ARR | How Annual Recurring Revenue can optimize subscription businesses + simple formula

ARR, or Annual Recurring Revenue, is a metric for the yearly revenue of a contract or a subscription. This makes it an important figure for all businesses selling SaaS (Software as a Service).

The predictive nature of the metric makes it a good indicator of the future health of a business. Because it measures the annual revenue a company expect to generate. It can thus be used to predict growth and overall company progress.

ARR definition - Breaking down the metric

The metric is the predictable yearly value of a subscription. Imagine if a customer pays 100 dollars a month for half a year, but is not yet contractually bound for another six months. Then the Annual Recurring Revenue is 600 dollars, rather than 1.200 dollars.

This also means that one-time setup fees, non-recurring add-ons and the like are not considered recurring revenue.

If the terms for the service are less than a year, it’s smarter to calculate their worth using another model such as Monthly Recurring Revenue (MRR), rather than ARR.

How can ARR grow businesses?

Annual Recurring Revenue gives you an accurate assessment of your SaaS-business’ revenue and health. Because it tracks recurring revenue, it can also give you insight into your business’ progress and potential for growth – and where you are losing momentum. By looking at this metric, you can accurately look into which business opportunities, you ought to emphasize. Whether they’re acquiring new customers, improving retention or upselling new paid features for existing customers.

Because a rising Annual Recurring Revenue signals a healthy company, it is also an important measurement, if you’re looking to attract investors on the lookout for new business opportunities.

How to calculate Annual Recurring Revenue

Calculating Annual Recurring Revenue is quite easy. You simply add together your current customers times the price of their subscription, plus customers in different pricing tiers times their pricing etc. Thus the equation reads:

ARR formula:

ARR = ( # of customers in tier A x monthly subscription price x months of the year ) + ( # of customers in tier B x monthly subscription price x months of the year ) + ...

Lets’ say you have two tiers of service with ten customers paying 10 dollars a month, and twenty customers paying 15 dollars. Then the Annual Recurring Revenue is 4.800 dollars (10x10x12) + (20x15x12). Simplified Annual Recurring Revenue If you have a lot of different tiers and add-ons, You can also calculate Annual Recurring Revenue by dividing your monthly revenue by the number of customers. This gives you the Average Revenue Per User, or ARPU. Simply multiply the ARPU with 12 and you have a simplified ARR.

Simplified ARR formula:

Simplified ARR = ARPU * 12

This, however, does not give you a thorough assessment of your Annual Recurring Revenue.

Expansion Annual Recurring Revenue

Upselling (existing customers upgrading their product) or cross-selling (customers changing tiers) can also change your actual ARR. If you want a more accurate assessment of your Annual Recurring Revenue, it’s therefore important to include this in your equation.

Upsales and cross-sales can be calculated by taking the number of customers multiplied by their new fees, minus the number of customers multiplied by their old fees.

Expansion ARR formula:

Expansion ARR = (# of customers in a new tier x monthly subscription price) – (# of customers, had they remained in their tier x monthly subscription price) x remaining months of the year

Churn Annual Recurring Revenue

This metric measures the opposite of the Expansion ARR. This is lost revenue due to customers cancelling or downgrading their products/services.

Churn ARR formula:

Churn ARR = (# of cancellations x monthly subscription price) + (# of customers in a downgraded tier x monthly subscription price) – (# of customers, had they remained in their tier x monthly subscription price) x remaining months of the year

Complete Annual Recurring Revenue

By combining all of the above metrics the Complete Annual Recurring Revenue is calculated as below.

Complete ARR formula:

Complete Annual Recurring Revenue: ARR – # of upsales/cross-sales + Expansion ARR – Churn ARR


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