What is Annual Recurring Revenue (ARR)? How to Calculate It

While nothing is certain these days, it’s nice to have a reliable income stream. The subscription model — monthly or annual recurring revenue for products or services — helps businesses rely on deposits consistently being made directly into the company checking account, month after month and year after year.

But what, exactly, is annual recurring revenue — and how can it help your bottom line? Read on to learn more how revenue management software can help.

• What is annual recurring revenue (ARR)?
• How to calculate annual recurring revenue
• Differences between ARR and MRR
• How to improve your ARR
• What to look for in sales-tracking tools

Annual recurring revenue (ARR) is predictable and consistent revenue derived from a company's products and services, projected over one year. Companies that offer annual subscriptions use this sales metric to determine expected yearly revenue.

ARR is frequently used by companies that offer a software as a service (SaaS) model. It is also equally useful for streaming services, mobile phone bills and almost any product or service that has consistent, predictable charges.

Use these three steps to calculate ARR:

1. Add up the total revenue from annual subscriptions for your products and services.
2. Add up the total amount of additional ongoing revenue (things like maintenance and support).
3. Subtract the total amount lost through subscription cancellations (otherwise known as customer churn).

Here's the formula:

Annual subscriptions + additional ongoing revenue - cancellations = ARR

For example, an SaaS company has annual subscriptions of $10 million. The company has additional revenue of $1 million for maintenance fees. It loses about 2% of customers every year or $200,000.

Here's how it looks as a formula:

$10,000,000 + $1,000,000 - $200,000 = $10,800,000

If your products or services are sold via a monthly subscription, you can use the same formula. However, first multiply the monthly recurring revenue by 12.

To drill down further and get a clearer picture of how your sales strategy works, break down the ARR formula into these components:

• Revenue added from new customers
• Revenue added from renewals
• Revenue added from upgrades
• Revenue lost from downgrades

Let's say the same SaaS company had additional revenue of $500,000 annually from new customers.

Here's how it looks as a formula:

$10,800,000 + $500,000 = $11,300,000

Note that for an SaaS company, the ARR should include the subscription fees for the service along with additional fees for things like ongoing maintenance and support. ARR refers to ongoing revenue. So, when calculating your ARR, make sure that you exclude any one-time charges or fees.

ARR is calculated annually, while monthly recurring revenue (MRR) is calculated monthly. MRR provides a more granular financial picture, showing changes on a month-to-month basis. For example, if you have a change in pricing strategy in April, you can measure the immediate effect in May. MRR also lets you track revenue fluctuations based on things outside your control, like shopping seasons or economic conditions.

ARR provides a clear picture of a company's expected revenue for the next year, allowing for better financial planning and forecasting. It also helps track a company's growth over time by comparing ARR year over year (YOY). ARR provides a consistent and predictable revenue stream, helping businesses forecast future income accurately. And companies with stable ARR are often valued more highly by investors because of their predictable cash flow. They're more attractive because investors prefer stable revenue streams over fluctuating one-time sales.

Some other benefits of ARR include:

• Customer retention: ARR emphasises the importance of maintaining long-term customer relationships, leading to increased customer loyalty.
• Reduced sales pressure: There's less pressure on the sales team to constantly acquire new customers, so they can focus on upselling and cross-selling to existing customers.
• Sales targets: With a consistent revenue stream, it's easier for sales and marketing leaders to set realistic goals for their reps.
• Scalability: It's easier to scale operations and growth strategies with a reliable revenue base.
• Performance metrics: ARR provides clear metrics on revenue growth and customer retention.
• Customer insights: ARR offers valuable insights into customer behaviour and preferences through subscription and usage patterns.