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Annual Recurring Revenue (ARR)

Guide to Understanding Annual Recurring Revenue (ARR) in SaaS

Last Updated May 3, 2024

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Annual Recurring Revenue (ARR)

How to Calculate Annual Recurring Revenue (ARR)

ARR stands for “Annual Recurring Revenue” and represents a company’s subscription-based revenue expressed on an annualized basis.

While not a GAAP metric, the annual recurring revenue (ARR) metric measures a SaaS company’s historical (and future) operating performance more accurately than the revenue recognized under accrual accounting standards.

The annual recurring revenue (ARR) reflects only the recurring revenue component of a company’s total revenue, which is indicative of the long-term viability of a SaaS company’s business model.

In practice, the ARR is the primary KPI used to measure the health of SaaS and other subscription-based companies with business models oriented around recurring revenue and multi-year contracts, particularly for forecasting year-over-year (YoY) growth.

Since ARR represents the revenue expected to repeat into the future, the metric is most useful for tracking trends and predicting growth, as well as for identifying the strengths (or weaknesses) of the company.

Annual Recurring Revenue Formula (ARR)

The annual recurring revenue (ARR) metric is a company’s total recurring revenue expressed on an annualized basis.

Conceptually, the ARR metric can be thought of as the annualized MRR of subscription-based businesses.

The formula to calculate the annual recurring revenue (ARR) is equal to the monthly recurring revenue (MRR) multiplied by twelve months.

Annual Recurring Revenue (ARR) = Monthly Recurring Revenue (MRR) × 12 Months

The ARR metric factors in the revenue from subscriptions and expansion revenue (e.g. upgrades), as well as the deductions related to canceled subscriptions and account downgrades.

In order to properly calculate the metric, one-time fees such as set-up fees, professional service (or consulting) fees, and installation costs must be excluded, since they are one-time/non-recurring.

For example, let’s say a customer negotiated and agreed to a four-year contract for a subscription service for a total of $50,000 over the contract term.

To calculate the ARR of the SaaS provider on this particular customer, we would divide the contract value ($50,000) by the number of years (4), which comes out to an ARR of $12,500 per year.

  • Annual Recurring Revenue (ARR) = $50,000 ÷ 4 Years = $12,500

What are the Full-Form Components of ARR?

There are a total of six components to annual recurring revenue (ARR), which must be analyzed to truly understand the underlying growth drivers and customer engagement rates.

  1. New ARR ➝ New ARR is the revenue earned from new subscriptions
  2. Expansion ARR ➝ Expansion ARR is the revenue earned from subscription upgrades (upselling, cross-selling, product bundling).
  3. Renewal ARR ➝ Renewal ARR is the revenue earned from existing subscription renewals.
  4. Churned ARR ➝ Churned ARR is the revenue lost from canceled subscriptions.
  5. Contraction ARR ➝ Contraction ARR is the revenue lost from downgraded subscriptions
  6. Reactivation ARR ➝ Reactivation ARR is the revenue earned from customers that had cancelled their subscription in the past, but decided to re-subscribe.

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ARR vs. MRR: What is the Difference?

The monthly recurring revenue (MRR) and annual recurring revenue (ARR) are two of the most common metrics to measure recurring revenue in the SaaS industry.

The differences between ARR vs. MRR, including the relationship between the two, is as follows.

  • Monthly Recurring Revenue (MRR) ➝ MRR is a company’s normalized revenue, expressed on a per-month basis. Like the annual recurring revenue (ARR) metric, MRR only captures the revenue from active accounts on subscription-based payment plans. When evaluating companies with short-term contracts that last less than one year, MRR is the appropriate metric to focus on.
  • Annual Recurring Revenue (ARR) ➝ Both KPIs, MRR and ARR, are intended to measure the predictable and recurring revenue of a SaaS company, but ARR is more “forward-looking” as it is commonly used to estimate revenue for future years. Moreover, ARR is derived from the most recent MRR, which also represents the main drawback to ARR because this assumes that the most recent month is the most accurate indicator of future performance.

Annual Recurring Revenue (ARR) Calculator

We’ll now move to a modeling exercise, which you can access by filling out the form below.


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1. SaaS Annual Recurring Revenue Operating Drivers

Suppose we’re projecting the annual recurring revenue (ARR) of a SaaS company that ended December 2021 with $4 million in ARR.

The ending ARR will be equal to the beginning ARR plus the net new ARR, which is composed of three factors:

  • New ARR ➝ The new ARR added from new customers acquired in the month
  • Churned ARR ➝ The lost ARR from customers that churned in the month (e.g. cancellations, non-renewal, downgrade)
  • Expansion ARR ➝ The additional ARR from the existing customer base (e.g. upselling, cross-selling)

For January 2022, we will assume that $200,000 worth of new ARR was brought in, followed by $250,000 in February.

  • New ARR, January = $200,000
  • New ARR, February = $250,000

In both months, the churn rate and expansion ARR will be estimated as 6% and 2% respectively.

  • Churned ARR (% Churn) = 6%
  • Expansion ARR (% Upsell) = 2%

The new ARR will be hard coded for January and February, and then the beginning ARR will be multiplied by the respective churn rate and upsell assumptions.

January 2022:

  • Churned ARR = –$240,000
  • Expansion ARR = +$80,000

February 2022:

  • Churned ARR = –$242,000
  • Expansion ARR = +$81,000

2. ARR Calculation Example

Since we now have all the necessary inputs for our annual recurring revenue (ARR) roll-forward schedule, we can calculate the new net ARR for both months.

  • Net New ARR, January = $200,000 – $240,000 + $80,000 = $40,000
  • Net New ARR, February = $250,000 – $242,000 + $81,000 = $88,000

The ending ARR for January comes out to $4,040,000, which becomes the beginning ARR for February.

If we add $88,000 to the beginning ARR, we calculate the ending ARR in February of $4,128,000.

  • Ending ARR, January = $4,000,000 + $40,000 = $4,040,000
  • Ending ARR, February = $4,040,000 + $88,000 = $4,128,000

ARR Calculator

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