How can your customer success team best calculate annual recurring revenue (ARR), especially for a SaaS or subscription-based company? Let’s review some simple ARR equations and how to optimize any of your customers’ recurring revenue for long-term growth.
What is annual recurring revenue?
Annual recurring revenue (ARR) looks at how recurring or subscription-based revenue grows over time. It encompasses all recurring revenue in a given year, including subscriptions, membership and license fees.
ARR is a good metric in long-term planning for subscription models with longer contract durations. It also offers a glimpse into how a company is performing on new sales and upgrades (or on the flip side, customer churn and downgrades). It’s sometimes referred to as committed or contracted annual recurring revenue.
How to calculate annual recurring revenue with examples
There are multiple, straightforward ways to calculate annual recurring revenue, depending on your company’s subscription model(s) and contract durations:
When tallying up for your time period (usually on an annual basis), keep in mind any recurring items like products delivered on a quarterly, monthly or annual basis, memberships to online communities, or subscriptions to paid content. Also make sure to exclude one-time payments wrapped up in your customer’s initial contract (i.e. sign-up, set-up, or installation fees, consulting services, discounts, one-time product add-ons).
ARR examples
Let’s take a look at an example of how to calculate ARR using all three formulas above.
The customer
Your new customer subscribes to a one-year contract with monthly billings of $500. How the customer is billed is irrelevant for certain formulas, as outlined below.
Formula 1: all annual revenue for all customers
The ARR for this customer across the year is $6,000. You also have 9 other customers with similar contracts (all with monthly billings of $500). Your ARR for the full year is $60,000.
Formula 2: total annual revenue for one customer
This is a more granular look at just this new customer’s ARR for the year, which is $6,000.
Formula 3: total annual revenue for subset of customers
This provides a clearer breakdown for customers with multi-year contracts. Let’s say five of your customers have three-year contracts. Their monthly billing rate is still $500. The ARR for the year (for these particular customers) will be $30,000.
ARR vs. MRR and tracking revenue long-term
Annual recurring revenue is most helpful for long-term forecasting and planning, but don’t discount the benefits of tracking in closer detail. Monthly recurring revenue (MRR) reveals more immediate shifts in revenue and the company’s health, including new contracts, expansions, or churn. For smaller or newer subscription-based companies, tracking MRR may be sufficient.
Why annual recurring revenue matters
Annual recurring revenue is a great tool in your company’s forecasting toolbox, but as with MRR, it is not revenue recognized. Instead, use it as a consistent tracking metric for potential/planned revenue. Don’t fold in the previous year’s revenue – ARR’s purpose (and strength) is in projecting what your company will generate (i.e. growth) in the upcoming year.
To ensure your customer success team is financially aligned with other departments and the company’s overall goals, keep the following in mind when tracking and calculating ARR:
- What’s our growth from new contracts, including those with different term lengths?
- Have we calculated net and gross expansion/contraction from existing customers?
- How can we use this as an indicator for customer churn?
- Are we seeing any trends in our average selling prices?
Additional resources on annual recurring revenue
- Webinar: SaaS retention benchmarks: How does your company compare? with Rob Belcher, managing director at SaaS Capital
- Tool: The Churn Virus Calculator and White Paper: How Customer Turnover Impacts Revenue Growth and Valuation, by Tim Condor and Ali Cudby, Alignmint Growth Strategies
- Blog: Everything You Need to Know About Recurring Revenue
- Blog: 20 quick insights on Customer Success and SaaS metrics with Dave Kellogg, Dave Kellogg Consulting
- Blog: Key SaaS and Customer Success metrics you should care about with You Mon Tsang, CEO and co-founder, ChurnZero and Dave Kellogg, Dave Kellogg Consulting