By Night Watcher · Examples are fictional and illustrate a research method.
The definition
Annual recurring revenue (ARR) is the yearly value of the subscription revenue a business has under contract at a point in time. It is a snapshot: it tells you what the current customers would pay over the next twelve months if nothing changed.
For monthly plans, ARR is usually monthly recurring revenue (MRR) × 12. For annual plans, it is the yearly subscription value. For a multi-year contract, it is the contract value for one year, not the full contract total. A customer on a $2,400 three-year contract billed $800 a year adds $800 of ARR, not $2,400.
What counts, and what does not
Count recurring subscription fees and recurring add-ons at the price the customer actually pays, after discounts. Leave out one-time setup or onboarding fees, professional services, hardware, refunds, and trial users who have not paid.
Usage-based charges are where companies differ. Some include a committed minimum, some include a trailing average of usage, and some leave usage out. None of these is wrong, but mixing methods between periods makes growth look better or worse than it is. Pick a rule, write it down and apply it every month.
ARR is not revenue
Revenue in the accounts is recognised over the period the service is delivered, under accounting standards. ARR is an operating metric, not an accounting figure. A growing company often has ARR above its revenue for the last twelve months, because the customers it signed recently have not yet been paying for a full year.
ARR also differs from revenue run-rate. Run-rate annualises all revenue in a period, one-off fees included. A month with a large setup fee raises run-rate but not ARR. When someone quotes an ARR figure, it is worth asking which of these they mean.
The moving parts
ARR changes for four reasons. New ARR comes from new customers. Expansion ARR comes from existing customers paying more, through upgrades, extra seats or add-ons. Contraction ARR is existing customers paying less. Churned ARR is customers who leave.
Net new ARR in a period is new plus expansion, minus contraction and churned ARR. Tracking the four parts separately shows why ARR moved. A flat ARR can hide strong sales offset by heavy churn, which calls for a different fix than weak sales.
Worked example
Take a fictional company with 300 customers on a $50 monthly plan and 40 customers on a $1,200 annual plan. Monthly plans contribute 300 × $50 × 12 = $180,000 of ARR. Annual plans contribute 40 × $1,200 = $48,000. ARR is $228,000.
Over the next quarter it adds 30 monthly customers ($18,000 of new ARR), moves 10 monthly customers to a $100 plan ($6,000 of expansion ARR) and loses 15 monthly customers ($9,000 of churned ARR). Net new ARR is $18,000 + $6,000 − $9,000 = $15,000, so ARR at the end of the quarter is $243,000.
Using ARR for growth and valuation
Compare ARR over time with a compound growth rate rather than an average of monthly changes; the CMGR calculator does this from any two dates. When ARR is used to value a subscription business, the multiple applied to it is an assumption that depends on growth, churn, margins and the market, so treat any single multiple as a scenario rather than a benchmark.
The SaaS valuation calculator applies low, base and high multiples to your ARR so you can see how much the answer depends on that one assumption.
Your worksheet
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ARR worksheet Date of snapshot: Monthly-plan customers and MRR: Annual-plan customers and yearly value: Multi-year contracts (value for one year): Recurring add-ons included: Excluded one-time fees and services: Usage-based revenue rule: ARR at snapshot: New ARR this period: Expansion ARR: Contraction ARR: Churned ARR: Net new ARR:Download the text worksheet
Test your assumptions
Use the related free calculator, then compare the scenario with evidence from actual buyers.
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