Annual Recurring Revenue (ARR) is a way for measuring subscription revenue for Software-as-a-Service (SaaS) businesses using yearly or multi-year contract agreements.
ARR as a key metric is not used as frequently as Monthly Recurring Revenue (MRR) because SaaS businesses commonly offer monthly payment terms and therefore MRR provides a better view of how the business is changing month to month.
The article below will answer the following questions for you:
ARR is a way for you to measure the revenue of your subscription business.
It also provides a way to objectively compare different SaaS businesses. However, it can get confusing when measuring ARR because you may offer the ability to pay for a monthly subscription or an annual subscription to access your software.
SaaS businesses will often provide discounts of 10-30% for signing up annually. This benefits the company with cash up front, while reducing churn because the customer is committed for a longer period of time versus with a monthly contract.
There are a few ways to calculate your annual recurring revenue. The important part is defining how you do it at your company and commit to that approach.
The easiest way to calculate ARR is to take your monthly recurring revenue and multiply it by 12 to get ARR.
ARR = Monthly Recurring Revenue (MRR) x 12 months
This approach is a bit misleading though when you have contract durations under 12 months. Imagine if you have MRR of $100K. When multiplied by 12 this would imply you have $1.2 million of annual recurring revenue.
That would be representative of your business if they were all annual contracts.
But, let’s say they aren’t. In fact, let’s say they are all monthly contracts and you churn out 5% of those customers on a monthly basis. That means by the end of 12 months, you will have lost 46% of your original customers.
Can you see how that $1.2 million ARR is misleading?
If they were all annual contracts, then it 100% works.
The answer depends. What are you comparing your ARR to? It’s best to compare your ARR to SaaS companies in the same industry vertical at the same stage of growth. For example, if you are a venture backed company, you can expect your investors to look for these ARR levels at each stage of growth:
In order to grow your ARR, you need to continue adding new customers and increasing the amount that they pay you each year.
The best way to do that is by staying close to your customer and understanding their needs. If you’re able to design a customer feedback loop back to your product and engineering teams, you can continuously innovate and build product your customers love.
This is easier said than done. But when done well, SaaS businesses can achieve exponential growth in ARR. Try inputting your current metrics in our Sales Forecast Template.
It will calculate your ARR for you and help you visualize what it takes to hit your growth targets.