Annual run rate (ARR) is a metric that projects your upcoming revenue based on your current earnings, assuming that you keep generating the same amount of revenue in the following months.
This makes ARR one of the most useful metrics for startups that don’t have much revenue data to work with just yet. Through ARR, you can estimate how much money you’ll make in a year based on the limited data that you possess, such as revenue generated over a month.
That said, ARR can only give you a rough estimate of your future revenue. As a result, over-relying on your ARR can actually harm your business.
In short, it’s easy to misinterpret and misuse your ARR, which is why it’s among the most misunderstood SaaS metrics.
To make the most out of your ARR calculations, you should know exactly what ARR is good for, how to calculate it, and what are the limitations of using your ARR to project upcoming revenue.
So, in this article, we will cover everything you need to know about correctly calculating your ARR, including:
- What Is the Annual Run Rate (ARR)?
- How to Calculate Annual Run Rate?
- Annual Run Rate Examples
- When Is It Important to Calculate the Annual Run Rate?
- Benefits of Calculating Annual Run Rate
- Drawbacks of the Annual Run Rate
- Annual Run Rate FAQ
What Is the Annual Run Rate (ARR)?
Annual run rate (ARR), also called revenue run rate or simply run rate, is a SaaS metric that estimates your company’s expected annual revenue based on your current or previously generated revenue.
In other words, ARR helps you predict how much revenue your business would generate in a year if you maintained your financial performance.
One thing to keep in mind is that annual run rate and annual recurring revenue are two different metrics.
While they share the same abbreviation, ARR, annual recurring revenue is a SaaS finance metric that only applies to subscription-based businesses.
Annual run rate, on the other hand, can be calculated by any company regardless of their revenue model.
How to Calculate Annual Run Rate?
Calculating your annual run rate is easy, especially if you have several months of revenue data.
Bear in mind, though, that your annual run rate is a rough estimation of your yearly revenue.
That said, using multiple month’s worth of revenue data in your annual run rate calculations instead of your monthly revenue might give you a slightly more realistic figure.
In other words, the more revenue data you possess, the more accurate your revenue estimations are going to be.
So, let’s take a look at the annual run rate formula.
Annual Run Rate Formula
Here’s a simple formula you can use to calculate your annual run rate:
Essentially, to calculate your annual run rate, simply take the revenue you’ve generated over a specific period (e.g. a month or a quarter) and multiply it by the number of such periods in a year.
Annual Run Rate Examples
Now, let’s take a look at a few annual run rate calculation examples to see how you can apply the formula above to calculate your annual run rate.
Let’s start with the very basics and calculate the ARR using monthly revenue.
Let’s say you’ve generated $4,000 in monthly revenue. In this case, your ARR would be $4,000 x 12 = $48,000.
Now, let’s calculate ARR using quarterly revenue data.
For this example, let’s assume you’ve made $4,000 in the first month of the quarter, $6,000 in the second month, and $3,000 in the third month.
Here’s how you’d calculate your ARR in this case:
($4,000 + $6,000 + $3,000) x 4 = $52,000.
As you can see, calculating your ARR isn’t difficult.
If you want to calculate your ARR using revenue generated over a different period, simply add every month’s revenue together and multiply your total revenue by the number of periods in a year.
For example, if you want to calculate your revenue using 6 month’s worth of revenue data, multiply the total revenue generated over 6 months by 2.
When Is It Important to Calculate the Annual Run Rate?
Let’s be honest – more often than not, your annual run rate doesn’t reflect the actual amount of revenue you’ll generate over the year.
Still, it can be useful to calculate your ARR in several situations, including:
- Estimating startup performance. You can calculate your ARR based on just weeks or months of data. For this reason, ARR is particularly useful for new companies that don’t have much data to work with. Although ARR isn’t as accurate as some other metrics, such as average revenue per user (ARPU), it could give you a general idea of your financial performance.
- Setting sales goals. ARR can help you set realistic sales goals. Based on your performance in the previous months, you can estimate how much revenue you could potentially generate in a year. This can aid your sales team in planning a sales strategy that will help them meet their annual goals.
- Evaluating business changes. If you’re restructuring your company, launching new products, or making other business changes, calculating your ARR can help you evaluate whether you’ve made the right business decision. If your ARR has declined after implementing a business change, you might want to reconsider it.
Benefits of Calculating Annual Run Rate
Now that you know in which situations you should calculate your annual run rate, let’s see what benefits it can bring to your company.
Essentially, tracking your ARR can help you to:
- Predict future revenue. If your monthly revenue doesn’t fluctuate much, calculating your ARR can help you predict how much revenue your company will generate in a year.
- Manage your budget. Comparing your current ARR to past ARR calculations can assist you in managing your finances. For example, if your current ARR is lower than that of last year, you might want to consider lowering your expenses.
- Identify funding needs. Calculating ARR can help new companies to determine their funding needs. However, seasonal and rapidly growing companies shouldn’t rely on their ARR estimations as they can be highly inaccurate.
- Evaluate your company’s performance. You can use your ARR to estimate your current and future financial health. On top of that, comparing your ARR to your competitors’ ARR can help you gauge your overall performance.
- Manage your inventory. Calculating your ARR can help you determine your inventory needs. This way, you can effectively avoid overstocking or running out of stock.
Drawbacks of the Annual Run Rate
As a SaaS metric, annual run rate has several limitations that you should be aware of. Knowing where ARR falls short will help you avoid miscalculating, misinterpreting, and misusing ARR.
So, here are some ARR drawbacks that you should keep in mind:
- ARR doesn’t factor in churn rate. One of the main drawbacks of ARR is that it doesn’t take into account your churn rate, which can significantly affect the amount of revenue your business generates.
- ARR is not suitable for seasonal businesses. If you run a seasonal business, calculating your ARR can be a waste of your time. As a seasonal business, no matter if you base your ARR calculation on your off-season or peak season’s revenue, you will still get an unrealistic ARR figure.
- One-time sales can skew your ARR. To make your ARR projections as accurate as possible, it’s best to exclude large one-time sales from your calculations. Otherwise, you might get an unrealistically large figure.
- ARR doesn’t consider revenue growth. In short, ARR assumes that your revenue won’t change throughout the year. However, it’s highly unlikely that your revenue will still stay the same, especially if you’re a startup or a growth-stage company. For this reason, it’s important not to rely too much on your ARR projections.
Annual Run Rate FAQ
#1. Should I Calculate Annual Run Rate or Monthly Run Rate?
Typically, run rate refers to the annual run rate. As such, most companies only calculate their annual run rate.
That said, you can also calculate your run rate for virtually any time period to estimate your future financial performance.
If your company is brand new, for example, calculating your annual run rate based on your weekly revenue can result in highly inaccurate figures.
In this case, you might benefit more from calculating your monthly run rate.
To calculate your monthly run rate, simply multiply the revenue you’ve generated in a week by 4 weeks.
#2. What Is the Difference Between Run Rate and Burn Rate?
Both burn rate and run rate are SaaS metrics that are particularly useful for startups.
However, run rate and burn rate measure completely different things.
Put simply, run rate estimates your expected future revenue based on your current revenue.
Burn rate, on the other hand, measures the total amount of money your business needs to cover its monthly expenses. It can also help you figure out how long your business can operate without generating any revenue.
#3. What Other Revenue-Based Metrics Should I Calculate For my Business?
To get a complete picture of your company’s financial performance, consider calculating the following metrics:
- Monthly recurring revenue measures your monthly revenue generated from subscriptions.
- Annual recurring revenue estimates your yearly recurring revenue generated from subscriptions.
- Total contract value (TCV) calculates how much total revenue your company receives from each contract.
- Burn rate measures your negative cash flow.
- Annual contract value (ACV) refers to the average recurring revenue you generate annually from a single subscription contract.
- Average revenue per user (ARPU) calculates how much revenue on average you generate from one customer.
- Customer acquisition cost (CAC) measures your total expenses on acquiring a new customer.
- Churn rate gauges the rate at which you’re losing customers.