Annual Recurring Revenue: What Is ARR & How To Calculate It

How To Calculate ARR

To calculate ARR, take the revenue generated by the contract and divide it by the length of the contract. For example:

If a customer signs a three-year contract for $150,000, then the ARR would be $50,000.

Some companies will look at ARR at a more granular level by breaking it out into categories such as:

• ARR from new customers
• ARR from existing customers
• ARR from add-ons purchased on top of the base offering
• ARR lost due to churn

What To Exclude in an ARR Calculation

You can exclude the following in your ARR calculation:

• One-time fees (such as implementation fees)
• One-time purchases (such as non-recurring add-ons)
• Any other revenue that won’t be earned at an ongoing basis

Why Is ARR Important for a Subscription-Based Business?

Annual recurring revenue is a very important metric for companies that offer a subscription-based business model (such as SaaS companies) because:

• It is a strong indicator of a company’s financial health
• It helps companies forecast future revenue
• It allows companies to attract more investors because ARR represents a steady revenue stream and thus, a safer investment
• It helps companies report on expansion revenue from existing customers
• It aids in projecting cash flow
• And more

So if you’re a company that offers products or services which can be purchased via a subscription model (instead of a one-time payment), make sure to keep the above in mind when managing your business.

What Is the difference between ARR and MRR

ARR stands for annual recurring revenue while MRR refers to monthly recurring revenue. Many companies give customers the option of purchasing their subscription on a yearly or monthly basis, such as Amazon Prime.

Mistakes To Avoid When Calculating ARR

Although calculating your ARR may seem simple, there are several mistakes that companies often make when doing so. Here are a few of the most common mistakes that you should avoid when calculating annual recurring revenue:

• Counting ARR as cash. Remember that with a subscription-based model, you don’t receive all of the money in the agreement upfront—it will be paid out yearly for the duration of the agreement. For example, if a customer signs a two-year agreement for $50,000 you will receive $25,000 in the first year and $25,000 in the second.
• Using it as a historical metric instead of as a forward-looking metric. ARR looks at how much money you will receive in the future, not the past.
• Forgetting to include discounts or late payments in calculations. If you offer a discount on the subscription, be sure to take that into consideration instead of mistakenly using the base price in your calculations. And although late payments from your customers are not ideal, they still count as ARR.