What is ARR

What is ARR (Annual Recurring Revenue) and why it’s important?

What is ARR?

ARR or Annual Recurring Revenue is the total revenue expected to be generated by at least 12 monthly customer payments.

Annual Recurring Revenue is also known as Annual Contract Value (ACV) or simply ARR.

ARR can be represented in two ways: Monthly ARR. The number of recurring customers is multiplied by the average revenue per user/contract/month. Yearly ARR – The sum of 12 monthly ARRs (one for each month in the year).

What are some uses for Annual Recurring Revenue?

Businesses can use this metric to calculate their total revenue in the future, forecast their cash flow and financial health. Attract investors and lenders, or determine potential valuation.

How can I calculate Annual Recurring Revenue?

Here are some examples of the calculation for MRR and Yearly ARR:

MRR Calculation Example: If you have 25 customers paying $100/month, your MRR would be $25,000 (25 customers x $100).

ARR Calculation Example: If your MRR equals $25,000 and you have these same customers paying for the entire year (12 months), your ARR would be $300,000.

What are some common mistakes with Annual Recurring Revenue?

Understating the number of customers included in the calculation for MRR or ARR. Including revenue from non-recurring sources, such as one-time purchases, consulting fees, or service fees. Inflating the annual contract value by including early termination fees that will never be collected. Or by including large customers that may leave or renegotiate soon.

Why is ARR Important to know for subscriptions?

ARR is a critical part of determining the viability and potential success of a subscription business. If your ARR is too low, your business may be unsustainable, and you may need to rethink your pricing or offerings.

ARR is a critical part of determining the viability and potential success of a subscription business. #ARR Click To Tweet

Generally speaking, the more ARR you have, the more opportunities you will have for growth and improvement.

How can Annual Recurring Revenue be effective if it is difficult to forecast?

First of all, while ARR is not an exact science, it is a very useful metric. That tells us a lot about our businesses. This is why so many companies attempt to forecast their ARR and ACV. But even if we can’t be exact. We can still use ARR to determine how much money we expect to earn every month or every year. Which is very useful in planning our financial growth.

The future of the subscription economy and its effect on ARR

Since the subscription economy is still relatively new, it will be interesting to see what direction the industry heads moving forward. Will one company dominate all areas of subscriptions? Or will many companies remain profitable with ARR below $100,000 per year? Although only a handful reach and stay in that million-dollar club?

It’s clear that having an excellent idea for a product that people will subscribe to is merely the first step in being successful. If your company hopes to succeed in the subscription space, understanding Annual Recurring Revenue can be a powerful tool when used correctly.

By using ARR, you are already on your way to successfully forecasting your company’s financial health. But as with any numbers, it’s important to ensure you have all the information you need and that you calculate correctly.

Conclusion:

Annual recurring revenue is an important metric for understanding the financial health of a business. MRR is helpful in determining potential success and viability as a subscription-based business, while yearly ARR can be used to forecast future cash flow and earnings. 

While ARR may not always be exact, it can still provide valuable information about the health of your company. It can help you determine what improvements are needed to reach the $1 million club, but it will also tell you where to focus your energy if you are not there yet.

If your company is considering starting a subscription business, understanding ARR and how it works for your own business will be a huge advantage as you focus your energy on areas of improvement.