What is ARR (Annual Recurring Revenue)?
ARR is the abbreviation for Annual Recurring Revenue, a fundamental metric for SaaS or subscription businesses. Annual Recurring Revenue refers to the revenue that a business expects to receive from its subscriber base on an yearly basis. This metric allows you to have an overview of your SaaS business’s performance year over year and accurrately forecast growth.
How to Calculate ARR?
To calculate ARR, take last months recurring revenue only and multiple by 12 months. We’ll talk about how to define recurring revenue later. For now, lets look at an example.
If you did $83,333 in recurring revenue last month, whats your ARR?
The answer is $1m. We calculated this by taking your monthly recurring revenue (MRR) from last month, $83.3k, and multiplied by 12 months.
This figure assumes that no customers churn, that you have no downgrades, and that you upsell none of those customers to more expensive plans.
If you’re running a subscription business, you’ll probably have all three of those things (churn, downgrades, upsells). We’ll talk more about them later and how they effect cash flows.
The Annual Recurring Revenue Formula
You can calculate ARR by substracting MRR Churn (Monthly Recurring Revenue Churn) from MRR (Monthly Recurring Revenue Churn) and multiplying it by 12 months.
What is the Difference Between MRR and ARR?
The difference between MRR and ARR is that MRR refers to recurring revenue generated on a monthly basis, and ARR refers to recurring revenue generated on a yearly basis. ARR is calculated by multipying MRR by 12 months. Both metrics help you understand your company’s revenues and determine the health of your SaaS.
Is ARR The Same as Cash?
No. If you have a subscription model, you might sell 2+ year plans where you get paid upfront but to calculate ARR you have to divide by the # of years.
For example, if you sell a customer a $10k plan today that covers the next 2 years, how much ARR is that?
ARR: $10k/2 years = $5k
Cash today: $10k
$5k vs. $10k is a big difference.
This is the number one mistake SaaS founders make when doing ARR calculations. Collecting cash up front is great for the SaaS business model but these longer term subscriptions have to edited in real-time to figure out true ARR.
Another mistake saas companies make is they’ll look at the total revenue the collected over the last 12 months, add those monthly figures together, and call that their ARR.
When most analysts talk about ARR, its a forward looking figure. You take last months revenue and multiple by the next 12 months. SaaS founders love to use ARR in board decks and advisor emails because it makes your revenue look bigger.
The SaaS business model is so popular because if you deliver a great product, those customers will stick with you every month. But what if you don’t? Well you get churn.
If Customers Buy More or Downgrade and Cancel, How Does That Affect ARR and Run Rate?
Lets start off this month with $100k in monthly recurring revenue. This is the same as $1.2m in ARR.
To calculate MRR next month, here’s what you do:
Total starting MRR: $100,000
1 MRR lost to churn: -$5,000
2 MRR lost from downgrades: -$1,000
3 New MRR from upsells: $8,000
4 New MRR from new customers: $10,000
Total new MRR: $112,000 or $1.344 in ARR
Some quick definitions:
1) MRR lost to churn measures revenue you lost from customers who cancelled their accounts completely. Lets say a customer paid $1,000/mo and cancelled. Your MRR lost to churn would be $1k for this one cancelled account. $1k cancelled out of $100k total MRR means your churn rate is already 1%. This is a key saas metric.
2) MRR lost to downgrades is the same as MRR lost to churn, but the customer doesn’t cancel completely. They downgrade from $1k/mo to $250/mo. MRR lost to downgrades would be $750 ($1000-750=250/mo left). The best way to prevent downgrades each month is to try and sell annual contracts or longer term contracts. This will improve the health of your business.
Selling for a calendar year and then delivering great product over that year period is great, but generally when new customers pay for a multi year deal, they’re also more incentivized to get on-boarded and start getting value. Use that to your advantage.
3) New MRR from upsells is new revenue you get from selling old customers new products. Do not include new customers in upsells. Upsells only measure how good you are at selling old customers, new things. For example, if a customer was paying $1500/mo and you sold them an add-on for $500/mo, they now pay $2000/mo. The upsell revenue is $500. This is called expansion revenue. It’s another key saas metric.
4) New MRR from new customers is all the revenue you closed this month from landing new customers. If you signed up 10 new customers who all paid $200/mo each, thats $2000 in new MRR from new customers.
All of these are key metrics you want to track in your saas business to make sure you’re always increasing your monthly revenue.
What Are Some Examples of SaaS Companies and their Annual Recurring Revenue?
Lets take a look at some examples of SaaS companies and their ARR.
Sendbird does about $22m in ARR with 420 customers who generate average revenue of about $52,000 per year.
Bombora is bootstrapped and does $30m in ARR, only counting their subscription revenue. The company also sells one off projects as well.
Rosterfy does $100k in monthly recurring revenue which is $1.2m in ARR. They have about 100 customers that pay average revenue of $1,000 per month.
Now that you have a good understanding of ARR, be sure to start calculating it every month. You should track ARR and MRR to make sure you continue to build a healthy SaaS business.