What is Annual Recurring Revenue?

Annual Recurring Revenue

What is Annual Recurring Revenue?

Annual recurring revenue (ARR) is a B2B SaaS metric that quantifies the total value of subscription revenue your business receives from its customers on an annualized basis. 

ARR is a useful metric for quantifying the growth and success of any business with a subscription-based revenue model, as well as forecasting its future financial performance.

 

How is Annual Recurring Revenue Calculated?

Annual recurring revenue for your business may be calculated in a few different ways, depending on the complexity of your pricing model and how your customer contracts are structured.

The most basic formula for calculating your company’s ARR is:

ARR =(Monthly Subscription Cost) (Number of Customers)(12 months)

 

Example 1: Simple ARR Calculation

You operate a B2B SaaS company with 87 subscribers, each paying a subscription fee of $224 per month. You may calculate the ARR of your business as:

ARR = ($224)(87 subscribers)(12 months) =$233,856

With this type of ARR calculation, you’re essentially calculating your monthly recurring revenue (MRR) and forecasting it over a 12-month period while assuming 100% customer retention and zero growth.

You can aim for a more conservative (but potentially more accurate) calculation of your long-term ARR by only including subscribers that are under contract for the foreseeable future:

ARR = (Monthly Sub Cost)(Subs on minimum 1 year contract) 12 months

 

Example 2: Simple ARR Calculation – Only Long-Term Subscribers

You operate a B2B SaaS company with 87 subscribers. Some 32 of your subscribers are on month-to-month contracts with a 30-day notice period for cancellation, while the remaining 55 are locked in to annual agreements. All subscribers pay a subscription fee of $224 per month. You may calculate the ARR of your business as:

ARR = ($224)(55 subscribers)(12 months) = $147,840

This ARR calculation comes with a higher degree of certainty because it only includes subscribers that are locked into long-term contracts, and whose revenue is therefore guaranteed to be collected.

One of the most common ways for B2B companies to keep track of ARR is by calculating MRR on a rolling monthly basis and multiplying by 12 to normalize the results on an annual basis. 

This requires formulas for calculating monthly changes in MRR and converting MRR to ARR:

End of Month MRR= Start of Month MRR + New MRR from Customer Acquisition

+ New MRR from Customer Upgrades – Lost MRR from Customer Downgrades

-Lost MRR from Customer Churn12

ARR = (End of Month MRR)12 months

 

Example 3: Rolling Monthly ARR Calculation

You operate a B2B SaaS company whose MRR at the beginning of the month was $12,320. During the month, your sales team added 12 new subscribers on long-term contracts at $224 per month – a total of $2,688 MRR. You gained $375 in new MRR from customer upgrades, but lost $250 in MRR from customer downgrades. You also had two subscribers cancel, creating an MRR loss of $448 per month. 

Your ARR at the end of the month can be calculated as:

End of Month MRR = ($12,320)+($2,688)+($375)-($250)-($448) =$14,685

ARR = ($14,685)(12) =$176,220

 

Notes on Calculating Annual Recurring Revenue

B2B SaaS marketers are generally in agreement that non-subscription payments (e.g. set-up fees, one-time charges, training and service fees, credit adjustments, non-recurring add-ons, etc.) should be excluded from MRR and ARR calculations.

However, there’s still some disagreement on whether ARR calculations should include all subscription customers or just those on long-term contracts. 

Including all subscribers in your calculation can lead to over-estimating your ARR, while focusing solely on customers with long-term contracts will show you how much of your potential ARR is actually guaranteed. 

The method you choose may even depend on the purpose of your analysis. If you’re hoping to impress investors, you’ll want to show a higher potential upside. If you’re planning your annual budget for the upcoming year, a conservative ARR calculation helps ensure you’ll have the resources to execute on your vision. Either way, it’s important to be clear and transparent about how you’re calculating ARR and which of your subscribers are included in the calculation.

Monthly vs Annual Recurring Revenue – What’s the Difference?

Most B2B SaaS companies measure their recurring revenue on a monthly basis, then project the result over 12 months to calculate annual recurring revenue (ARR). 

The MRR metric provides short-term feedback on how business activities are driving revenue growth or decline within the business, while ARR provides a long-term projection of revenue that indicates the overall health and growth trajectory of the business.

At the end of the day, MRR and ARR are both measuring how much subscriber revenue your business expects to receive.

Why is Annual Recurring Revenue Important?

Quantifying Business Growth and Results

Measuring ARR allows you to quantify the growth of your subscription-based business and see how your revenue compounds over time as you add new customers and work to retain your existing ones.

Revenue Forecasting and Strategic Planning

Measuring ARR gives you the ability to forecast revenue into the future and optimize your resource allocation to propel your SaaS growth strategy.

Business Valuation

The value of your business is equal to the total sum of its future revenues minus its future expenses. ARR is an indicator of how much revenue your business might generate in the future, making it a useful metric for determining the overall value of your business.

 

Maximizing Annual Recurring Revenue with RevOps

Revenue Operations (RevOps) is a B2B business function whose goal is to maximize the revenue potential of an organization by aligning marketing, sales, and customer success across the entire customer lifecycle. 

At Directive, RevOps is just one aspect of the Customer Generation methodology we use to drive customer-led ARR growth for our B2B SaaS clients.

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