ARR stands for Annual Recurring Revenue. It is a key metric used by SaaS (Software as a Service) businesses. ARR measures the value that a business would earn from a customer over the period of a year, assuming that the customer continues to use and pay for the service.
Relevant Templates:
It's a critical measure in SaaS businesses because these companies operate on a subscription basis. ARR provides an estimate of the predictable and recurring revenue components of the subscription-based business, typically excluding one-time and non-recurring charges.
To calculate ARR, the business would take the monthly recurring revenue (MRR) from a customer and multiply it by 12. For example, if a customer subscribes to a service that costs $100 per month, the ARR from that customer would be $1,200 ($100 x 12).
ARR helps businesses to predict their future revenue and to evaluate their growth over time. It's also useful for investors, who often use metrics like ARR to determine the value of SaaS companies.
One mistake I have seen in SaaS modeling before is that a company will take its total revenue from a year and define this as ARR, however that would not make sense since you have customers joining over the time-frame and so the total revenue earned in a year is not necessarily representative of the recurring revenue expected over 12 months.
Here's Why:
Let's say 10 customers join in month 1 and pay $50/mo. and then 10 customers join in month 2 and pay $50/mo. Your ARR after month 2 would be $12,000, however if you total the revenue you have earned from those customers up, you have the first month cohort earning 2 months' worth and the second month cohort earning 1 month worth (so you end up with a value of $1,000 for the first cohort and $500 for the second cohort (totaling $1,500) but in theory, going forward every 2 months you will be earning $2,000 from these cohorts. Extrapolating that example out to 12 months has the same initial lag effect and this is why the ARR has to be calculated using the total MRR at the end of the period and multiplied by 12. That is your ARR at any one point.
If you had recurring revenue contracts that are of all different contract terms (6 month, 12 month, 24 month, etc...), you could simply take the weighted average monthly value of all contracts and multiply that by 12 to get the ARR. This is more useful for enterprise SaaS (B2B) companies.
