Annual recurring revenue (ARR) is one of the metrics used to measure your revenue growth. In this article, we will learn what ARR is, how it is calculated, and how you can improve it.
What is ARR?
Before we define what ARR is, let us first know what revenue and recurring revenue are.
Hence, ARR is the expected amount generated by your company in a year (12 months time frame) in exchange for providing goods and services. Unlike monthly recurring revenue (MRR) that offers short-term insights, ARR gives a broader picture of the overall performance of your business.
If you are a growing Subscription as a Service (SaaS) company, you’re more likely to attract more investors if you have an excellent, predictable revenue like ARR. It will also make your board members more satisfied. Thus, ARR is an important metric to analyze your business and help you anticipate growth.
How to Calculate ARR?
There are several ways on how to calculate ARR.
When your monthly recurring revenue (MRR) for all customers is available, the easiest way to calculate the ARR is by multiplying your MRR by 12, i.e.
ARR = MRR x 12.
If MRR is not available, then you first need to calculate the following:
- the total amount of annual subscriptions from all customers;
- the total amount of additional yearly ongoing revenue from all customers; and
- the yearly total loss due to cancellations.
After that, you can now compute the ARR using the formula below:
ARR = amount of annual subscriptions + amount of yearly additional ongoing revenue - yearly total loss due to cancellations.
Since ARR is a forward-looking metric, meaning it refers to ongoing or recurring revenue, we will exclude elements that are not recurring in nature. These elements can be one-time fees, set-up fees, non-recurring add-ons, etc.
It is also essential to note that each term should be calculated annually when using the above formula. Hence, when the unit of time is not in a year, you need to convert it first. Consider the following examples:
- Customer A subscribes to a 1-year plan with a billing of $150 per month.
ARR = $150 x 12 months = $1800
- Customer B subscribes to a 15-month plan for $20,000 and no additional services.
ARR = $20,000/15 x 12 = $16000.
We divide first the total plan by 15 months to get the monthly revenue, then multiply it by 12 months.
- Customer C subscribes to a 1-year plan for $170,000, which includes 5 different subscription components. The customer also commits to $15,000 of training.
ARR = $170,000
The training fee of $15000 is not included since it’s a one-time payment and not recurring in nature.
Increase your ARR!
Are you satisfied with your current ARR? Do you think you can still improve it? I’m sure there is since everything always has room for improvement! Vaporware advises to always check these three levers:
- Acquire more customers by trying new marketing platforms, increasing awareness through different marketing strategies, and improving your business so that clients can see its value quickly.
- Increase average revenue per user (ARPU) by developing new pricing models to increase customer lifetime value and build new products, features, and services.
- Reduce customer churn by increasing reliability to improve customer satisfaction.
You can maximize your ARR by tracking how it goes up and goes down. While it’s easy to calculate and create graphs for your ARR, it’s just one metric. To maximize the overall revenue, you still need to compute the other metrics. Lido can help you with that! It can build dashboards to monitor your data and compute different metrics like ARR. Try Lido by signing up here for free!