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The average is an important number that you can use to measure central tendency or spread of data. With recurring revenue, however, it becomes trickier to calculate because there are multiple instances of the metric being measured.
You could look at monthly ARR as your measuring stick, but if we do that, we have to also account for months with no revenue. To avoid this, we will use annualized recurring revenue (ARR) instead.
By taking the year-to-year growth rate of recurring revenues and dividing it by time, we get the average yearly growth rate of the company. This gives us our final calculation of mean ARR!
Mean ARR is more appropriate in terms of consistency than monthly ARR. Monthly ARRs vary greatly depending on how much money the company makes in one month versus another.
With mean ARR, it evens out and looks closer to the overall growth rate of the company.
The second way to calculate ARPR is to find the mean of all these numbers. The mean is simply the total amount divided by the number in question. In our case, the total is the product sales times repeat purchases, so the mean would be $\frac{Sales * Repeat Purchases}{Number Of Customers}$.
This seems slightly more complicated than the first method we discussed, but it is not! This means that you will get the same result, just with different math.
The reason this calculation makes sense comes down to how businesses work. Most companies have an initial sale, then people keep buying their products or services to maintain their loyalty. This process is repeated over and over again, making it hard to distinguish between individual customers and what is essentially one very expensive person. The average buy-repeat ratio removes this barrier by figuring out what the average is for similar businesses and using that as your multiplier.
The second way to calculate ARPBS is to find the mean of all sales divided by the number of months in the time period. For example, if there were three years with an average purchase price of $1,000 and one year with an average purchase price of $2,500, then the mean or average spending is $1,667 which is calculated as (price for month x quantity purchased per month) / total months.
In this case, we know that the total months was twelve so we divide by twelve to get our average spend per month.
This method assumes that your customers will continue to come back and buy the product consistently throughout the life of the subscription. If this isn’t the case, you may want to look at other calculation methods such as calculating median income!
Just make sure to only include data points in the average that are directly related to each other. For instance, if there was a six-month gap between purchases, those six months wouldn’t be included when determining the average monthly expenditure.
The second way to calculate ARR is by calculating the average lifetime of a client. This is done by taking the total amount spent over time divided by the number of months in that period.
For example, if a company spends $1,000 one month and then nothing for two months, their ratio is 0-2/0+2 = 2. A very small value!
Conversely, if a business makes monthly purchases all year long, their ratio is always greater than zero (no matter how much they spend). An infinity (or never ending) ratio!
This method assumes that customers will continue to purchase services or products from you after their initial transaction. If this isn’t the case, you should use the first method described above.
However, even if a few people drop off, your ARR can still be quite high because you are only looking at the time frame when most people were spending money with you.
In the recurring revenue world, your average transaction price is not simply calculated by taking the average of all transactions, but instead determined using a different metric — the average trial period for each transaction.
A trial period can be anything from one month to years depending on what product you are selling. With this understanding, the average trial period becomes an important component in calculating your ARPA.
By introducing the concept of engagement into our calculations, we can get a more accurate picture of how much money you will make with your business model.
Engagement equals time! The longer someone is willing to spend or invest in your products and services, the higher the ARPU (average per user) value that you have. A lower investment means a low ARPU and thus income potential.
There are many ways to calculate engagement, but I will go over two of my favorites here. You can find the rest of the calculators here.
The average is typically determined by adding up all of the items in the list and then dividing that total by the number of items in the list. However, when calculating recurring revenue for your business, there’s an additional component you need to include in the calculation. This is the monthly subscription fee!
When calculating the average cost per month, it is important to only include costs that are directly related to running the business. This includes things like employees salaries, marketing expenses, website development resources, etc.
Don’t add in the subscription price as part of the average cost, because this includes the initial purchase payment! Subscription prices are usually paid at time of sale, therefore including them when determining the average cost can skew the numbers.
We will talk more about how to calculate the average monthly cost later in this article, but first let’s take a look at some examples.
Examples: Calculating average variable costs
Below we will be looking at the expense ratio of two different companies. These companies have different levels of annual revenues, so their average cost calculations will differ slightly. But, for the most part, they use the same concepts.
Company A has higher than normal employee turnover which increases operating expenses due to hiring and training new workers. They also spend money advertising to promote sales which makes sense since they still want to draw in customers.
The average is typically calculated using an equation that includes both input variables! The average recurring revenue (ARR) of a business comes down to how much money they spend in the long-term on their product or service.
The average doesn’t necessarily mean what every member of the group spends, it means the total amount spent as part of your job or position at the company. For example, if Amy buys a lot of coffee for her office, then she isn’t included in the average because her costs aren’t related to her employment here.
If Bob also purchases a large quantity of coffee during his time at work, then he too won’t be counted towards the average due to his personal spending habits. It would only include him if he worked for the same company for life or at least a significant length of time.
Another way to calculate average recurring revenue is by calculating the average length of time that customers remain loyal to you before they defray their subscription or membership fees. The cost per user can be adjusted depending on whether users drop off for one month, two months, three months, etc.
By looking at the average length of time memberships last, we are able to get an accurate estimate of what the ARV should be!
This method assumes that people who pay monthly will not cancel their service immediately unless it is due to death or bankruptcy of the individual. By figuring the average duration of time members enjoy the service, we can determine the cost per user and use that as our ARV.
While most entrepreneurs focus on revenue per day, which is great for highlighting your product’s success, average recurring revenue (ARR) is an even better way to assess the health of your business.
Average monthly recurring revenues tells you two important things about your business: 1) How well it is performing in terms of attracting new clients and 2) How well it is keeping those current clients.
The first thing to note about ARRs is that they only include payments that have at least a 30-day grace period. This is because some months there may not be enough money spent by patients or doctors to reach this threshold.
So what does this mean? It means that you should expect some large gaps between numbers when calculating ARRs.
This makes sense since patients can stop paying their medical bills at any time — sometimes due to lack of improvement, but more frequently due to cost.
Furthermore, some clinicians will choose to no longer treat a patient after he or she runs out of coverage, leaving you with a zero income stream.
