Tracking your metrics is key to growing any business.
They can help you measure the success of your business, highlight areas for business growth, help you make strategic decisions, and so much more.
If there’s one metric that’s really important to SaaS companies, though, it’s the Annual Recurring Revenue (ARR) metric.
So, in this guide, we will cover everything you need to know about ARR to boost your SaaS company’s growth, including:
- What is Annual Recurring Revenue (ARR)?
- How to Calculate ARR?
- What’s the Difference Between ARR and MRR?
- 3 Examples of ARR for Real Companies
- If Customers Buy More or Downgrade and Cancel, How Does That Affect ARR and Run Rate?
- Annual Recurring Revenue (ARR) FAQ
What is Annual Recurring Revenue (ARR)?
Annual Recurring Revenue (ARR) refers to the revenue that a business expects to receive from its subscriber base each year.
This metric allows you to have an overview of your SaaS business’s performance year over year and accurately forecast growth. As such, ARR is a fundamental metric for SaaS or subscription businesses.
How to Calculate ARR?
Theoretically, all you have to do to calculate your company’s ARR is to multiply your last month’s recurring revenue by 12 months.
Let’s say, for example, you did $83,333 in recurring revenue last month – multiplied by 12, that brings your ARR to just under $1 million.
In reality, though, this calculation isn’t entirely accurate.
That’s because if you run a subscription business, chances are your company has product downgrades, upgrades, and customer churn, all of which affect your ARR.
So, the exact way you should calculate your ARR will depend on your company’s pricing strategy – and we have formulas to help you figure that out.
Annual Recurring Revenue (ARR) Formula
Without further ado, here’s what the basic ARR formula looks like for businesses using a monthly billing pricing strategy:
It’s really that simple – just subtract Monthly Recurring Revenue Churn (MRR Churn) from your Monthly Recurring Revenue (MRR) and multiply it by 12 months.
If you run a subscription business that has plan upgrades or add-ons, though, you should also include the total amount of revenue gained from upgrades or lost from downgrades per month.
In this case, this is what your formula will look like:
Annual Recurring Revenue (ARR) = (Monthly Recurring Revenue (MRR) – Monthly Recurring Revenue Churn (MRR Churn) + monthly revenue gained from upgrades/add-ons – monthly revenue lost from downgrades) x 12
But what if your pricing strategy is built on annual billing?
Well, in this case, your formula will look a bit different, like so:
Annual Recurring Revenue (ARR) = total revenue from yearly subscriptions + total recurring revenue gained from upgrades/add-ons – total revenue lost to churn
In this formula, you should only calculate revenue gained from upgrades and add-ons if it affects the annual subscription price – so, to calculate your ARR correctly, disregard any one-time payments.
What’s the Difference Between ARR and MRR?
Both MRR and ARR are important metrics that help you to track your recurring revenue and determine the health of your SaaS company.
However, there is one key difference between Monthly Recurring Revenue (MRR) and Annual Recurring Revenue and that is the time period at which they’re calculated.
MRR calculates the recurring revenue generated on a monthly basis, while ARR calculates the recurring revenue generated on a yearly basis.
The Importance of Calculating Both ARR & MRR
Both MRR and ARR are metrics that can help you determine your business’ health and estimate revenue growth.
By tracking how your revenue grows each year, ARR has a macro approach that can help you plan long-term product and pricing strategy changes.
MRR, on the other hand, has a micro approach – it tracks your revenue growth month by month, so it can help you immediately monitor the effects of your product or pricing strategy changes.
While these metrics are valuable separately, tracked together they can help you make and plan effective decisions to grow your business.
Why ARR is an Important SaaS Metric
ARR doesn’t just show how well your SaaS company is currently doing – it also allows you to measure your business progress year-over-year, which makes it one of the most important SaaS metrics.
In particular, calculating your ARR helps your business to:
#1. Determine Your Business’ Health
Tracking your company’s ARR is the best way to measure the success of your subscription business.
That’s because subscriptions are the core of your business, so calculating exactly how much revenue they bring in per year helps you see if your business is operating successfully.
Your ARR can also show you whether your business is growing each year and, if not, it can help you plan the necessary changes to improve your business.
#2. Estimate Future Revenue Growth
ARR can also help you forecast how much revenue your business will generate in the future.
If you’re planning any product and pricing changes, ARR can help you to calculate and estimate the expected annual revenue after implementing the changes.
As such, ARR can work as a foundation for more complicated calculations that can help you to set realistic goals and make strategic decisions instead of taking blind risks.
#3. Attract Investors
Measuring your ARR can show your current company health, reveal opportunity areas, and determine the actions needed to grow your business – overall, it helps you to be systematic about selling your services.
Because of this, ARR can help you to attract more investors to your company – after all, ARR allows you to forecast the future success of your business, which can be attractive to investors as they know exactly what they’re investing in.
3 Examples of ARR for Real Companies
Before we look into some ARR examples for real companies, let’s see an example of how you could calculate a subscription company’s ARR.
For this example, let’s take Spotify – the most popular music streaming service to date that had global revenue of €2.18 billion in the third quarter of 2021 alone.
So, here are the Premium plans that Spotify currently offers to its customers:
For this example, let’s say our customer has an Individual plan that he’s paying $9.99/monthly for the whole year without canceling his subscription.
Here’s how you’d calculate Spotify’s ARR for this customer:
- Monthly Recurring Revenue (MRR) – $9.99
- Monthly Recurring Revenue Churn (MRR Churn) – $0
- ARR = ($9.99 – $0) x 12 = $119.88
Now, let’s say our example customer decides to switch to a Duo plan that costs $12.99 a month after 6 months and continues to use it for the rest of the year.
So, in this case, you’d calculate the ARR for this customer like this:
- Monthly Recurring Revenue (MRR) – $9.99
- Total revenue gained from Duo upgrade per month for the remaining 6 months – $12.99 – $9.99 = $3 x 6 = $18
- Monthly Recurring Revenue Churn (MRR Churn) – $0
- Monthly revenue lost from downgrades – $0
- ARR = $9.99 x 12 + $18 – $0 – $0 = $137,88
You can see how both the pricing strategy Spotify uses and customers’ choices affect the calculations.
To calculate Spotify’s entire ARR, though, we would need to calculate all the subscriptions plans, upgrades, downgrades, and churn over the year.
And now, let’s take a look at some examples of SaaS companies and their ARR:
- Sendbird does about $22m in ARR with 420 customers who generate an 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.
- Rosterfy does $100k in monthly recurring revenue which adds up to $1.2m in ARR. They have about 100 customers that pay an average revenue of $1,000 per month.
Want to see more ARR examples of real companies? Check out our SaaS database to see the ARR of 30,000 other SaaS companies!
If Customers Buy More or Downgrade and Cancel, How Does That Affect ARR and Run Rate?
Let’s 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 the lost revenue from customers who canceled their accounts completely. Let’s say a customer paid $1,000/month and canceled. Your MRR lost to churn would be $1k for this one canceled account. $1k canceled 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. Instead, they downgrade from $1k/month to $250/month. MRR lost to downgrades would be $750 ($1000-$750=$250/month left). The best way to prevent downgrades each month is to try and sell annual contracts or long-term contracts. This will improve the health of your business.
Selling for a calendar year and then delivering great products 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 new things to old customers. For example, if a customer was paying $1500/month and you sold them an add-on for $500/month, they now pay $2000/month. 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/month each, that’s $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.
Annual Recurring Revenue (ARR) FAQ
#1. What’s the Difference Between ARR and Revenue?
The main difference between Annual Recurring Revenue (ARR) and revenue is that ARR only measures your subscription-based revenue year-over-year, while total revenue measures all of your company’s cash inflows.
#2. What’s the Difference Between ARR and ACV?
Annual Contract Value (ACV) measures the annualized revenue a company generates per customer on average in a year (or multiple years).
Annual Recurring Revenue (ARR), on the other hand, measures the recurring revenue your company generates from all of your subscription accounts year-per-year.
So, the key difference between ARR and ACV is the number of accounts they measure – ACV measures a single account, while ARR measures all of your subscription accounts.
#3. What’s the Legal Definition of ARR?
According to Law Insider, the legal definition of ARR is: “Annual Recurring Revenue means, as to any month, (a) contractually recurring revenue to be recognized in the next twelve (12) months, inclusive of At-Risk Recurring Revenue, but exclusive of (b) any revenue that is non-recurring, (including, without limitation, one-time installation fees, perpetual license fees, and non-recurring professional services fees).”
#4. Why is Tracking Annual Recurring Revenue Important?
Tracking Annual Recurring Revenue is important because it gives valuable information about your SaaS company’s health.
Even more, it can also help you estimate future revenue, set realistic goals, and improve your decision-making, all of which help to grow your business.
Key Takeaways
By now, you should have a better understanding of ARR and how to calculate it for your SaaS company.
Let’s just go over some of the key points mentioned in this article:
- Annual Recurring Revenue (ARR) calculates the revenue your business expects to generate from subscription services year-over-year.
- Calculating your company’s ARR is fundamental to the growth of SaaS companies since it can help you determine your business’ health, estimate future revenue growth, and attract investors.
- The basic ARR formula involves subtracting your monthly recurring revenue churn from your monthly recurring revenue and multiplying this number by 12.
- Measuring both ARR and MRR is useful for your SaaS company as both of these metrics can facilitate your business growth by helping you make strategic business decisions and estimating their financial outcomes.