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Glossary Terms
Compass - The Only Sales Glossary You Need
Businesses, especially those in the software as a service (SaaS) industry, majorly count on Annual Recurring Revenue (ARR) for growth. ARR mainly refers to the amount of predictable revenue expected to count in annually.
It is analyzed as one of the critical business metrics as it helps investors predict future revenue streams.
Annual recurring revenue (ARR) is a critical financial metric used primarily for businesses to measure attainable revenue and forecasting revenue that may be generated over 12 months.
Annual Recurring Revenue is considered as a primary metric to measure year-over-year growth of SaaS and subscription companies using a recurring revenue model.ARR is also represented as the Monthly Recurring Revenue (MRR).
Let's say there is a software-as-a-service (SaaS) company called "Company X" that provides a cloud-based project management tool. They offer different subscription plans to their customers, ranging from basic to premium features.
Suppose Company X has 1,000 customers who are subscribed to their premium plan, which costs $100 per month. Each customer pays on an annual basis, so they are billed $1,200 upfront for the year.
To calculate the annual recurring revenue (ARR) for CloudSolutions, you multiply the number of customers by the annual subscription price.
In this case, it would be:
ARR = Number of customers * Annual subscription price
ARR = 1,000 customers * $1,200
ARR = $1,200,000
Therefore, Company X has an annual recurring revenue of $1,200,000. This represents the predictable, recurring revenue that the company can expect to receive on an annual basis from its subscription customers.
The difference between annual recurring revenue and revenue is as follows
ARR accounts for subscription-based revenue, whereas total revenue accounts for each amount the business caters to, irrespective of where it comes from.
The second difference between the two is that the former is an essential aspect for SaaS companies, and subscription, on the other hand, total revenue, should be distinct from these aspects.
You should start tracking annual recurring revenue as soon as your business begins offering subscription-based services or renewable contracts. This is especially relevant for SaaS companies, digital platforms, and any model with ongoing billing.
Monitoring ARR monthly, quarterly, and annually can help identify trends and support long-term strategic planning
ARR is important because it gives a clear picture of the company’s recurring revenue stream, allowing for better financial planning and forecasting. It helps:
In short, ARR highlights whether your business is growing sustainably.
To calculate annual recurring revenue, monthly recurring revenue is required. To calculate it step wise as follows:
Step 1: Determine MRR
Adding the revenue generated by active subscription within 30 days(a month)
Which, however, includes the revenue on a monthly basis.
Step 2: Determining average monthly recurring revenue
If MRR is seen fluctuating during a whole year, calculation of average MRR is required by summing up the MRR every month and diving the calculated number of month
Step 3: Multiplying the average monthly recurring revenue by 12:
After the average MRR, multiply it by 12 to retrieve ARR.
To show it mathematically:
Annual recurring revenue = (Total amount of monthly subscriptions per month + Total amount gained from new customers per month + total amount earned for upgrades and add-ons per month - total amount lost from downgrades in a month - Total amount lost from churn) X 12.
Businesses need to get critical metrics as it mainly helps investors predict future revenue streams. Practical strategies to implement to increase ARR are discussed below:
Businesses that rely on ongoing subscriptions or contractual revenue benefit most from tracking ARR. This includes:
For these companies, ARR is a leading indicator of long-term value and growth potential.
