What is Annual Recurring Revenue?
Annual recurring revenue (ARR) is the money a business expects to receive annually from contractual and subscription agreements as well as other forms of recurring revenue. In most contexts, it is deemed the value of recurring subscriptions normalized to one year. To calculate ARR, take the total contract and divide by number of years. If a subscriber purchases a three-year $150 subscription, the ARR for this would be $50 a year.
ARR is a reliable barometer of a subscription business’ health. As it is repeatable revenue, investors see it as a good indication of the trajectory of a business’ progress and growth. ARR can indicate the momentum in renewals, upgrades and sales as well as lost revenue from customer churn and downgrades. Its stability and predictability makes it easier to compare a startup’s performance over time and against its peers.
ARR comprises annual, fixed contract fees only — no set-up fees, non-recurrent add-ons, credit adjustments and other one-time are included. Also, subscriptions with a tenure of less than a year should not be part of the ARR since these often include a provision for cancellation in 30 days. These short subscriptions should instead be included in the more appropriate metric, the MRR (monthly recurring revenue).
Breaking down the ARR into its components such as ARR from upgrades and ARR from new customers provides a clearer picture of the segments most responsible for revenue growth. Businesses can optimize ARR by:
- Improved customer acquisition.
- Encourage upgrades by existing customers.
- Increased customer retention.