?
Recurring revenue businesses include software subscription companies such as Netflix, Spotify, and Amazon Prime. These companies charge customers on a monthly or annual basis for access to their service. Other examples of recurring revenue businesses include software-as-a-service (SaaS) companies, which typically charge customers on a monthly or annual basis for access to their software.
What are the advantages of having a recurring revenue business?
There are several advantages to having a recurring revenue business:
- Predictability: It is often more predictable than one-time sales, so it can provide a more stable foundation for future growth.
- Visibility: It can provide visibility into a company's future cash flows.
- Customer loyalty: Businesses with this revenue model often have higher levels of customer loyalty compared to other businesses.
What are the disadvantages of having a recurring revenue business?
Some of the potential disadvantages of having a recurring revenue business include the following:
- Customer churn: Because customers are paying regularly, they can easily cancel their subscription if they are not happy with the service or product.
- High customer acquisition costs: It can often be expensive to acquire customers for this type of business.
Why do investors prefer investing in recurring revenue businesses?
Investors are often attracted to recurring revenue businesses because of the predictable nature and reliability of the revenue. In addition to having “higher quality” revenue, recurring revenue businesses are often seen as being more stable and less risky compared to others.
What kinds of financing are the best for recurring revenue businesses?
There are several financing options available for recurring revenue businesses, which include the following:
- Debt financing: Debt financing, such as venture debt, can be a good option for businesses that have predictable and recurring revenues because they typically come with long repayment periods and larger sizing.
- Equity financing: Equity financing can be a good option for businesses that have high growth potential and recurring revenues because the capital is “permanent”, in the sense that it doesn’t need to be paid back, and it can all be “put to work.”
- Revenue-based financing: this form of financing is a great option for businesses with recurring revenue because it does not require collateral, there are no warrants, covenants, or personal guarantees, and funding is typically provided within 48hrs.