Annual recurring revenue (ARR) is a term used in subscription-based businesses to indicate the amount of revenue that is committed and recurring on an annual basis.
In other words, ARR is the total amount of revenue a company expects to receive from customers who have committed to renewing their subscriptions at the same rate for another year.
This SaaS metric is important for subscription businesses because it provides a more accurate picture of the company's recurring revenue than monthly recurring revenue (MRR) does.
Using a proven SaaS Metrics Template like ours can help you track a lot of important metrics in one place. For now, let's dig into what you need to know about ARR and how it's used.
ARR includes all forms of recurring revenue, such as subscriptions, membership fees, and license fees.
Items such as:
For example, if a customer pays $120 per year for a subscription, that customer's contribution to the company's ARR would be $120. If the customer pays $120 per month for a subscription, that customer’s contribution to the company’s ARR would be $120x12 = $1440.
There are a few things that should not be included in annual recurring revenue when calculating ARR.
One example is one-time payments, such as sign-up fees or installation charges.
Another is revenue from non-recurring services, such as consulting services that are not part of an ongoing contract.
Discounts and other forms of price adjustments should also be excluded from the ARR calculation.
You can identify items that aren't part of your annual recurring revenue by looking at your yearly subscription contracts and determining which charges are recurring and which are not.
There are two ways to calculate ARR.
The first is to simply add up all of the recurring revenue that you expect to receive over the course of a year.
This is the most straightforward way to calculate ARR, but it can be difficult to do if you have a large number of customers with different subscription terms.
The second way to calculate ARR is to use the ARR formula, which takes into account the different lengths of time that customers have been subscribed.
This method is more accurate, but requires more information and can be more difficult to calculate.
The ARR formula is:
ARR = (Total revenue from new subscriptions in a period) + (Recurring revenue from existing subscriptions at the beginning of the period)
- (Churned revenue from existing subscriptions during the period)
+ (Upgrades or downgrades to existing subscriptions during the period)
This formula can be used to calculate ARR on a monthly, quarterly, or annual basis.
To calculate ARR on a monthly basis, you would simply substitute "month" for "period" in the formula.
To calculate ARR on a quarterly basis, you would substitute "quarter" for "period."
And to calculate ARR on an annual basis, you would substitute "year" for "period."
1. To calculate ARR on a monthly basis, you would simply substitute "month" for "period" in the ARR formula.
For example, if a company expects to receive $1,000 in recurring revenue per month, their ARR would be $12,000 (1,000 x 12).
2. To calculate ARR on a quarterly basis, you would substitute "quarter" for "period" in the ARR formula.
For example, if a company expects to receive $3,000 in recurring revenue per quarter, their ARR would be $12,000 (3,000 x 4).
3. To calculate ARR on an annual basis, you would substitute "year" for "period" in the ARR formula.
For example, if a company expects to receive $10,000 in recurring revenue per year per client, their ARR would be $10,000 (10,000 x 1 client).
As a business, increasing your revenue is the ultimate goal. And one of the best ways to do this is to increase your ARR. But what strategies can you apply to do so?
Acquire new customers
It might sound obvious, but new customers means more profits. So implementing strategies to find new leads and reach out to new customers to get them to sign up for a subscription is a must. This is where your marketing team comes into play.
Upsell annual subscriptions
You can do this by offering a discount if they subscribe yearly vs monthly. At face value, this sounds like a potential loss of revenue, but locking your customers into a year contract will actually benefit you long term. That’s because people are far more likely to unsubscribe in less than 12 months or upgrade to an annual subscription because they love your product. Either way, you end up with higher revenue in the long term.
This is a tactic often seen in gyms. Most gyms will upsell you on yearly passes knowing full well that most people don’t stay consistent after a month. So they take advantage of new year’s day, and offer a significant discount. Even though the contract value is lessened on paper, it actually increases in services used v services paid for.
You’ll also find that renewals are much more likely on yearly subscriptions than monthly ones - so find your business’ new year’s day equivalent and take advantage!
Annual recurring revenue (ARR) is a measure of all the recurring revenue that a company expects to receive over the course of a year.
Monthly recurring revenue (MRR) is a measure of all the recurring revenue that a company expects to receive over the course of a month.
Both metrics are important in assessing the success of a subscription model, but ARR provides a more accurate picture of the company's long-term growth potential. It’s important to know the difference between ARR and MRR to know how to make the best use of both key metrics.
Annual recurring revenue is an important metric for subscription-based businesses because it provides a more accurate picture of the company's long-term growth potential.
MRR can fluctuate from month to month, but ARR is a more stable metric that can be used to predict a SaaS company's future growth.
ARR allows you to forecast revenue accurately so you can plan your distribution of resources efficiently. And because it provides predictable revenue, you can adapt your pricing strategy to maximize your ROI.
To streamline your financial planning, download our SaaS Company Operating & Valuation Model Template now. Follow these simple steps to get started:
No, annual recurring revenue (ARR) is not the same as revenue. Revenue includes all the money that a company earns, while annual recurring revenue only includes the recurring portion of that revenue.
We need to differentiate between the two because subscription businesses typically have a mix of one-time and recurring revenue.
Committed annual recurring revenue (CARR) is a measure of all the recurring revenue that a company has committed to receive over the course of a year.
This metric is important for subscription businesses because it provides a more accurate picture of the company's long-term growth potential. This means the metric allows you to project for future revenue, allowing you to build your business plans.
CARR is calculated by adding up all the recurring revenue a company expects to receive from current customers (minus any churned revenue).
To calculate CARR, you would use the following formula:
CARR = (Total recurring revenue from new subscriptions in a period) + (Recurring revenue from existing subscriptions at the beginning of the period) - (Churned revenue from existing subscriptions during the period)
This formula can be used to calculate CARR on a monthly, quarterly, or annual basis.
To calculate CARR on a monthly basis, you would simply substitute "month" for "period" in the formula.
To calculate CARR on a quarterly basis, you would substitute "quarter" for "period."
And to calculate CARR on an annual basis, you would substitute "year" for "period."
1. To calculate CARR on a monthly basis, you would simply substitute "month" for "period" in the CARR formula.
For example, if a company expects to receive $1,000 in recurring revenue per month from new subscriptions and has $2,000 in recurring revenue from existing subscriptions, their CARR would be $3,000 ((1,000 + 2,000) - 0).
2. To calculate CARR on a quarterly basis, you would substitute "quarter" for "period" in the CARR formula.
For example, if a company expects to receive $3,000 in recurring revenue per quarter from new subscriptions and has $6,000 in recurring revenue from existing subscriptions, their CARR would be $9,000 ((3,000 + 6,000) - 0).
3. To calculate CARR on an annual basis, you would substitute "year" for "period" in the CARR formula.
For example, if a company expects to receive $12,000 in recurring revenue per year from new subscriptions and has $24,000 in recurring revenue from existing subscriptions, their CARR would be $36,000 ((12,000 + 24,000) - 0).