What is ARR in Sales? Definition and Calculation Guide

Tracking ARR is crucial for SaaS businesses to measure growth and predict future revenue. In fact, 80% of SaaS companies consider ARR their key metric. But what exactly is ARR and how do you calculate it accurately?

In this comprehensive guide, we'll break down the definition of ARR, explain what revenue to include, and walk through detailed examples of ARR calculations. Plus, discover how to analyze ARR data to gain valuable insights into your business.

By the end, you'll be an ARR pro, ready to impress your boss and make data-driven decisions. Let's dive in!

Understanding Annual Recurring Revenue (ARR)

Annual Recurring Revenue (ARR) is a key metric that measures the recurring revenue a company expects to receive from its customers over a 12-month period. It's an important indicator of the health and growth potential of a subscription-based business.

ARR differs from other revenue metrics like Monthly Recurring Revenue (MRR) in that it normalizes recurring revenue to an annual basis. It also only includes revenue from subscriptions, not one-time fees.

Investors and stakeholders closely watch a company's ARR growth to gauge its long-term prospects and ability to generate stable, predictable revenue streams. Let's take a closer look at what ARR includes and why it matters.

1. Definition of ARR

ARR represents the annualized value of all recurring subscription revenue a company expects to receive from customers based on the current month's subscriptions. It does not include any one-time fees, professional services, or variable consumption charges - only predictable subscription revenue.

For example, if a customer signs a 2-year contract for $24,000, the ARR would be $12,000 per year. ARR helps normalize different contract lengths and billing periods to an annual basis.

2. How ARR Differs from MRR and Total Revenue

While similar to Monthly Recurring Revenue (MRR), ARR provides a longer-term, annualized view of recurring revenue. MRR looks at recurring revenue month-to-month, while ARR projects it out to a yearly basis.

Total revenue, on the other hand, includes all of a company's revenue sources, both recurring and non-recurring. ARR only measures the recurring subscription component of revenue that can be counted on year after year.

3. Types of Revenue Included in ARR

ARR calculations should only include fixed, contracted recurring revenue from subscriptions. This typically includes:

• Revenue from new customers who sign up
• Recurring revenue from existing customers who renew
• Upgrades and add-ons to existing subscriptions

ARR should exclude:

• One-time onboarding or setup fees
• Professional services and training revenue
• Variable or consumption-based charges

4. Why ARR Growth Matters to Investors

Investors prize the predictable nature of recurring revenue. With traditional sales models, revenue resets to zero at the beginning of each period. Recurring revenue provides a more stable, reliable foundation.

A track record of strong ARR growth indicates a company is successfully acquiring, retaining and expanding its subscriber base. It's a signal of product-market fit, efficient customer acquisition, and an ability to grow future revenue.

ARR helps subscription businesses become more predictable. By tracking the ARR contributions from new customers, existing customers, upgrades, and churn, companies gain insight into the factors driving recurring revenue growth.

Understanding and tracking your ARR is essential for any subscription business. It provides a clear view into the long-term health and growth trajectory of recurring revenue. To further aid in managing leads and revenue, consider using sales intelligence tools.

The next section will dive into the specifics of how to calculate ARR based on your subscription terms and contract types. You'll learn the formulas to use and metrics to track to master this critical measure of your recurring revenue performance.

How to Calculate ARR: Formula and Examples

Calculating ARR provides a clear view into the recurring revenue your subscription business can count on over the next year. The basic formula is straightforward, but there are important nuances to consider to ensure you're capturing an accurate picture of your ARR.

ARR represents the annualized value of your recurring revenue contracts. It normalizes different billing periods and contract terms to give you an apples-to-apples comparison of your recurring revenue base.

Let's walk through the ARR formula, what to include and exclude, and a few examples of how to calculate it for common subscription scenarios.

1. The Basic ARR Formula

The simplest way to calculate ARR is to take your monthly recurring revenue (MRR) and multiply it by 12:

ARR = MRR x 12

For example, if your MRR is $100,000, your ARR would be $1.2 million.

However, this assumes all of your contracts are on a monthly billing cycle. To calculate ARR more precisely, use this formula:

ARR = (Total contract value / Contract term in years)

2. Examples of ARR Calculations

Scenario 1: A customer signs a 2-year contract for $24,000.

• Contract value: $24,000
• Contract length: 2 years

ARR = $24,000 / 2 = $12,000 per year

Scenario 2: A customer pays $1,000 per month.

• Monthly recurring revenue: $1,000

ARR = $1,000 x 12 = $12,000 per year

3. What to Include in ARR

ARR should only include revenue from recurring subscription contracts, such as:

• Monthly or annual subscription fees
• Recurring add-ons or upgrades
• Contracted recurring professional services

Save time on these calculations and manage your revenue streams efficiently using AI sales automation.

Exclude one-time fees like setup charges, installation, or training. Also exclude variable usage charges that fluctuate month-to-month.

4. Normalizing ARR for Multi-Year Contracts

For contracts longer than one year, you need to normalize the total contract value to an annual amount. Simply divide the total contract value by the number of years.

For example, a 3-year, $90,000 contract would contribute $30,000 to ARR each year.

ARR = $90,000 / 3 = $30,000 per year

Calculating ARR gives you a big-picture view of the recurring revenue you can expect over the next 12 months. Be sure to only include truly recurring revenue and normalize for different contract terms to get an accurate annual view.

Next, we'll look at how you can analyze ARR to evaluate business performance and make revenue forecasts. Breaking ARR down into new, expansion, and churned components provides powerful insights into the health of your recurring revenue streams.

Analyzing ARR to Gain Insights into Business Growth

Analyzing your ARR by breaking it down into different components provides valuable insights into the health and growth trajectory of your recurring revenue streams. Examining new, expansion, and churned ARR helps identify areas of strength and weakness. Comparing your ARR growth rate to benchmarks for your company stage lets you gauge your performance against peers.

ARR analysis also enables more accurate revenue forecasting and financial modeling. However, it's important to understand ARR's limitations and look at additional metrics for a complete picture of business performance.

1. Breaking Down ARR into Growth Components

To gain a deeper understanding of what's driving your ARR growth or decline, segment your ARR into:

• New ARR from newly acquired customers
• Expansion ARR from existing customers upgrading or expanding their contracts
• Churned ARR from customers who have canceled or downgraded

Calculating the ARR for each of these components, along with their percent contribution to total ARR, provides insight into the health of your customer base and revenue.

For example, if new ARR is growing but churned ARR is outpacing it, that points to issues with customer retention that need to be addressed. Strong expansion ARR indicates your existing customers are finding value and increasing their spend.

2. Benchmarking ARR Growth Rates by Company Stage

Comparing your ARR growth rate to benchmarks for your company stage helps you understand how you're performing relative to similar businesses. According to data from OpenView Partners, here are the median ARR growth rates by ARR range:

• $1-2.5M ARR: 100-140% growth rate
• $2.5-5M ARR: 80-100% growth rate
• $5-10M ARR: 60-80% growth rate
• $10-15M ARR: 50-60% growth rate

Keep in mind these are median values, and top-performing companies in each range often greatly exceed these growth rates. But they provide a general target to aim for.

3. Using ARR for Revenue Forecasting and Modeling

Since ARR represents the annual value of your recurring revenue contracts, it's a key input for building financial models that forecast revenue into the future. You can model out expected ARR based on anticipated new customer acquisition, churn, and expansion.

This helps with setting growth targets, planning budgets, determining cash needs, and making strategic decisions. SaaS businesses often build models around ARR to determine how much funding they need to raise to hit their growth objectives.

4. Understanding ARR Limitations and Context Needed

While ARR is a critical metric, it doesn't tell the whole story on its own. It's important to look at ARR in the context of other SaaS metrics to get a complete picture:

• Customer acquisition cost (CAC) and customer lifetime value (LTV) to understand the efficiency of your growth
• Gross and net revenue retention to see how well you're retaining revenue from existing customers
• Gross margins to ensure you're building a profitable business as you grow

ARR also doesn't reflect the nuances of your contract terms, like one-time fees, discounts, or variable usage-based pricing. It normalizes all contracts to an annual value, regardless of their actual length or structure.

ARR is a powerful metric for measuring the scale and growth of subscription revenue, but it's most meaningful when analyzed in the context of other metrics that reflect the health of your business.

We've covered a lot! Analyzing ARR provides crucial insights into the health and growth potential of a subscription business. But you made it this far, so you're well on your way to becoming an ARR master. The only thing left to lose is untapped revenue if you don't put these ARR analysis principles into practice!

Conclusions

Understanding ARR in sales is crucial for SaaS businesses to measure growth and recurring revenue streams.

In this guide, you discovered:

• The definition and importance of ARR for subscription companies
• How to calculate ARR using the right formula and revenue inputs
• Analyzing ARR to gain insights into growth, churn, and forecasting

Don't let your SaaS company's growth potential slip away - master ARR and watch your recurring revenue soar with automation!

Use Bardeen to automate sales prospecting and save time so you can focus on growing your SaaS business.