Annual Recurring Revenue (ARR)

What is it?

ARR stands for Annual Recurring Revenue. You can pronounce it like a pirate (“Argghh”) or call out the letters (“A.R.R.”). It is the amount of Subscription Revenue your company expects to generate over the course of a year assuming current contracts remain in place.

It is calculated at the customer level and is an important part of SaaS financial analysis.

​ARR is the lifeblood of SaaS businesses and is standard practice to report internally. It has many uses across Sales, Marketing, Customer Support, Product Development, Cashflow, and Financial Forecasting.

​How is it calculated?

ARR is an annual figure (aka 12 months). To calculate you need the Monthly Recurring Revenue (MRR) value of a contract and multiply by 12. Then add up the entire customer population to get ARR for your company.

See below for detailed calculation.

Why is it important?

Given the predictability of ARR, you can derive accurate long-term forecasts around Cashflow and Revenue growth. This sets the scene for fund raising and business investments like hiring.

When ARR is analyzed certain ways, you can proactively manage results to drive your business valuation higher. A standard framework for analysis is New, Upsell, Downsell, and Churn. These 4 types of ARR changes can be analyzed monthly and gives a clear picture of what is driving your predictable revenue up and down.

​See below for detailed calculation of New, Upsell, Downsell, and Churn.

​NOTE: we recommend reporting ARR in constant currency when analyzing multiple years. If you decide not to then make sure you include foreign exchange (Fx) as a 5th driver.

​How do I improve this metric?

SaaS businesses want ARR to grow. To grow takes an entire company. Literally every function from Sales to Accounting has some responsibility when it comes to ARR performance. Here are real world examples of managing ARR.

1. Connect Sales Commissions to ARR. This will drive selling activity geared towards Subscription Revenue, connects into your financial models nicely, can be monitored under the New and Upsell drivers, and can be reported daily to ensure months and quarters are tracking towards plan.

2. Monitor customer product usage. This is a great way to mitigate potential churn from customers that either do not realize how beneficial your service is or are having trouble using it. You can proactively have “How to…” documents on the ready to take them from being a frustrated customer to power user and advocate of your service.

3. Identify opportunities to upsell your existing customers (aka Whitespace analysis). Selling to your base is much more cost effective. Customers that purchase multiple services are usually stickier and less likely to churn in the future.

4. Run Customer Lifetime Value (CLTV) analysis. Understanding which customers drive the most value over their entire lifetime (aka relationship) with your business allows you to focus resources where the biggest gains will be. This is a heavier lift that requires Gross Margin and Cost to Acquire (CAC) analysis to paint a complete picture. Consider grouping CLTV by various regions, marketing channels, sales teams, and industries to see where your business’ value resides.

​Want to learn more?

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