As more solution provider companies make the pivot into MSP and CSP territory and transform their business models, there are some new financial metrics that become as important as gross and net margin.

Recurring revenue financial models are becoming the new standard.

We are all familiar with the basic formula to figure out profitability, right? Take all revenue, subtract the cost of goods sold to get our gross operating margin and then subtract business costs to get our profit margin. On paper it is a fairly straightforward concept. Inside the recurring revenue business, there are metrics within that formula that will help us understand the overall health of our subscription business and potentially improve decision making down the road.

Annual Recurring Revenues

Annual recurring revenues are a fairly straight-forward metric. Annual recurring revenues are the source of truth for business. Annual recurring revenues are the source of truth for business because it tells the actual revenue recognition. To calculate annual recurring revenue, add up the expected total yearly billings of the customer’s annual subscriptions and usage fees. Annual recurring revenue is also used in determining other metrics later on.

Average Revenue Per Unit

Average revenue per unit is most used in a business with subscriptions and fees that may vary from one customer to another. To calculate average revenue per unit, divide the total revenue by the number of subscribers. This is helpful when done by product line to help determine profitability and growth.

Conversion Rates

Most recurring revenue products offer no-cost trials. While this is a great way to entice people to try products, finding out your conversion rates can help you understand if you are attracting the right people for the no-cost trial, if the free trials are converting to paying customers and what products are most popular.

For example, a lot can be seen about the conversion rate of people who visit a website versus the number of people who sign up for the free trial. One can then calculate the conversion rate of free trials to paying customers. These conversion rates give insight into the behavior of current and potential customers, the usability of our website and the popularity of individual products.

Lifetime Value and Customer Acquisition Cost Rati0

These two metrics, when compared together, can give a better understanding rather than just customer acquisition costs alone. First, let’s look at the customer acquisition costs. This metric will help understand how much it costs to bring on a new customer. To find this metric, we add up all sales and marketing expenses and divide that by the number of new customers added during the same time. Wish customer acquisition cost, the lifetime value metric can be found. Lifetime value metric predicts the profit the company could make from a single customer for the entire life of the relationship. For this calculation, take the average revenue per account and multiply that by gross margin and customer life.

Then take lifetime value and compare it to customer acquisition costs. The ratio should be three or higher. If it is not, there may be a hidden problem in either not enough value from each customer, or exceptionally high costs to acquire customers.

This is a very telling metric.

Customer Net Profitability

Customer net profitability will help determine if money is made or lost form a customer over the lifetime of that customer. A simple formula to calculate this is to take the lifetime revenues from that customer and subtract the customer acquisition costs.

This is a great metric to look at to help determine where profitable customers are, and by that, we can begin to target additional similar type of customers.

Retention and Churn Rates

At the heart of every recurring revenue business is loyalty and keeping current customers happy and engaged. Without this, the business churns through customers and spends lots of time and money to acquire new ones. Retention rate is a percentage of customers that the company maintains from year to year. Churn rate is the percentage of customers that a company loses from year to year. Retention rate high and churn rate low is the key.

Examining these metrics across different periods of time and different product lines can help identify where the company is doing well, and where it needs improvement. Increasing retention and decreasing churn will help all other metrics improve as well.

These are just a few metrics to leverage for understanding a recurring revenue business. The more key financial metrics for business decisions based on the data are understood, the more likely the business is to grow recurring revenue income as profitably as possible.

There is still time to join Theresa at HostingCon in New Orleans on Sunday to learn more about partnership best practices, recurring revenue and other topics to help grow your business. Register here.