ANNUAL RECURRING REVENUE GUIDE

Mark Henderson

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WHAT IS ANNUAL RECURRING REVENUE?

Annual recurring revenue, or ARR, is a SaaS metric used to measure the monetary value of a customer contract or recurring subscription, expressed as an annual value.

In simpler terms, ARR is a metric of recurring revenue generated by customers within a single calendar year.

For most SaaS businesses, annual recurring revenue is the sum of all new subscriptions and upgrades, minus downgrades, and cancelled subscriptions. 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. 

Example

If a customer purchases a subscription with a monthly renewal agreement for $2,000 per month, then Annual Recurring Revenue would be $24,000

$2,000 * 12 = $24,000 ARR

If a customer purchases a 3-year subscription service worth $15,000 with a renewal agreement, then Annual Recurring Revenue would be $5,000. 

$15,000 / 3 = $5,000 ARR

HOW TO CALCULATE ARR

Calculation of ARR depends on a business’s pricing strategy, the complexity of a business model, among other factors. Calculating ARR is simple:

ARR= (Total $ amount of yearly subscriptions + total amount gained from expansion revenue) – total $ amount lost due to cancellations. 

Some of the 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?

Acquire more customers – Getting more subscribers is the obvious way to increase ARR. A growing customer base will translate to more recurring revenue. It’s also essential to keep customer acquisition costs low to reduce the time it takes to generate positive ROI.

Find strategies to retain customers- Every business person knows how difficult it is to attract a new customer than keeping 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.