Annual Recurring Revenue (ARR) is the amount of money a company can expect to bring in from subscriptions on an annual basis. But what does that mean IRL?
Subscription businesses rely on their sales and marketing teams to bring money into the company in two ways: by selling new subscriptions and by selling upgrades to existing subscribers.
Annual recurring revenue is one metric to determine the success of these teams. ARR and its partner metric, Monthly Recurring Revenue (MRR), allow businesses to forecast cash flow in the short term and plan for expansion.
This article will cover what you need to know about ARR, how it measures the overall health of your business, and how smart tools such as Baremetrics provide key insights about ARR, LTR, churn, and more!
How Do Subscription Businesses Drive Growth?
Most subscription businesses acquire new customers regularly to increase subscription revenue. They also need to cater to the needs of existing subscribers to reduce churn.
To get more revenue from existing clients, companies may offer add-ons to their yearly subscription. This upsell increases the total amount the customer pays, bringing more money into the business.
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How to Calculate Annual Recurring Revenue
As mentioned earlier, Annual recurring revenue is the amount of money a company expects to bring in from subscriptions on an annualized basis.
This figure calculates the amount of subscription revenue, plus add-ons, minus downgrades, and minus churn or cancellations. ARR also takes into account your tiered pricing or other revenue generators.
ARR considers one-year, multi-year, and month-to-month contracts or short-term subscriptions.
For example, the ARR of a month-to-month $10 subscription would be $120, even though the client is not obligated to stay longer than a month.
Similarly, the total revenue for a $10 per month subscription on a two-year contract would be $240, but the ARR would still be $120. A yearly subscription at $10 per month would also have an ARR of $120.
What is Monthly Recurring Revenue (MRR)?
Monthly recurring revenue, or MRR, works the same way as ARR, but the figure is calculated on a monthly basis instead of per year.
The value of MRR is the ARR divided by 12. MRR helps us understand trends related to customer acquisition and subscription upgrades and downgrades.
ARR allows for longer-term projections and forecasting over one-year and multi-year terms while considering overall revenue and average churn rate.
Why is Recurring Revenue an Important Metric?
If you operate on a subscription model, ARR and MRR are essential indicators of the health of your business. But they don't show the full story.
There are several important stories hidden in data, such as why customers are choosing to let their subscriptions lapse or cancel, or why they request a downgrade. Sometimes you lose subscribers because of involuntary churn — that's customer loss because of failed payments, which a dunning process can help you recover.
Customer retention is essential to any business, as customer acquisition cost means your business makes more profit by keeping existing subscribers happy than bringing in new ones. In that sense, it's not just about the number of subscribers, as those customers may be in it for the short term. Increasing the lifetime value of a customer contract should be the goal.
How Do SaaS Businesses Use ARR and MRR?
Software-as-a-service (SaaS) businesses use ARR and MRR as their main revenue metric.
These metrics are how these organizations assess the state of the business to plan new product offerings and customer acquisition strategies. It is also an important metric to demonstrate business health when pitching to investors or reporting back to stakeholders.
Baremetrics Provides Smarter Insight Into Churn and Revenue Metrics
To sustain a subscription business, it is key to know what's working and what isn't. While expansion revenue is nice to see, it's hard to repeat if you don't know why customers choose to upgrade their subscription packages.
The bottom line: you need to know exactly what's driving growth or causing churn rate to skyrocket in certain time periods.
That's why SaaS and subscription companies love Baremetrics.
Baremetrics provides you with smart, actionable data on the information you already have. Its smart dashboard lets SaaS companies better understand their recurring revenue and churn rates so they can take steps to increase the former and decrease the latter.
Interested in reducing churn, driving growth, making decisions with data-backed confidence? Sign up for a free trial today.