What is ARR (Annual Recurring Revenue)?
Definition
ARR (Annual Recurring Revenue) is the value of recurring subscription revenue normalized to a one-year period. It's the most important metric for SaaS companies because it represents predictable, contracted revenue that will recur annually.
Unlike total revenue, ARR excludes one-time fees, professional services, and variable usage charges. It focuses purely on the subscription component that makes SaaS businesses valuable: recurring, predictable revenue.
For example, if you have 100 customers each paying $1,000/month on annual contracts, your ARR is $1.2M ($100 × $1,000 × 12 months). This number tells investors and management how much recurring revenue the business will generate over the next 12 months.
How to Calculate ARR
Basic ARR Formula
Where: MRR = Monthly Recurring Revenue from all active subscriptions
Example:
MRR: $83,333
ARR: $83,333 × 12 = $1,000,000
Alternative ARR Formula (For Mixed Contracts)
Use this when you have a mix of monthly, annual, and multi-year contracts.
Example:
- • Monthly contracts: $50,000/month × 12 = $600,000
- • Annual contracts: $300,000
- • 3-year contracts: $450,000 / 3 = $150,000
- Total ARR: $1,050,000
Why ARR Matters
1. Primary Valuation Metric
SaaS companies are typically valued as a multiple of ARR. A company with $10M ARR might be worth 5-15x ARR ($50M-$150M) depending on growth rate, profitability, and market conditions.
Example: A SaaS company growing 100% YoY might get a 10x ARR multiple, while one growing 20% might get 3-5x.
2. Growth Measurement
ARR growth rate is the key metric investors track. "Triple-triple-double-double-double" (T2D3) is a famous growth benchmark: triple ARR for 2 years, then double for 3 years to reach $100M ARR.
Path to $100M ARR: $3M → $9M → $27M → $54M → $108M in 5 years.
3. Business Predictability
Unlike project-based or transactional businesses, ARR gives you visibility into future revenue. If you start the year with $10M ARR and 5% monthly churn, you know roughly how much you'll end with, making planning and hiring decisions easier.
4. Investor Communication
When raising capital, investors will ask "What's your ARR?" as the first question. It's the universal language for SaaS company size and scale.
ARR Movement Components
Understanding how ARR changes month-to-month helps identify growth drivers and problems:
New ARR
ARR from new customers acquired this period. Driven by sales and marketing effectiveness.
Expansion ARR
Additional ARR from existing customers (upsells, cross-sells, more seats). The best kind of growth.
Contraction ARR
ARR lost from downgrades (customers moving to cheaper plans). A warning sign of value delivery issues.
Churned ARR
ARR lost from customer cancellations. This must be minimized for healthy growth.
Ending ARR = Starting ARR + New ARR + Expansion ARR - Contraction ARR - Churned ARR
Example: $1M + $100K (new) + $50K (expansion) - $10K (contraction) - $30K (churn) = $1.11M (+11% growth)
ARR Benchmarks & Milestones
| ARR Milestone | Typical Company Stage | What It Means |
|---|---|---|
| $1M ARR | Product-Market Fit | Proven people will pay, ready for Series A |
| $10M ARR | Growth Stage | Significant market validation, Series B territory |
| $50M ARR | Scale Stage | Market leader emerging, Series C+ |
| $100M ARR | IPO-Ready | Public market readiness threshold |
| $1B+ ARR | Market Domination | Category-defining company |
Common ARR Mistakes to Avoid
❌ Including Non-Recurring Revenue
Don't include setup fees, professional services, or one-time charges in ARR. Only subscription revenue counts.
❌ Counting Unpaid Invoices
ARR should only include paying customers. If a customer hasn't paid their invoice, they shouldn't be in ARR yet.
❌ Mixing ARR and Bookings
Bookings (total contract value signed) ≠ ARR. A 3-year $300K contract is $300K in bookings but only $100K in ARR.
❌ Ignoring Contraction and Churn
Some companies only report "new ARR added" without showing how much was lost to churn. Always track net ARR movement.
Frequently Asked Questions
What is the difference between ARR and revenue?
ARR only includes recurring subscription revenue normalized to an annual figure. It excludes one-time fees, professional services, hardware sales, and variable usage charges. Regular revenue includes all these sources.
How do I calculate ARR from MRR?
Simply multiply your MRR by 12. For example, if you have $100,000 in MRR, your ARR is $100,000 × 12 = $1,200,000. This assumes stable recurring revenue without significant seasonality.
Should I include annual contracts in ARR immediately?
Yes. When a customer signs a $120,000 annual contract, you add $120,000 to ARR immediately, even though you recognize revenue monthly ($10,000/month) for accounting purposes. ARR measures contracted recurring revenue.
Track Your ARR
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