What Is Annual Recurring Revenue (ARR)?
Annual recurring revenue (ARR) is the total amount of revenue that a company can expect to receive each year from its products and services. Companies that offer yearly subscriptions use this metric to determine their expected annual income.
For a SaaS company, ARR should include both the product’s subscription fees plus any additional professional services that the company offers. Common examples of these services include product installation, training, and maintenance contracts.
Who Should Use the Annual Recurring Revenue Model?
The annual recurring revenue (ARR) model is best suited for companies that sign customers to a term of at least one year. This model estimates each customer’s charges over a year and projects this out as ongoing revenue.
Companies that offer monthly subscriptions can also estimate their annual recurring revenue by projecting each customer’s monthly charges out to one year. However, because customers can end their subscriptions at any time, this model may be less accurate for businesses with monthly subscriptions. In this case, it may be more beneficial to use a monthly recurring revenue (MRR) model.
How Do You Calculate Annual Recurring Revenue?
There are a few things you’ll need to calculate before you can figure out your annual recurring revenue (ARR). You’ll need to know:
1. The total dollar amount of annual subscriptions.
2. The total dollar amount of additional ongoing revenue (training, installation, support, etc.).
3. Total dollar amount lost through subscription cancellations (customer churn).
Once you have those numbers, the formula for calculating your ARR is:
Annual subscriptions + additional ongoing revenue – cancellations = ARR.
If you sell your product on a monthly basis, you can use a similar formula and then multiply the monthly number by 12.
Why Is Annual Recurring Revenue Important?
Many SaaS businesses consider ARR to be the most important metric in measuring their company’s success. Here are a few reasons why:
1. It highlights what’s working (and what isn’t)
A company that knows the annual recurring revenue of a product can more easily determine whether its sales and marketing campaigns for that product, as well as the overall customer acquisition cost, are profitable.
2. It’s a leading indicator of future growth
ARR is often seen as a leading indicator of future growth because it represents the amount of revenue that a company can expect to receive on a recurring basis. This gives investors and analysts a good idea of a company’s potential for future growth.
3. It’s easy to calculate
ARR is relatively easy to calculate, which makes it one of the most popular metrics among SaaS companies. All you need is to take the total recurring revenue for a given period (usually one year) and divide it by the number of customers at the end of that period.
ARR refers to the revenue your company can expect to receive on a yearly basis from customers who subscribe to your products or services. It’s important to remember that ARR excludes any one-time charges or fees related to your company’s offerings.
For example, let’s say your company sells a B2B SaaS app. Some of your upsell options include an enterprise version of the software and regular onsite training with your staff. Expansion revenue from add-ons like these should be included in your ARR.