What is Annual Recurring Revenue?

Annual recurring revenue (ARR) is revenue that a company can expect to generate every year, on a recurring basis, assuming customers renew their subscriptions. This metric is especially important for businesses that operate on a subscription basis, such as software as a service (Saas) companies.

If a company has a high ARR metric, then they have an active customer base that they are safely assuming will continue to use their product.

ARR vs. MRR

ARR shouldn’t be confused with monthly recurring revenue (MRR). Simply put, the difference is the length of time being used to determine the total amount of revenue. ARR reflects an entire year, whereas MRR only looks at a single month.

ARR is the accumulation of MRR over a 12-month period.

Both are important to measure because they provide different insights. ARR will show progression year over year and can be used to help set strategic KPIs. MRR shows more detailed growth patterns and allows you to identify fluctuations that should be addressed in order to maintain customer retention.

Why is Annual Recurring Revenue Important?

ARR is important for businesses to measure and utilize because it’s invaluable for forecasting and setting KPIs for sales teams.

• It’s an important metric used to measure growth. If your ARR is the same year over year, then your company is staying stagnant and not actually growing. A successful business will see their ARR increase every year. If it’s not, then there are issues that need to be addressed.
• ARR helps with forecasting. Sales forecasting requires data, and ARR is an important metric to utilize. Knowing how much revenue you can safely rely on generating will assist in determining realistic sales growth, and future revenue.
• It helps illustrate customer retention. If your ARR starts to decline, it’s a clear sign that customers are no longer interested in your product. If they aren’t renewing, where are they going, and why? SaaS companies should always use their ARR to help determine customer retention and address issues if customers aren’t renewing their annual subscriptions.
• ARR should be used to determine KPIs. If you’re able to accurately forecast your ARR, it can be used as a benchmark when determining KPIs for your sales team. Knowing the average amount of revenue expected is key when setting goals and working towards overall company growth, so use it to your advantage when planning and measuring success.

How to Calculate ARR

The easiest way to calculate ARR is to add up your MRR. However, this gets complicated if you offer different subscription tiers to customers. To get a more accurate estimate, you should use an ARR formula.

To get a more accurate calculation, do the following: Add up overall subscription costs + recurring revenue from add-ons or other upgrade items, and then subtract revenue lost from cancellations.

If you have different subscription tiers, track those separately, and set up a formula to account for downgrades that still produce annual revenue, albeit less.

When calculating your ARR, you should not include one-time transactions such as set up fees, late fees, or single-cost add-ons. Since these aren’t recurring transactions, they don’t count towards ARR.

How to Increase ARR

To increase ARR, sales reps will need to onboard more customers and up-sell existing clients. Relying on the same customers year over year will result in stagnant ARR (or a decline, if they choose not to renew), so the best way to increase recurring revenue is to continually grow your customer base.