When companies can count a sizable portion of their income as recurring revenue, accounting and financial forecasting becomes much easier. But while these kind of billings have captured a larger share of corporate profits recently, recurring revenue is not created equal. According to some estimates, as much as 40 percent of the typical firm's sales are made up of subscriptions or other repeat business. That means tracking and understanding recurring revenue is extremely important.
Ranking recurring revenue
Most executives would be happy to get any sort of repeat business on the books, but their CFO or accountant will know that a hierarchy of recurring revenue exists. That pecking order has come to form the foundation of many business plans. A brief list of the most desirable forms of recurring revenue, starting from the most valuable, usually looks like this:
Hard contracts: Most cell phone service plans or cable and internet packages are hard contracts that virtually guarantee a predictable revenue stream.
Auto-renewal subscriptions: Not unlike hard contracts, except for the fact that a customer may be able to cancel them after a certain amount of time.
Sunk-money subscriptions: An arrangement where customers make an initial platform purchase but need to buy proprietary accessories or other smaller products to continue using the platform.
Standard subscriptions: Revenue that will recur for only a limited amount of time but could be renewed by the end of the period.
Sunk-money consumables: Similar to sunk money subscriptions but applicable to platforms that do not require proprietary products to operate. For example, a coffee maker might fit this model, since it is a platform but uses accessories made by several different companies.
Simple consumables: Products bought on a one-off basis but have potential to become recurring through customer loyalty.
3 critical metrics
Within these recurring revenue models are many different metrics and variables that can be recorded and analyzed for accounting and planning purposes.
1. Customer acquisition cost
You need to spend money to make money, and CAC is one way of determining exactly how much of the former you might be doing. In the modern age of statistical analysis, CAC has become a crucial barometer of a company's success or failure. Since it involves many variables and assumptions, it might also be one of the hardest to accurately record. CAC includes any cost involved in attracting customers. Advertising and marketing budgets are the most obvious factors here, but obtaining accurate CAC figures means knowing what went into product research and development, distribution channels, sales meetings and more.
2. Customer lifetime value
While CAC helps understand what it took to win business, customer lifetime value (CLV, or sometimes LTV) is a measure of the total reward from that business. Again, this may invite an over-reliance on assumptions and estimates that could result in overeager budget planning later. To accurately assess CLV requires nominal calculations like the sum of all contracted sales, as well as more complex formulas like the annual discount rate.
While CAC is one metric that most companies will look to reduce, churn is never a number that should go too high. Particularly for subscription services, a high churn rate is a major business metric to avoid. Churn can be calculated from the number of customers on a monthly basis or according to revenue. It's important to keep a close eye on churn rate, but fortunately it's often easier to track than more complex metrics.
Whether they are basic or more complicated, any metric is impossible to track and understand without the right tools for the job. Consero helps businesses understand these metrics better, and gives them what they need to take full advantage of those insights.