What is Annual Recurring Revenue (ARR)?

Metrics are powerful tools when used with the proper understanding and context. Annual Recurring Revenue(ARR) and Monthly Recurring Revenue(MRR) are vital metrics for any company to succeed that depend on subscriptions. With the help of these metrics, you can overview your business’s health and measure the rate at which you should expand your business. 

With the help of today’s ARR guide, you will be able to calculate ARR and understand the difference between ARR, MRR, and Total Revenue. Also, we will dive into the key aspects that affect ARR. 

The content we will cover on ARR:

• What is Annual Recurring Revenue (ARR)?
• Difference Between ARR and MRR?
• ARR vs. Revenue
• How to Calculate Annual Recurring Revenue
• Why ARR is Important
• ARR Benchmarks
• Increasing ARR

What is Annual Recurring Revenue (ARR)?

Annual Recurring Revenue is a company’s expected revenue for providing a product or service to your customers in a year. In other words, ARR is the recurring revenue a business generates annually. 

ARR helps you get an overview of your company’s performance on an annual basis.

Recurring revenue is the essence and the most salient feature of any subscription model; without it, your company will disintegrate. 

With ARR, you can measure the relationship with your customers, such as upgrades, downgrades, new subscriptions, and cancelations. Traditional accounting methods such as GAAP(Generally Accepted Accounting Principles) cannot measure these factors. 

ARR will differ from the subscription amount if the contract is longer than a year. For multi-year subscriptions, ARR will be normalized to a one-year period. 

Difference Between ARR and MRR?

Annual Recurring Revenue is often used in B2B subscription businesses when the minimum contract term is one year. ARR is also used in B2C to measure the company’s performance annually. Monthly Recurring Revenue is used for B2B & B2C businesses with monthly subscriptions. 

B2B companies with multi-year contract periods, higher transaction value, and lower transaction volume use ARR. MRR is often used for companies in the early stages, especially if their subscription period is less than a year. 

MRR shows the in-depth performance of your product or service monthly. This helps you measure the effects of changes you might have made to your product, such as pricing or any feature updates. 

For SaaS companies, ARR is used to create a company’s road map and valuable long-term planning yearly. 

Companies tend to use both metrics as ARR is seen as a valuation metric, and MRR is used as an operating metric. In other words, ARR is used to see the company’s recurring revenue at a macro level, and MRR is used at a micro level. 

MRR and ARR go hand in hand; you must work with both to have the whole picture. While MRR is used to have a day-to-day product analysis, ARR shows your company’s annual performance to potential investors or in board meetings. 

ARR vs. Revenue

Revenue is the total amount of a company’s income, while ARR is the income only from the subscription-based revenue. 

One-time fees on your product or any product outside the subscription won’t count in ARR. 

For Example, your SaaS offers a monthly subscription and special offers such as consultation. The total revenue would be the sum of all of it, including ad-hoc services and subscriptions. However, the Annual Recurring Revenue SaaS will only include the monthly subscription you receive for your product or services. 

How to Calculate Annual Recurring Revenue

Calculating the Annual Recurring Revenue is quite simple; you can use the formula given down below to get started.

For B2B businesses with yearly subscriptions:

ARR = (Contract Value) / (Duration of contract in years)

For Example, if a customer has a 2-year subscription for $40,000, your ARR will be:

ARR=$40,000/2

=$20,000 

For companies based on monthly subscriptions, you can use this formula: 

ARR = (Subscription Value) x (12/ Duration of contract in months) 

For Example, if a customer gets a 3-year subscription(36-month) for $60,000, which is billed monthly, the ARR will be:

ARR=($60,000)x(12/36)

=$20,000

Why ARR is Important

You need ARR to check your business’s yearly performance and whether it is reaching its goal. These metrics help founders track their company’s performance and work on their customers’ pain points. 

Tracking Tangible Growth:

ARR helps you build your financial standing, which will help you map out the best way to expand your business. In addition, it helps you see the impact of upgrades and changes you make in your product or services yearly. You can look at ARR as a compass to track your company’s growth. 

Forecast Future Revenue:

ARR is used to calculate more complex calculations in your financial model. For Instance, you can forecast future revenue by cross-examining the churn percentage, acquisition goals, potential pricing changes, and packaging against ARR. 

Helps Set Realistic Goals:

Every founder wants to make millions, and it’s good to aim high, but simultaneously company’s decision can’t be made on unrealistic standards. ARR helps you set realistic goals you can achieve in the future. 

With ARR, you can look into customer’s pain points and how you can tackle them to grow your business. ARR helps you answer questions such as how to expand the business, bring in more customers, and upsell existing customers. 

ARR Benchmarks

For any early-stage company, you need to have growth metrics, which can also get quite overwhelming. Alongside that, you need to compare your growth with other early-stage companies. Yo can achieve with the help of a few benchmarks, and you can measure your ARR growth. 

With the help of the venture capital ecosystem, you can determine your business’s stage and future trajectory.

Investors usually use the following benchmark with ARR as a key metric:

Product-Market-Fit is being established:

Pre-Series A =< $1M ARR

Product-Market-Fit has been established

Series A = > $1M ARR

Increase Growth & Scale via repeatable customer acquisition:

Series B = >$8m ARR

ARR Milestone for Series-A:

1. $1M-$2M
2. $2M-$4M
3. $8M-$10M(Needed to raise Series-B)

The goal for any startup is to achieve Series B($8M-$10M) within 24 months. This is why startup founders should closely monitor ARR growth, as it is one of the primary metrics that investors assess. 

ARR growth for startups can be broken down into year-over-year and month-over-month growth, and you can measure it by the following benchmarks.

Year-over-year growth:

ARR>80% ––––– Good

ARR>100% –––––– Great

ARR>200% ––––––––– Outstanding

Month-over-month growth:

ARR>10% ––––– Good

ARR>15% –––––– Great

ARR>20% ––––––––– Outstanding

According to Bessemer Venture, average companies with $1-$10M of ARR have a growth rate of 200%, which decreased to 60% for companies over $100M ARR. 

Henceforth, as revenue increases, the growth rate decreases. This means that you need to push your company to have the maximum amount of growth rate at the early stage of the business. Because as soon as you hit the sweet spot of product-market fit, you can quickly grow your business effectively and more efficiently. 

Increasing ARR

To have a stable growth rate in the long term, you need to have a lower churn rate and a higher customer acquisition rate increasing the ARR. To achieve that, you can use the following strategies. 

Ideal Customer Acquisition:

Before launching your product, you must narrow the ideal customer profile. Which will help you target the right prospective customers. 

Any product essentially provides a service to its users to solve a particular problem and make their lives easier. Therefore you need to ensure that your product is targetting the customers’ pain points which will help your business have a successful long-term growth. 

Spend money to make money:

You must ensure that you are investing in your customers’ success. If you acquire a customer, you must ensure they stick around.

Set up a customer success team to safeguard your customers’ needs and solve their issues, growing your ARR. 

Playing the long game:

All successful businesses have one aspect in common: they always play the long game. Achieving short-term goals is essential, but don’t forget about increasing your revenue by having a subscription increase after a period of time. 

If you feel your product is underpriced, use add-ons and upsells, which will grow your MRR increasing ARR as a byproduct. Look into your competition, see what they are charging their customers, and try to match their prices. 

Knowing your product’s worth is essential. Don’t oversell or undersell; find the right amount that benefits you and your customer.

At the End:

In the end, you need to track your ARR to grow your business. If you are starting out, you need to measure your MRR, ARR, and more which you will use in your financial models. This can be difficult and straining for a new business if you spend most of your time building your financial model. Therefore, you can always get a free consultation at Numberly and help us take some load off your hands and help you grow your business.