Annual Recurring Revenue (ARR)

What is Annual Recurring Revenue (ARR)?

Annual Recurring Revenue (ARR) is the value of your firm's subscriptions' contracted recurring revenue components normalized to one year. This metric is commonly used by SaaS businesses that have a subscription-based model. 

While calculating ARR, you must not consider any one-time fees or other cash flows. Instead, only think about the revenue earned through subscriptions. Companies can also monitor various aspects of ARR (such as ARR from new clients, ARR from product upgrades, etc.) to understand what contributes the most toward revenue generation.

Formula for ARR

Below is the general formula to calculate the Annual Recurring Revenue:

Annual Recurring Revenue (ARR) = Sum (Annual Recurring charge of all the paying customers)

1. If your company has a monthly payment structure, you can calculate ARR as mentioned below:

Annual Recurring Revenue (ARR) = Contract Value * (12 / Duration of the contract in months)

2. If your company has a yearly payment structure, you can calculate ARR as mentioned below:

Annual Recurring Revenue (ARR) = Contract Value / Duration of the contract in years

It is important to note if all the charges mentioned in the invoice are one-time or recurring.

ARR vs MRR: How to calculate each?

Annual Recurring Revenue (ARR) is generally calculated for contracts with at least one year. On the other hand, if the contract duration usually is less than one year, it could be more beneficial to track ARR. In these short-term contracts, Monthly Recurring Value (MRR) provides a more accurate representation of the revenue. 

You can calculate the MRR by simply multiplying the number of paid monthly customers by the average revenue per user per month.

Importance of ARR for SaaS businesses 

ARR is an essential metric that helps SaaS businesses to understand the following aspects:

1. Measures a company's growth: ARR's expected and stable nature is a good indicator of a company's growth. You can compare the yearly ARR of a company to see where the company is heading from a business growth perspective.
2. Assesses the effectiveness of a business model: ARR takes only the revenue earned from subscriptions and doesn't consider one-time charges. Hence, ARR can quickly evaluate whether or not the company's subscription model is effective. 
3. Helps in forecasting revenue: ARR is commonly used to forecast a company's revenue. It is kept as a reference value for revenue and is used in other calculations to forecast the company's upcoming revenue. 

ARR: Benchmarks & Examples

The business growth of a new company is generally volatile. So, here are some benchmarks that can help you to compare your ARR with other companies:

1. The average growth rate for businesses with $1-10 million/month of ARR was about 200% and decreased to 60% for companies with an ARR of more than $100 million/month. 
2. The average growth rate for businesses with an ARR of less than $1 million/month is 144%. 

Here are a few examples of how you can calculate the Annual Recurring Revenue (ARR):

1. Suppose a client signs a 2-year deal for a service at $50,000, and the client is billed monthly; you can calculate the ARR as follows:

ARR = Contract Value * (12 / Duration of the contract in months)

ARR = $50,000 x (12/24) = $25,000.

2. Suppose a client signs a 3-year deal for $90,000 and is billed annually; you can calculate the ARR as follows:

ARR = Contract Value / Duration of the contract in years

ARR = $90,000 / 3 = $30,000.