Annual recurring revenue is the lifeblood of any SaaS business.
It’s the predictable revenue that you can generate every year.
By tracking this SaaS metric, you can measure the pulse of your business and quantify the momentum at which you can grow.
But what’s the best method for ARR growth?
In this guide, we’ll cover what ARR is, how to calculate it (with a few examples), and a few benchmarks.
We’ll also dive into some relevant metrics, why SaaS ARR is crucial for your company, and a kickass method for increasing your annual recurring revenue!
This Article Contains:
- What Is Annual Recurring Revenue?
- Why Is ARR Important for a Subscription Business?
- How to Calculate Recurring Revenue
- Measure Your ARR Growth with SaaS Benchmarks
- 3 Simple Ways to Increase Recurring Revenue
- What Are Some Other Relevant Metrics to Track?
- Skyrocket Your Growth with Recurring Annual Revenue
Let’s get started.
What Is Annual Recurring Revenue?
ARR stands for annual recurring revenue.
Unlike total revenue, which measures all cash inflows, this SaaS metric focuses on subscription revenue.
SaaS ARR helps companies understand two key things:
- Earnings from expansion revenue (upselling, cross-selling, and new sales).
- Churn from lost customers and downgrades.
With this data, you can determine expected future revenue based on annual subscription earnings. ARR growth also contextualizes the velocity at which you can scale (more on that later).
Some may confuse it with other metrics, like:
- Annual contract value: Instead of measuring the contract value of multiple accounts, annual contract value measures a single account.
- Annual run rate: Your annualized run rate estimates yearly earnings based on quarterly or monthly revenue.
Speaking of monthly revenue, you may have heard of another key metric that sounds strikingly similar…
What is the difference between ARR and MRR?
Instead of measuring earnings on an annual basis, MRR measures monthly recurring revenue.
The main differences between the two metrics are:
A. ARR:
With this metric, you can view year-over-year progression at a macro level.
This helps with long-term product plans and creating a road map for your SaaS product.
B2B subscription based companies often use this metric:
- If they provide an annual subscription term (minimum).
- If they provide a multi-year subscription term.
- If they deal with low transaction volumes but high transaction values.
Annual revenue can work well with GAAP revenue (Generally Accepted Accounting Principles) if your subscriptions are in multi-year or annual intervals, unlike MRR.
What’s that?
GAAP revenue is an established set of rules for financial reporting in the US.
Instead of relying on your own figures, following GAAP standards means better revenue recognition.
Why’s this useful?
Formal revenue recognition helps you receive more credible auditing, provide investors with transparent reports, and benchmark performance against other companies.
Note: If you have non-standard subscription or contract durations (e.g. 14 months and six days), this can make calculating ARR accurately more challenging.
B. MRR:
Monthly recurring revenue allows you to see company growth month by month rather than on an annual basis.
B2B and B2C businesses with monthly subscriptions often use MRR, although it isn’t unusual for companies with yearly subscription terms to also track monthly recurring revenue.
This metric can vary dramatically from GAAP revenue due to the different number of days in monthly subscriptions.
That said, viewing monthly revenue is useful for calculating your annualized run rate. You can track run rate fluctuations at different periods of the year (especially with pricing strategy or product changes).
Also, this micro-scale measurement is helpful if you have non-standard contract durations.
Knowing ARR and MRR gives you valuable insight into your business’s health, revenue forecasting, financial planning, and operational expansions.
Why Is ARR Important for a Subscription Business?
It’s a fantastic SaaS metric for impressing investors and other key stakeholders, as it can:
- Measure performance: Tracking this metric sheds light on your revenue growth, where you’re experiencing churn, and why. Then, you can make informed decisions when assessing hiring, planning, financing, and increasing company efficiency.
- Boost and forecast revenue: Tracking expansion revenue from cross-selling and upselling provides insight into what tactics are working for an existing customer, which helps you predict and improve future revenue.
- Attract investors: A SaaS business with a reliable business model is more likely to attract investors. Investors also prefer predictable revenue via a subscription model over one-time sales.
How to Calculate Recurring Revenue
The methodology for calculating ARR depends on factors like your pricing strategy and business model complexity.
Luckily, the formula itself is pretty simple.
If you charge customers annually, your ARR calculation is:
[(Total contract value) / (Duration of contract in years) ] x (Number of customers)Here’s an example to illustrate this:
Suppose 100 customers sign up for a 1-year subscription with a total contract value of $50,000.
Your ARR calculation is:
(50,000/1) x 100 = $5,000,000
While this is fairly straightforward, let’s discuss how to keep your calculations error-free.
Calculating ARR: 2 Best Practices
To get accurate results, be aware of what to include (and exclude) in your calculations:
A. What You Should Include in Your ARR Calculation
For accurate calculations, you need to incorporate:
- Expansion revenue: An existing customer upgrading to a higher value plan.
- MRR churn: Lost customers or downgrades to lower-value plans in a given month.
- Recurring invoices: All recurring fees and subscription revenue, such as charges per seat or user.
B. What You Shouldn’t Include in Your ARR Calculation
Your annual recurring revenue is a forward-looking SaaS metric. The focus is revenue forecasting rather than recording past income.
A common mistake is when businesses add non-recurring elements, such as:
- Set-up fees.
- One-time fees.
- Non-recurring add-ons.
Do not include these in your ARR calculation.
You can, however, use these elements when adding up your total revenue.
But how do you know if your revenue growth measures up to the competition?
Measure Your ARR Growth with SaaS Benchmarks
Growth can be challenging, especially for an early-stage company.
Using growth benchmarks can help you gain a firmer footing on where you stand.
A good benchmark for an early-stage startup is roughly around $1M ARR. For a mid-stage subscription business, it’s typically at least $5M.
According to a 2021 survey, the median year-over-year growth rate for companies with less than $1M ARR is 100%. This drops to under 40% for startups with $5M or more.
However, remember, startups don’t have to follow these benchmarks to the letter.
It’s a reference to get you thinking about how to assess performance to see what’s working and what needs changing.
Knowing ARR and how crucial it is for your SaaS company is one thing.
But you’re probably wondering… how can I improve it?
3 Simple Ways to Increase Recurring Revenue
Let’s discuss three ways to increase your annual earnings.
1) Identify Your Ideal Customer Profile (ICP)
If you target irrelevant customers, your churn will increase, and the chances of them renewing subscriptions will reduce.
For these reasons, creating a specific ICP is vital.
While your ICP depends on your goals, generally, B2B companies should consider customers’ location, company size, and past challenges.
An ICP can help you target your customer base better, appeal to their needs, and reduce churn, which increases recurring revenue.
2) Implement a Customer Success Team
Once a prospect signs a customer contract, they may still have questions. If left dangling, they may hesitate when the time comes to renew their annual subscription or even start looking for alternatives.
So, how do you maintain a relationship with a new customer?
Implement a proficient onboarding process. It sets the tone for things to come, and you can use your customer success team to guide a new customer along their journey. This is critical for reducing churn and solidifying loyalty.
3) Use a Powerful SEO Strategy
SEO is a vastly underrated strategy when it comes to ARR growth.
This method is a simple and effective one, given how widely applicable it is. How your individual business model operates doesn’t matter — every SaaS company benefits from an excellent SEO strategy.
It’s vital for:
- Boosting online visibility and traffic.
- Driving conversions.
- Facilitating credibility.
- Building authority.
- Standing out against competitors.
Increased online visibility lays the foundation for raking in more revenue.
Why?
Organic search drives around 50% of total traffic across the internet. In other words, companies who have invested in SEO are getting over half of all traffic across the web.
And if you rank on the first page, you see over 90% of that traffic.
As if that’s not enough, 49% of marketers claim that organic search has the best ROI of any marketing channel.
The best part?
It’s an affordable strategy, even for a smaller SaaS company!
Investing roughly $1K per month in SEO may earn companies a solid revenue boost of around 2-5%.
Want in?
Startup Voyager is a content and SEO agency that specializes in helping companies create well-optimized content.
With our SEO magic, find and target valuable keywords that’ll drive crazy organic traffic growth, attract more prospects, and set the stage for higher annual revenue.
Now, let’s delve into other important metrics.
What Are Some Other Relevant Metrics to Track?
The main metrics you’ll need to consider include:
- MRR: This gives you an overview of your monthly revenue
- Revenue churn: This measures lost revenue from cancellations and downgrades
- PQL: This tracks the number of product-qualified leads you have in a given month (determined via product usage signals)
- Activation rate: This determines the percentage of new users who reach a certain milestone in the onboarding process
- Active users: This indicates the level of user engagement with your product or services
- ARPU: This stands for average revenue per user and shows how successful your subscription model is
- CAC payback: This is the period of time it takes for you to earn back your CAC (Customer Acquisition Costs)
Skyrocket Your Growth With Recurring Annual Revenue
Every subscription business knows how important good bookkeeping is. Understanding which metrics you need — and how to use them — is where it gets difficult.
Measuring ARR is essential for indicating future revenue, red flags, and benchmarking your performance against rival companies.
Follow our best practices for ARR calculation and revenue growth, and you can measure your success with pinpoint precision.