What Is ARR in SaaS and How Is It Calculated (Accurately)

How is ARR different from MRR?

ARR is calculated for annual terms, with a one-year minimum, so subscriptions with less than one-year terms shouldn’t be recorded in ARR. Shorter term subscriptions should be calculated as monthly recurring revenue (MRR), because they are month-to-month and could possibly be cancelled without warning (or obligation from the subscriber). However, don’t get confused: some contracts are billed monthly but require a long-term contract, and therefore the ARR formula is applicable. Nevertheless, MRR can also provide an important metric for SaaS businesses, and answers other valuable questions.

How should I calculate ARR, and what should be included (or excluded) from the calculation?

You may calculate the ARR value for any subscriptions that have a contract that is at least one year. Then, the guideline for which formula to use is determined by the billing agreement:

  • Subscriptions Billed Monthly:
  • Subscriptions Billed Annually:

Is ARR higher than revenue?

Annual Recurring Revenue is not typically higher than revenue, overall, because it is subscription based, and doesn’t include one-time charges or late fees (which are counted as revenue). It is expected that the amount you calculate for ARR is lower than the overall revenue.

What additional insights can ARR calculation give my business?

ARR can also show you how your accounts are performing over time. Calculating ARR regularly as a matter of course will ensure that any important changes in contracts — for better or for worse — will be immediately apparent and can be addressed quickly if necessary.

What are some of the specific potential benefits of measuring ARR?

1. It provides a clear picture of a business’ overall health. Knowing where your company is performing well and where it’s lacking can help you strategize to improve your bottom line and make your company run more efficiently.

What pitfalls should we avoid when Interpreting ARR?

Here are some of the common pitfalls to be aware of when analyzing the results of your ARR calculations:

  1. Don’t Mistake ARR for Cash. ARR is not the same as cash. A two-year contract for $30,000 still means the ARR is only $15,000, so it’s unwise to bank on the total contract amount until it’s been received.
  2. Remember that ARR is future-focused, not backward-focused. The revenue calculated is for the upcoming 12 months, not the 12 months that have just passed.
  3. Don’t forget discounts! If you’ve offered your customer a discount on their subscription price, that needs to be considered when calculating ARR.
  4. Late payments count, too. Even delinquent payments should be included in your ARR calculations.

How can my business increase ARR?

Long-term growth of your business is paramount, and the easiest and most obvious way to increase ARR is customer acquisition. However, there’s more to it than that, as shared by Finmark.

  1. The ICP (Ideal Customer Profile). Every business should have an ICP to know which prospective customers should be targeted. Understand their pain points and how your product can solve them.
  2. Make sure you have a strong customer success team. It’s important that once a customer signs the contract, they continue to be supported through onboarding and beyond. Their happiness will lead to retention, and yes — you guessed it — higher ARR.
  3. Always look at the big picture. Use add-ons and upsells to increase ARR, and consider subscription increases after a certain period, a year for example. Even a small increase can lead to significant gains in overall revenue.

Conclusion

The power of understanding ARR should not be underestimated by SaaS businesses. Having this information not only helps you monitor the company’s overall health but can also reveal which decisions are having a positive or negative impact and influence your long-term strategies.

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2Checkout (now Verifone)

2Checkout (now Verifone)

2Checkout (now Verifone) is the leading all-in-one monetization platform for global businesses built to help clients drive sales growth across channels.