Annual recurring revenue (ARR) is a key metric used in the world of Software as a Service (SaaS) to measure a company’s predictable, recurring revenue for a given period. ARR refers to the annualized value of all subscription-based contracts for the lifetime of those contracts i.e. the total amount of revenue that a company expects to receive from its customers on an annual basis for the duration of their subscription.
The calculation of ARR involves normalizing the recurring revenue generated by customers over a single calendar year. This means that businesses must take into account any discounts or refunds provided to customers that may lower their monthly subscription rate. The basic formula for calculating ARR is as follows:
ARR = (Total Annualized Value of Subscriptions) / (Number of Months in the Year)
The Total Annualized Value of Subscriptions refers to the total value of all subscription-based contracts for the lifetime of those contracts, while the Number of Months in the Year refers to the number of months in the calendar year.
SaaS companies rely heavily on ARR to understand their revenue streams, forecast future revenue growth, and evaluate the effectiveness of pricing strategies. By calculating ARR, businesses can get a better understanding of their long-term revenue potential and growth prospects. ARR is also useful for investors and analysts who want to evaluate the financial health of a SaaS company. A high ARR indicates that a company has a strong base of recurring revenue that is predictable and reliable.
