Annual Recurring Revenue (ARR)

What is Annual Recurring Revenue (ARR)?

Annual Recurring Revenue measures the total amount of recurring revenue a business is due to receive over the subsequent 12 month period. It’s a metric commonly used by subscription companies and SaaS companies to track the value of their current active customers.

What is recurring revenue?

Recurring revenue is any form of revenue that is set to repeat at regular intervals. Revenue gained from a monthly or annual subscription would be an example of recurring revenue. Recurring revenue does not include one-off purchases, and these should not be included in ARR.

Data Smarties: MRR and ARR

How to calculate MRR:

To calculate ARR, take all of your current active subscriptions, and total the annual revenue they are due to provide over the next 12 month period.

Do not include one-off payments and purchases.

In instances where a customer has a payment plan that exceeds one year you should adjust their revenue down, to reflect a 12 month period. (e.g. if a customer pays $1,000 every 24 months, you should record $500 in ARR.)

Common misunderstandings

Annual Recurring Revenue is not to be mistaken for a) Annual Revenue or b) Projected Annual Revenue.

• Annual Revenue would typically refer to the revenue a business has actually generated over a previous 12 month period. Whereas ARR describes the potential value of their current subscriptions. Annual Revenue also includes one-off purchases not covered by ARR.
• Projected Annual Revenue is a forecast of the actual revenue a business will generate over a 12 month period. Typically it will incorporate multiple factors including Churn Rate and projected growth. It will also include one-off purchases. Whereas ARR only measures the potential value of the subscriptions a business holds at that moment in time.

Pros:

ARR is a rolling figure, meaning you do not need to wait until the end of a fixed reporting cycle to report on business performance. It reflects every revenue change – as and when they happen, (from new subscribers to canceled subscriptions).

That’s why ARR is a popular metric for subscription companies – it gives a direct, up-to-date figure for the total value of your current subscriptions. This is helpful for tracking momentum – i.e. is the value of your subscriber-base growing or shrinking, and to what extent?

Cons

When used in isolation, ARR only gives a limited view of a business’ performance. It does actually indicate how much of that potential recurring revenue is likely to end up as cash in the bank. To calculate this you need to incorporate other metrics like Churn Rate and LTV (Customer Lifetime Value).

ARR does not always behave in a consistent manner – indeed, ARR can vary a lot based on your billing cycle. For example, if all of your customers were due to renew their subscription on the same day of the year, (and a proportion of your customers always churn when their accounts come up for renewal) you would expect to see a significant drop in ARR on that one day.

Breaking down ARR

ARR is affected by many factors, including new customers, plan changes, price changes, and cancellations. In order to better understand why their ARR is changing, many businesses also track the following metrics:

• New ARR: total ARR gained from new customers
• Churn ARR: total ARR lost from customers who have canceled their subscription
• Expansion ARR: total ARR gained from existing customers (e.g. customers who upgrade their plan)
• Contraction ARR: total ARR lost from existing customers who have downgraded their plan
• Reactivations ARR: total ARR gained from old customers who have reactivated their subscription.