SUBSCRIPTION FINANCE
Annual Recurring Revenue: What is ARR & How to Calculate It
What is Annual Recurring Revenue (ARR) ?
Annual Recurring Revenue, or ARR, is a metric that shows the money that comes in every year for the life of a subscription (or contract). More specifically, ARR is the value of the recurring revenue of a business’s term subscriptions normalized for a single calendar year. For example, if your subscriber purchases a two-year subscription for $12,000, the ARR would be $6,000 for each year. ARR is predictable revenue that can be counted on every year.
ARR vs Revenue
ARR is the recurring revenue from subscriptions, and revenue is an all-encompassing term that describes any type of business income, whether it’s recurring or not.
ARR vs MRR
ARR should be calculated for annual terms — with a one-year minimum. Subscriptions that have terms that are less than one year shouldn’t be recorded in ARR. These types of short-term contracts often allow for subscription cancellation within 30 days. If these subscriptions were calculated as ARR, that would be inaccurate. Instead, shorter-term subscriptions should be calculated as monthly recurring revenue (MRR).
How to calculate ARR
To find ARR you must account for all recurring revenues within your business. To do this, subtract the amount of revenue lost from cancellations from the revenue generated by annual subscriptions and upgrades.
ARR calculations can include the following:
- Revenue from new and renewing customers
- Upgrades and add-ons
- Losses from downgrades and lost customers
To calculate ARR divide the total contract value by the number of relative years.
ARR formula
To calculate the ARR, use the following formula:
ARR = (Sum of the year’s subscription revenue + recurring revenue from upgrades and add-ons) – revenue lost from downgrades and cancellations that year.
Remember that any expansion revenue received through upgrades or add-ons will impact the annual subscription price of a customer. One-time selections should not be included in this equation.
You can also calculate ARR by multiplying your monthly revenue by 12.
ARR Example
For example, if a customer signs a four-year contract for $4,000, divide $4,000 (contract cost) by four (number of years) for an ARR of $1,000/year. If a customer declines to renew a $6,000 contract over two years, divide $6,000 (contract cost) by two (number of years) for an ARR decrease of $3,000.
ARR only includes fixed contract fees, not one time charges. Rather, single charges (or variable revenue) should be accounted for separately. If any extra, non-subscription charges are lumped into ARR, accuracy is lost in your calculations.
Billing cycles don’t affect ARR, as long as the term of the subscription is a year or more and the subscription is recorded the same regardless of how payments are structured.
Ready to take the next step? Talk to one of our experts today.
Why is ARR important for a subscription business?
ARR is a good measurement of the health of a subscription business. Because ARR is the amount of revenue that a company expects to repeat, it enables measurement of company progress and prediction of future growth. It’s also a useful metric for measuring momentum in areas such as new sales, renewals, and upgrades — and lost momentum in downgrades and lost customers.
ARR is particularly useful as a metric to:
- Clarify company health. ARR measures company performance in specific areas, showing where revenue is growing or being lost and why. Knowing your ARR can help you make better decisions regarding employee assessment, compensation, operational planning, and financing to improve the bottom line and help increase company efficiency.
- Increase revenue. Tracking relationship changes provides insight into what customers want and need and helps to promote cross-selling and up-selling, which leads to increased revenue.
- Forecast revenue. Planning the duration and cost of different subscriptions helps forecast revenue from potential clients. Tracking the value of renewals and the cost of lost customers (i.e., churn) helps businesses manage expenses more precisely and maintain cash resources.
- Retain top talent. Monitoring ARR encourages a business to focus on individual sales territories to determine what’s working and what needs changing. Compensation commensurate with productive job performance results in less turnover and cuts new employee training costs.
- Attract investors. Investors prefer the contractually obligated revenue, predictable sales models, and accurate revenue forecasting of the subscription economy over one-time sales. Subscription businesses with ARR can thrive because owners can sell predictably and systematically.
What is ARR growth rate?
ARR growth rate is the adjustment in annual recurring revenue over a period of time, typically depicted as a percentage. Increasing ARR growth rate year after year is usually a sign of product-market compatibility.
What is a good ARR growth rate?
Your business’s ideal growth rate should be between 20% and 50%. Any growth rate under 20% indicates that your company isn’t growing fast enough to succeed in the long run. Growth over 50% doesn’t leave you enough time to increase revenue while keeping up with costs.
The Journey to Usership
The playbook for modernizing monetizing, and scaling your subscription business
The world's leading enterprises run on Zuora.
With Zuora running in the background, we are well-equipped to deliver sustainable value to our customers, based on dynamically evolving offerings that fit the healthcare industry & care providers’ demands.
– Rahma Samow
Head of Siemens Healthineers Digital Health Global
Learn From the Best
Unlock resources from the leading experts
