What is Annual Recurring Revenue (ARR)?

Annual Recurring Revenue (ARR) is a key financial metric that reflects the predictable revenue a company expects to generate from subscriptions or recurring contracts over a 12-month period. SaaS sales and other subscription-based businesses commonly use ARR to monitor long-term revenue performance, measure customer growth, and forecast future earnings.

ARR includes only recurring revenue, such as subscription fees or service retainers. It does not account for one-time payments, onboarding costs, or variable usage fees. This makes ARR a reliable indicator of business stability and future revenue potential.

For example, if a customer signs an annual contract for $10,000 or subscribes to a $1,000-per-month plan, those figures contribute $10,000 to accounts receivable (AR) and $12,000 to accounts receivable (AR), respectively. A simple way to calculate ARR is to multiply Monthly Recurring Revenue (MRR) by 12.

While MRR offers a short-term view of revenue changes, ARR provides a bigger picture of business scale and momentum. Tracking ARR helps leaders set strategic goals, evaluate churn, and plan for sustainable growth. It is especially valuable when communicating performance to investors or making long-term operational decisions.

Annual Recurring Revenue Formula

There are two common ways to calculate Annual Recurring Revenue (ARR), depending on your pricing model:

• ARR = Monthly Recurring Revenue (MRR) × 12

This is the most straightforward method for businesses with consistent monthly billing.

• ARR = Total Contract Value ÷ Contract Length in Years

This is useful when working with annual or multi-year contracts. For example, if a customer signs a $24,000 contract over two years, the annual recurring revenue (ARR) is $12,000.

Both approaches help standardize revenue across accounts, making it easier to track growth, project future income, and assess customer value over time.

ARR vs. MRR: Key Differences

While Annual Recurring Revenue (ARR) and Monthly Recurring Revenue (MRR) both track recurring revenue, they serve different purposes:

• ARR offers a long-term view. It reflects the total amount of recurring revenue a business expects over a year. It is ideal for strategic planning, setting annual targets, and reporting to investors.
• MRR gives a short-term snapshot. It shows how much recurring revenue a business brings in each month. MRR helps monitor growth trends, identify churn early, and react to performance fluctuations.

In summary, MRR helps manage the day-to-day, while ARR keeps you focused on the big picture.

Why ARR Matters for SaaS and Subscription Businesses

ARR is one of the most critical metrics for SaaS and subscription-based businesses. It provides a clear and consistent view of a company’s revenue potential over the year, based solely on active subscriptions.

Here’s why ARR is essential:

• Forecasting: It helps teams plan revenue targets, hiring, and operational expenses with greater confidence.
• Investor reporting: ARR is a key metric for communicating business performance and momentum to stakeholders.
• Growth tracking: ARR reveals the impact of customer acquisition, expansion, and retention efforts.
• Strategic decisions: It helps leaders assess when to scale teams, enter new markets, or launch new products.
  

In short, ARR is a foundational metric for effectively running and scaling a recurring revenue business.

Common Mistakes When Calculating ARR

Accurate ARR calculation is critical, but it’s easy to get wrong if incorrect inputs are included. Here are the most common mistakes:

• Including one-time charges: Setup fees, implementation costs, or hardware sales should not be counted in ARR.
• Adding usage-based fees: Variable charges that fluctuate month to month don’t qualify as recurring.
• Ignoring churn or downgrades: ARR should reflect current recurring revenue, so adjustments must be made when customers cancel or reduce their plan.
• Failing to separate contract terms: Mixing annual and monthly contracts without standardizing them leads to misleading figures.

To keep ARR accurate, always use consistent data, update for changes in customer status, and align your calculation with GAAP or internal revenue recognition policies.