As we've discussed before, the term recurring revenue refers to income that comes in repeated transactions or engagements. For example, if you sell books via Amazon, your book sales come with a website and monthly subscriptions paid through their service.
This is different than one-time purchases like what I buy at the grocery store for my house - I might purchase those once a year! More likely, I'll spend $25 on milk every week!
Recurring revenues are much more stable and reliable than one time buys because they have a regular source of income. This makes it possible to budget appropriately and feel confident in having enough money coming in to cover expenses.
It also gives you the opportunity to focus on other things besides just gathering more cash, which can become distracting as well as annoying. Plus, you get to see some results from your hard work sooner rather than later!
Average IRR is simply the average amount of recurring revenue an entrepreneur receives per month. The reason why it's important to know this metric is because it tells you two things:
* How successful you are as an entrepreneur
* How close you are to running out of capital (the cost of starting a business)
The first thing it indicates is how successful you are as an entrepreneur. By definition, being an entrepreneur means owning a small business so it necessarily follows that most entrepreneurs earn some sort of income directly from their businesses.
For any business that offers services to other people, there are three main categories of revenues they can generate. These are:
1) Client fees – these are typically paid at fixed time intervals (for example, monthly health insurance or phone coverage). Examples include health care providers such as psychiatrists or podoconuscts, smartphone companies like Apple or Google, or any type of professional service provider.
2) Freelance labor – this is similar to item #1 except instead of paying per client, you get paid per hour. For freelance writers, it’s the writing hourly. For lawyers, it’s their billable hours. For engineers, it's their pay-per-hour rate.
3) Products/services - This is what most entrepreneurs and marketers refer to as “Sell stuff!” You will find yourself in this category if you own a restaurant, car dealership, house, or whatever else.
The difference between items #2 and #3 is that with the first two, you have a set amount of money allocated for each activity, but with product sales you're investing your time into marketing and selling them so you need to make sure you have enough to do it without running out of money.
So what is average recurring revenue? It’s simply multiplying the average monthly revenue (AMR) times how many months it took to reach that AMR. For example, if an item costs $20 per month with a one-month trial period and then monthly subscription fees after the one-month free trial, its ARR would be $180 — $20 x 30 = $60 spent up front, followed by $150 per month for 30 months total!
That’s not very high of an ARR, but remember, this only includes items people are actually paying for! Many apps have free trials or limited access features, so exclude those from the calculation when calculating app ARRs.
It’s important to note that while some companies may try to exaggerate their app ARS by including feature cost in the price, this doesn’t make the figure any higher. I believe investors understand that business models where you pay more than necessary for a product/service will fail, so excluding these expenses when calculating ARS makes more sense.
There are two ways to calculate the average recurring revenue (ARR) of your business. The first is calculating what percent of your businesses’ time spent in activity or engagement mode you consider recurrent. For example, if one of your services is consulting, then its ARRR would be determined by how many hours you spend doing consultant work.
The second way to calculate the average ARRR is looking at the length of time it takes to achieve that recurring income. So instead of thinking about whether a service is recurrent, think about whether an investment in your business has return on investment (ROI).
With both of these definitions, the lower the ARRR the better! A high ARRR means more money being invested into your business will result in more income. It also implies that your business has longer engagement times than the other area’s it competes with.
It’s important to remember that not every business has a large amount of recurring revenue, even if their product or service offers repeat purchases.
In fact, most one-time purchase products have much higher ARRs than what they realize! This is because people perceive these products as expensive at first, but then once you get use to them, you subconsciously feel like buying them again.
A user might buy your one-month subscription package for an app for $19, but they will continue paying the monthly fee until it expires. They may also reorder another month’s worth later on.
This how many big name apps make money — Netflix, Amazon Prime, YouTube Red, etc. People pay heavily up front, but eventually work around this cost in order to make content free and watch it constantly.
So instead of comparing yourself to direct competitors, compare yourself to ones with similar recurring revenue models.
Many successful startups don’t actively promote their product during its initial launch, preferring to let word of mouth do the talking. A lot of times, people will find and talk about your product online or through social media groups.
The average is often used to describe how fast a business grows, because it removes context such as start up time or downturns in revenue. By looking at only the steady stream of income, this number can be skewed due to changes in seasonality or costs.
By calculating an annualized growth rate, we get a more accurate picture of just how quickly or slowly the company is growing. This is typically done by taking the ratio of one year over another. For example, if revenues were $1 million in Year 1 and $2 million in Year 2, then the growth rate would be 10x – a very strong grower!
However, using the same numbers, this would not tell you much about whether the company is growing faster than expected or slower than normal. To fix this, we will use our ARRs from before to help determine the correct growth rates.
We will assume that these two years are outside of seasons when the company has experienced slow activity (for instance, during the winter). Therefore, we know for certain that these two years represent normal activity for the company. Using these assumptions, here are the calculated growth rates.
The second key metric to know about any business is its growth rate. This is how fast or slow the company is growing compared to other businesses in its field.
The growth rate of a company is calculated by taking its yearly revenue and dividing it by its annual sales, which are both measured at the end of a given period (in this case, a year). Then you take the ratio of those two numbers and divide that into one more, which is the average growth rate per year for past years.
This calculation assumes that the company’s revenues have increased over time. If they have decreased, then using their lowest-ever yearly revenue as a baseline instead of their highest is appropriate.
By looking at the averages, we can get an idea of how quickly or slowly the company is expanding. A higher number indicates faster growth, while a lower number means slower growth.
A common rule of thumb is to consider anything above 1% as rapid growth and anything below 0.5% as stagnant or declining growth. Some industries, like technology, can easily grow rapidly so having low requirements for the benchmark makes sense.
For our purposes here, let’s use Walmart as an example. It is considered a stable industry with very steady growth rates because it never goes up too much nor down too far from its previous highs. Its average growth rate over the last 10 years has been just under 2%.
While most entrepreneurs focus on how to make their product or service popular, less emphasis is placed on what to do after that. The next step is often overlooked, which is making money off of it! This is typically referred to as revenue generation, but some refer to it as profitability due to the negative connotation of the word “generation”.
Most experts agree that figuring out how much your business is worth is the key to determining its future success. By knowing this number, you can begin to assess whether or not changing certain strategies will help you reach your financial goals.
It also gives you an idea of where your current strengths are and any weaknesses that may exist. Having this information makes it easier to determine if there are ways to improve efficiency so that you can spend your time on things that will matter the most to your business.
There are several different methods for calculating the value of a business, with varying levels of accuracy. Some of the more common types include assuming no debt, using average cost to produce products, deducting depreciation, adding back inventory, and applying any retained earnings such as capital raises or dividends.
A common way to value companies is by using either the price-to-sales or price-to-cash flow models. The former calculates the market value of a company based on how much its shareholders are paying for it, while the latter uses more practical numbers such as what the business makes in revenue and cash every month to determine worth.
The difference between these two methods comes down to whether you include the cost of investing in the company in future growth or not. If you don’t, then that investment is left out when calculating the “price” of the stock. It can be tricky to estimate this kind of investment, so most experts agree that you should leave it out. This is why the price-to-earnings (P/E) ratio isn’t used very often.
By leaving off the potential for growth, the P/E becomes artificially high due to the assumption that the company will keep spending money to grow even after they reach their goals. Technically, they have already done that! By ignoring future investments, people may also underestimate the true value of a company because they fail to take into account all of the things that could potentially help the company succeed in the future.