What is Annual Recurring Revenue (ARR)?

Annual Recurring Revenue is an essential SaaS business metric that refers to revenue, normalized on an annual basis, that a company expects to receive from its customers for providing them with the product and services. The measure is primarily used by businesses operating on a subscription-based model.

How to calculate ARR?

To put it in the simplest form, here are some examples:

• A customer subscribes to a service for $10 a month on a one-year contract. To find the correct number, multiply the monthly cost by 12. ARR equals $120.
• Another customer subscribes for $20 a month on a two-year contract. This would be $480 for the duration of the contract, or $240 per year.
• Finally, a third customer pays $5 per month, on a month-to-month contract. The ARR would be calculated by how long they remain a customer (up to $60 per year if they remain on the contract for at least 12 months).

However, as the complexity of the subscription model increases, ARR calculations depends upon various factors:

Customer revenue per year: The basis of your ARR calculation. This is the total revenue accrued each year through annual subscriptions.

Add-on purchases: Any purchase that increases the annual subscription price on an ongoing basis.

Product upgrades: Any upgrade that increases the annual subscription price on an ongoing basis.

Product downgrades: Any downgrade that decreases the annual subscription price on an ongoing basis.

Cancellations (Churn): Account cancellations and customers lost due to churn that results in lost revenue.

ARR Formula:

ARR = (Overall Subscription Cost Per Year + Recurring Revenue From Add-ons or Upgrades) - Revenue Lost from Cancellations.

Uses of ARR: Annual recurring revenue (ARR) is considered one of the most important metrics for subscription-based companies. Some crucial applications are:

• Quantifying the company’s growth
• Evaluate the success of the business model
• Revenue forecasting