What is Annual Recurring Revenue?
Annual recurring revenue (ARR) measures the monetary value of a customer contract, recurring subscription, or total company revenue from those sources, expressed as an annual value.
In simpler terms: it measures how much money your customers pay you within a single calendar year.
Most SaaS businesses will calculate annual recurring revenue by taking the sum of all existing and new subscriptions and upgrades, minus downgrades and cancelled subscriptions, over an annual reporting period.
ARR is closely related to MRR (Monthly Recurring Revenue), which shows the monetary value of customer contracts or subscriptions, normalized on a monthly basis. The difference between ARR and MRR is the period of time at which they’re normalized.
ARR is an important metric used by SaaS businesses to contextualize overall growth.
Let’s say a customer purchases a subscription from you with a monthly renewal agreement for $2,000 per month, and you want to calculate ARR for that specific customer. In that case, you’d make the following calculation:
$2,000/month * 12 months = $24,000 ARR
In this case, the Annual Recurring Revenue for that customer would be $24,000.
Now lets say a customer purchases a 3-year subscription from you worth $15,000 with a renewal agreement. To figure out ARR for that contract, you’d make the following calculation:
$15,000 every three years / 3 years = $5,000 ARR
In this case, the Annual Recurring Revenue for that customer would be $5,000.
How to calculate ARR
Calculation of ARR depends on a business’s pricing strategy, the complexity of a business model, among other factors. Usually you’ll either be calculating ARR for a specific customer like we did above, or total ARR for your business.
In most cases, calculating total ARR is simple:
ARR = (Total $ amount of yearly subscriptions + total amount gained from expansion revenue) – total $ amount lost due to cancellations
Some metrics that will directly affect ARR calculations include annual customer revenue, add-on purchases, product upgrades, product downgrades, and cancellations.
Apart from quantifying a business’s growth, ARR can be used to evaluate the success of a business model. This metric evaluates only the revenue obtained from subscriptions; hence SaaS business owners can use it to determine whether a subscription model is successful or not. Secondly, ARR can be incorporated in complex calculations to project a business’s future revenues.
How can you increase ARR?
We mentioned earlier that ARR measures how much money is coming in from your existing customers, plus any increased in revenue from new ones, minus any cancellations. That means you have three options when looking for ways to increase it: acquire more customers, decrease churn, and earn more money from your existing customers.
Acquire more customers
Getting more subscribers is the most obvious way to increase ARR: a growing customer base will translate to more recurring revenue. For most subscription businesses, the best way to do this is to keep customer acquisition costs low to reduce the time it takes to generate positive ROI.
Find strategies to retain customers
Every business knows how much more difficult it is to attract a new customer than it is to keep an existing one. Retaining existing customers will help you preserve your current user base and allow you to maximize customer lifetime value. For this reason, it’s important to invest in reliable ARR management tools to reduce subscription churn and boost customer retention.
Grab expansion opportunities
Expansion strategies like upgrades, up-sells, and cross-sells allow SaaS businesses to maximize the value of each subscription. Usually, users are willing to pay for extra features. It’s also a good idea to revisit your pricing strategy to ensure it aligns with your value metric.
Overall annual recurring revenue is one of the most important metrics for SaaS businesses. Therefore, SaaS businesses need to invest in top ARR tracking tools to have an accurate overview of the general health of their businesses.