What Is ARR (Annual Recurring Revenue)? Meaning, Formula and Examples

ARR, or annual recurring revenue, is the yearly value of a company’s recurring subscription revenue. It is usually calculated as monthly recurring revenue (MRR) × 12, so ARR is also read as annual run rate: your current recurring revenue projected over the next 12 months. One-time fees are not included.

ARR = MRR × 12

For example, $40,000 of MRR × 12 = $480,000 ARR. Run your own numbers in the ARR calculator, or see every SaaS formula in one place on SaaS metrics formulas.

Understanding Annual Recurring Revenue

Annual recurring revenue, as the name suggests, is the total forecasted annual revenue of a SaaS company based on the subscription contracts it has garnered. It only measures the income that is guaranteed and excludes all one-time or trial subscriptions.

This means ARR is generally calculated based on year-long or multi-year contracts. Even if the payment is made on a month-to-month basis, if there is a contractual arrangement or auto-renewal agreement, then the revenue forecasted is included in ARR.

That said, the calculations vary from business to business, and some organizations include all clients that they are reasonably sure will be retained. The critical element is that ARR considers the churn of customers and hence can be a good indicator of revenue retention.

How to calculate ARR

For a subscription business, ARR is your MRR multiplied by 12. The work is in getting the MRR base right, because ARR inherits every decision you make about it.

ARR = MRR × 12

Build the MRR base like this:

• Recurring revenue only. Setup fees, implementation and other one-time charges belong in total revenue, not ARR.
• Normalise every plan to a monthly value. An annual prepayment of $12,000 is $1,000 of MRR, which is $12,000 of ARR, spread across the year rather than counted in one month.
• Use what customers actually pay. Deduct discounts and coupons, not list prices.
• Count paying customers. Trials and free accounts add nothing until they convert, and long-delinquent customers should come out.

ARR then changes for the same four reasons MRR does:

Ending ARR = Starting ARR + New ARR + Expansion ARR − Contraction ARR − Churned ARR

ARR calculation example

Take three customers who each pay $10 a month. One upgrades to a pro plan for an extra $2 a month, and a different customer cancels.

ARR is a snapshot of the current run rate, so it reflects each change from the day it happens. The upgrade adds $24 of ARR straight away and the cancellation removes $120, whatever month they fall in. It is not a forecast of the revenue you will actually book this year.

To check the math on your own numbers, use the ARR and run-rate calculator. At larger scale the arithmetic is the same: $100,000 of MRR is an ARR of $1.2M.

ARR vs annual run rate vs revenue

ARR, annual run rate and total revenue are often used interchangeably, but they answer different questions. Annual recurring revenue counts only subscriptions. Annual run rate (sometimes called annualized revenue) projects a period’s revenue over a full year. Total revenue is what you actually recognise in your accounts, including one-time income.

In Baremetrics, ARR is calculated as annual run rate, MRR × 12, so for a pure subscription business the two numbers are the same. They split apart when you annualise total revenue, for example a quarter of revenue × 4. For when run rate misleads (seasonality, one-off spikes, large deals), read annual run rate: definition and calculation and what is annualized run rate?

ARR benchmarks: how long it takes to reach ARR milestones

Baremetrics looked at how fast SaaS companies hit ARR milestones across nearly 1,000 companies in its 2019 data set. The pattern: the first milestones are the slowest, and growth speeds up once recurring revenue starts to compound.

To compare your current metrics with similar companies, Baremetrics Open Benchmarks groups companies by what they charge per customer (ARPU).

How essential is ARR in measuring business success?

For a company that sells its products or services based on subscriptions, ARR is a critical metric that tells the story of its whole business model. Let’s explore why it is essential in measuring business success.

1. Provides a Clear Look at Revenue Trends

ARR takes into consideration all the existing customers of the company that the organization is confident they will retain. This means it provides a reasonably accurate assessment of the current state of the business. Only an unforeseen circumstance with disastrous effects on the company’s infrastructure or service-providing abilities would trigger a change in the state deduced via ARR.

2. Improves Profit Forecasting

ARR helps organizations forecast their profit for the entire year ahead. ARR shows what the business would bring in over the next 12 months if nothing changed, so it gives the organization a baseline for its revenue forecasts; churn, downgrades and new sales will move the real number.

3. Validates the Business Model

The whole point of a subscription business model is hoping that people will continue to pay for its services for the foreseeable future. ARR helps in asserting this and gives an indication to the management of whether the subscription business model is a viable alternative in that specific domain.

4. Provides Product Performance Insights

ARR considers only subscription revenue. In that sense, it is different from total revenue, which may include other sources of income such as one-time payments or add-on products, so it helps management focus only on specific products and the customers that use that product. It is also possible to calculate the ARR of individual products if the company has multiple products in its portfolio.

5. Facilitates Strategic Decision-Making

As mentioned above, ARR gives you a baseline for recurring revenue over the coming year. Hence, it plays an important role in deciding how much money can be spent on product features, sales promotions, employee appraisals, and more,etc. You can leverage metrics like ARR and growth rate to make smart investments in your business, ensuring that you maintain a reasonable burn rate and avoid cash flow concerns

When to Track ARR

ARR should only be used by organizations that earn most of their revenue from subscriptions. Such organizations generally run based on customer relationships, and the churn of customers is a big factor in the business’s success. Using ARR for measuring business success only makes sense in organizations that meet the following conditions.

1. Your organization gets the majority of its revenue from subscription-based products. If only a small percentage of your revenue comes from SaaS products, using ARR will distort your company’s real status.
2. Your organization provides a year-long contract or autorenewal-based subscription setting. If your company runs primarily based on short-term contracts, using ARR may be tricky because you cannot predict with reasonable accuracy whether your customers will renew until the end of the year. ARR cannot be used in such cases as an indicator to decide budget allocations. In such cases, Monthly Recurring Revenue (MRR) may be a better indicator.
3. Your contract with customers states that they cannot cancel without giving a sufficient notice period. If customers can cancel at will, even though the contract is at least one year long, using ARR might cause confusion. Some organizations, especially ones with large contract values, allow customers to cancel midway and only mention price protection in their year-long contract arrangements.
4. You want a metric that can provide the potential value of your business to investors even before the financial year ends or outside the Generally Accepted Accounting Principles (GAAP). 
5. Your business model does not include too many one-time payments, add-ons, or auxiliary services that can contaminate the ARR metric. These one-time payments and upgrades are generally not included in ARR, but they will be included in total revenue. If your business relies on these one-time payments more than subscription revenues, you are better off using absolute revenue rather than recurring revenue metrics.
6. Your decision-making horizon is less than a year and you want to make budgeting decisions based on expected revenue. If your budget allocation happens once a year, you are better off using metrics based on GAAP.
7. You are focused on retaining customers as well as gaining customers. ARR is an excellent measure to track the loyalty of your customers.

Baremetrics provides an easy-to-read dashboard that gives you all the key metrics for your business, including:

• MRR
• ARR
• Time to Value
• LTV
• total customers

Just check out this demo account here.

How to Leverage ARR to Improve Business Outcomes

Since ARR provides an accurate picture of the health of a company, it can be used in many ways to improve business outcomes.

1. Attracting Investors

Since ARR gives a real-time metric about the health of your business, it is very valuable when you are trying to get investors to grow your organization. If your business is predominantly subscription-based, investors only need to look at this single metric to get an idea about your current status. A cursory look into how your ARR has varied over a period of time will give investors all the information they need to assess your potential.

2. Planning Product & Business Growth

ARR shows what recurring revenue will look like in a year’s time if nothing changes. Hence, it gives senior management visibility into how much money is available for product development and allows them to plan the feature rollouts to prioritize the most loyal or tentative customers depending on the circumstances. Similarly, you can also allocate forecasted revenue into business growth investments, including scaling up marketing or sales efforts.

3. Setting Realistic Goals

ARR helps set goals that are achievable but not too easy at the same time. An organization with a low ARR has infinite potential to grow, and the senior management can pursue aggressive growth targets. On the other hand, an organization that already has a high ARR like Netflix or Amazon Prime can only grow them at a lower rate. Managers can prioritize steady growth vs. risky aggressive growth based on the current value of ARR and how it has varied.

4. Motivating the Sales Teams

Variation of ARR over a period of time gives you an idea about how well your sales team is performing. You can even analyze ARR in a granular way to find out which sales group brings in the most revenue or has the highest ARR. A positive change in ARR can be incentivized as a good motivational metric for the sales team.

5. Retaining Employees

Recurring revenue calculations help to determine the budget that you have access to even before the annual or quarterly reports are out. Offering raises at critical times is a key element of retaining employees. Having access to real-time ARR helps you make quick budgeting decisions to retain your star employees.

Other supporting metrics

As evident from above, it is very difficult to accommodate cancellations that happen in the middle of the year in ARR. So, ARR is best used when you have reasonable confidence in the contracts signed by your customers. An alternative that can be considered here is MRR, which is better when most of your contracts are short term.

Other than ARR and MRR, there are many relevant metrics that can help in measuring the success of a SaaS business. Customer Lifetime Value (LTV) is a key metric that can help in knowing your customers better and deciding which ones are worth your attention. It is calculated by multiplying the annual revenue by the average customer lifetime. Another metric is the Customer Acquisition Cost (CAC), which indicates how much the company needs to spend on average to onboard one customer.

Related metrics: MRR · annual run rate · annualized run rate · net revenue retention (NRR) · annual contract value (ACV) · churn rate · all SaaS metrics formulas

Conclusion

The key to succeeding in business is measuring the current state and setting realistic goals. Metrics like ARR are an important part of that puzzle.

The smart analytics tools provided by Baremetrics help you uncover these metrics and their meaning from the information you already have. Intuitive dashboards help management to better understand their products, sales teams, and customers.

Tired of wasting time on spreadsheets? Get a free trial of Baremetrics today!

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Frequently asked questions

What does ARR stand for?

ARR stands for annual recurring revenue: the yearly value of a company’s recurring subscription revenue. Because it is usually calculated as MRR × 12, ARR is also read as annual run rate. Baremetrics labels the metric Annual Run Rate and calculates it as MRR × 12.

How do you calculate ARR?

Multiply your monthly recurring revenue by 12: ARR = MRR × 12. A company at $40,000 MRR has an ARR of $480,000. Normalise annual and quarterly plans to a monthly value first, deduct discounts, and leave out one-time fees, trials and free plans.

Is ARR the same as revenue?

No. ARR only counts recurring subscription revenue. Setup fees, implementation and other one-time charges belong in total revenue, not ARR, so a company’s total revenue for the year can be higher or lower than its ARR.

What is the difference between ARR and MRR?

MRR is your recurring revenue for one month, normalised across all plans. ARR is the same figure annualised: MRR × 12. MRR is the better week-to-week operating signal, while ARR is the number people use to describe the size of a subscription business.

Does an annual plan paid upfront count in full toward ARR?

It counts at its annual value, not as a one-month spike. Baremetrics normalises non-monthly plans to monthly, so a customer paying $120 a year adds $10 to MRR for 12 months, which is $120 of ARR.

How long does it take a SaaS company to reach $1M ARR?

In Baremetrics’ 2019 data set of nearly 1,000 SaaS companies, it took the average company nearly two years to reach $1M in annual recurring revenue, and only for the companies that survived that long. A year in, most companies were at about $40,000 ARR.