If you’re in the SaaS business, one of the most important metrics you need to keep track of that’ll help determine your company’s long-term success and future growth is annual recurring revenue.
Few SaaS metrics are as powerful as ARR, especially if your subscription business has several clients with multi-year contracts. From providing a high-level overview of your financial health, to better forecasting, to providing insights on improving your growth or pricing strategy, there’s a lot to be gleaned from understanding your ARR, which includes calculating annual subscriptions, additional ongoing revenue, and losses from cancellations.
Not sure how to best calculate your ARR? Confused about whether it’s best to focus on your ARR or MRR? Or do you just want to know how you can start improving those metrics? Look no further. In this article, we’ll cover everything you need to know about your ARR to set you up for success.
TL;DR
- ARR is a revenue-based metric that showcases the yearly value of predictable and recurring revenue a SaaS business generates; it allows subscription-based companies to measure their year-over-year growth.
- ARR makes it easier to track and manage expenses, predict your future growth rate and forecast revenue, and help sharpen your business model. Through your annual revenue calculation, you can better understand and contextualize your company’s growth.
- Some ways to improve your ARR include increasing customer retention, tracking your ARR metrics, and optimizing your pricing strategy.
What is Annual Recurring Revenue?
ARR is a revenue-based metric that showcases the yearly value of recurring revenue a SaaS business generates; it allows subscription-based companies to measure their year-over-year growth.
ARR includes recurring revenue from both monthly billing cycles and annual contracts, plus any other membership or license fees. Let’s say you’re an HR SaaS company: your subscription model could include offering an annual subscription at a discounted rate to a learning platform like Udemy. This revenue, whether it’s charged monthly or annually, should be included in your ARR.
Conversely, there are a few things that you shouldn’t include in your total revenue when calculating your ARR. That means one-time charges, non-recurring add-ons, renewal or set-up fees, or anything that’s non-recurring should not be included.
How To Calculate ARR
Now that we know what’s part of ARR (and what isn’t!), let’s take a look at how you can accurately calculate annual recurring revenue to start getting insights into your revenue.
The true ARR formula is as follows:
ARR = (The total of your annual subscription revenue + recurring revenue from add-ons and upgrades) – revenue lost due to churns and/or downgrades.
If you want a quick and dirty answer (albeit less accurate), another ARR calculation can be done by multiplying your monthly recurring revenue (MRR) by 12. We’ve already talked about the different types of MRR, like New MRR or Churn MRR, so we recommend you read the full discussion here, but the most basic formula is:
MRR = Number of Customers * Average Monthly Fee
However, if you only choose one MRR metric to calculate your ARR, we recommend Net New MRR, which provides a high-level overview of your revenue, downgrades, and cancellations. The calculation for that is:
Net New MRR = (New MRR + Expansion MRR + Reactivation MRR) – (Churn MRR + Contraction MRR)
That means if your HR company had $5,000 in new MRR, $500 in upgrades, and $400 in reactivations, but you had a churn of $1,000 and $500 in downgrades, your Net New MRR would be $4,400.
You could then take that each month’s Net New MRR and add it together, then divide by 12 for an average Net New ARR.
When a customer signs a contract, the terms and values of that contract directly impact the calculation of ARR. Different contract durations and payment structures must be accurately reflected in your financial analyses.
The factors you need to calculate your ARR include:
- Customer revenue per year
- Product or service add-ons or upsells
- Product and account downgrades
- Revenue lost due to churn
ARR vs. MRR: Which is Better?
OK, so this is a tricky question. For a high-level view into your company’s financial health, ARR is best, as it represents the amount of revenue that a company expects to generate repeatedly, while MRR lends itself towards more granular insights that can be prone to more fluctuations—although it’s easier to make quick tweaks to improve your overall efficiency.
Companies that lean towards multi-year contracts (often B2B companies) are more inclined to use ARR, although it’s perfectly possible to use both metrics. That said, do note that ARR is more closely aligned with generally accepted accounting principles (GAAP).
Finally, ARR is often seen as a metric that helps determine the value of the company—not unlike a profit statement—whereas MRR can be used to get a peek into the nitty-gritty daily operations. All in all, there’s no single perfect metric to use: it’s best to track and report on both consistently in the beginning to see what work best for you.
How To Improve Your ARR
Combined with your MRR, ARR makes it easier to track and manage expenses, predict your future growth rate and forecast revenue, and help sharpen your business model. Through your annual revenue calculation, you can better understand and contextualize your company’s growth. And with data visualization, you can clearly understand what’s working and what isn’t, zooming in on potential problem areas like retention, renewals, or customer acquisition.
Remember: while it can be a little trickier to calculate, remember that if you have ARR at all, that means you likely have longer contracts with your customers, which is a strong vote of confidence and can help make your business look more attractive to stakeholders and attract investors.
That said, even if you think you have a solid ARR, there’s always room for improvement: industry data shows that the median SaaS growth rate is just 22%, and software companies growing at 20% annually have a 92% chance of failure in a few years.
Net customer acquisition is crucial for improving ARR by optimizing the efficiency of the customer acquisition process and attracting more qualified leads.
But it doesn’t have to be that way. Here are our top tips on how you can supercharge your company’s ARR to stay successful.
Increase customer retention
Remember that the customer acquisition cost can be up to 5 times higher than the cost of retaining current customers. While it may not be a quick win, focusing on reducing churn and keeping current customers is a cost-effective strategy that can also boost your customer lifetime value (LTV) in the long run. Some ways you can improve your customer retention rate is by providing a top-notch onboarding process, offering stellar customer support, and ensuring a barrier-free billing experience (like with Stax Bill’s automated credit card retries and updates).
Track your ARR metrics
The best way to effectively manage and improve your ARR is to monitor key ARR metrics and benchmark them against your goals, ensuring predictable revenue streams. There are a plethora of ARR-related metrics you can track, like net or gross dollar retention, LTV, CAC, and ARR growth rate. While it can feel overwhelming, there’s no need to manually segment all these metrics by customer types or products.
With Stax Bill, you can access powerful real-time data that you can analyze against various angles, providing a powerful view into your cash flow. And with over 40 automatically updating reports, you’ll have a wealth of actionable data-driven insights at your fingertips, 24/7.
Target the right audience
While you should be focusing on reducing customer churn, it doesn’t have to be an either/or situation when it comes to finding new customers and bolstering customer retention. If you have the budget and bandwidth, your SaaS company, especially if you operate within subscription businesses, should also focus on acquiring new customers. But it shouldn’t be a shot in the dark: spend time doing deep target audience research and brand tracking to determine the best growth channels for your organization (like cold calling, PPC, or SEO).
Optimize your pricing strategy
We’ve spoken at length about the importance of finding the optimal price point, but here’s a TL;DR version. You need to develop a well-researched ideal customer persona, organize a pricing committee, and A/B test pricing strategies (like dynamic pricing) for annual subscriptions. Whatever you do, don’t randomly select a price: base it on research, and try it out on different groups using subscription management software like Stax Bill to ensure minimal disruption and frustration.
Other alternatives can include upselling and cross-selling, which can simultaneously provide more value while increasing your (expansion) ARR and LTV.
Rethink your discount strategy
While offering discounted services or coupons might seem like the best way to stay competitive in a saturated SaaS market, promotional pricing can actually negatively impact your business and devalue your brand if done too frequently. Instead, consider offering discounts on yearly subscriptions strategically, sparingly, and preferably only for loyal customers (more info in our blog post here.)
The Bottom Line
Understanding your annual recurring revenue may feel insurmountable, but keeping track of your key ARR metrics can be easy as pie with billing software like Stax Bill. Don’t get lost in the ocean of competitors; stand out from the crowd with our automated, ASC 606-compliant subscription management platform that can help you reduce churn, increase revenue, and streamline the billing process. And with our powerful software monetization strategies, you’ll collect more on your invoices in no time.
Automate your billings experience today to improve your bottom line with Stax Bill. Contact us to learn more.
Quick FAQs about Annual Recurring Revenue
Q: What is Annual Recurring Revenue (ARR) in a SaaS business?
Annual Recurring Revenue (ARR) is a metric that represents the predictable and recurring revenue a SaaS company expects to generate annually. It provides a high-level view of a company’s financial health and helps in forecasting future growth. ARR includes revenue from annual subscriptions, recurring add-ons, and upgrades but excludes one-time fees and non-recurring charges.
Q: How can I improve my company’s ARR?
Improving ARR involves strategies such as increasing customer retention, optimizing pricing strategies, and enhancing customer acquisition processes. Focus on delivering exceptional customer experiences, implementing effective upselling and cross-selling strategies, and leveraging data analytics to understand customer behavior and preferences.
Q: Why is ARR important for SaaS businesses?
ARR is crucial because it helps SaaS businesses measure year-over-year growth, track and manage expenses, and forecast future revenue. It offers insights into the long-term financial viability of the company and is a key metric for attracting investors.
Q: How does ARR differ from Monthly Recurring Revenue (MRR)?
ARR and MRR are both metrics used to track recurring revenue. ARR provides an annual forecast of revenue, making it suitable for long-term planning and evaluation. In contrast, MRR offers a monthly view, making it useful for understanding short-term revenue fluctuations and making quick adjustments.
Q: What factors should be considered when calculating ARR?
When calculating ARR, consider factors like total annual subscription revenue, recurring revenue from add-ons and upgrades, and revenue lost due to churns or downgrades. It’s important to exclude one-time payments and non-recurring fees to ensure accurate calculations.
Q: What is the formula for calculating ARR?
The formula for calculating ARR is: ARR = (Total annual subscription revenue + Recurring revenue from add-ons and upgrades) – Revenue lost due to churns and downgrades. Alternatively, you can estimate ARR by multiplying your Monthly Recurring Revenue (MRR) by 12.
Q: How can pricing strategies impact ARR?
Pricing strategies significantly impact ARR. Conduct A/B testing to find optimal pricing points, consider dynamic pricing for flexibility, and avoid frequent discounts to maintain brand value. A well-researched pricing strategy can enhance customer acquisition and retention, thereby boosting ARR.
Q: What role does customer retention play in improving ARR?
Customer retention is vital for improving ARR as retaining existing customers is often more cost-effective than acquiring new ones. Enhance retention by providing excellent onboarding, customer support, and a seamless billing experience. Reducing churn increases customer lifetime value and stabilizes recurring revenue streams.
Q: How can data analytics help in enhancing ARR?
Data analytics provide insights into customer behavior, preferences, and churn patterns. By leveraging analytics, businesses can make informed decisions on product offerings, pricing strategies, and customer engagement tactics, ultimately driving improvements in ARR.
