What is Annual Recurring Revenue (ARR)?

ARR is a subscription-based estimation of the revenue you’ll have this year. Essentially, it’s the annualized version of MRR. It thus takes into account your current number of annual subscriptions and your pricing strategy, among other factors. ARR is of interest for sales and marketing departments, but especially so for management. The nature of this KPI means it’s used primarily by subscription-based service providers.

ARR is a relevant KPI for your finance team to monitor.

Why is Annual Recurring Revenue important?

The importance of Annual Recurring Revenue can be illustrated in an old children’s story– “The Tortoise and the Hare.”

The famous story recounts how the two animals agreed to run a race. The Hare, believing he would win on account of his speed, ran the first leg of the race quickly, but then became tired and took a nap. He believed he had enough time to rest himself and still cross the finish line well ahead of the Hare.

The Tortoise, meanwhile, plodded along far more slowly than the Hare. But in time, he eventually passed the still-sleeping Hare and went on to win the race.

In a competitive business environment, it could be helpful to imagine your company, especially in its startup phase, as more tortoise than hare. In other words, the stable, long-term goals represented by metrics such as ARR are a better focus than short-term, dramatically fluctuating metrics such as MRR. This isn’t to say that KPIs such as MRR aren’t important, but in the end, it’s better to prioritize the bigger picture and the “long game” in your business strategy.

With this in mind, ARR works best as a metric for projection and modeling. It’s a metric of key interest to stakeholders–few will care about your monthly ups and downs, especially in the early stages of your business. However, being able to show the increased value of your revenue and the success of meeting your long-term goals will demonstrate to others–and yourself–that your company is on the right track and worthy of investment.

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How to calculate Annual Recurring Revenue

To obtain an accurate number, the calculation for ARR considers churn (the amount of money you lose from cancellations). If you already know your MRR, you can multiply it by 12 to obtain your approximate ARR.

Important! This is where ARR contains a significant flaw–it’s extrapolated based on only the data from the past month. Thus, it’s important to analyze ARR in context with other measures of revenue, and not as a standalone metric.

If you have customers who have signed a multi-year contract, and your revenue period for them is greater than one year, be sure to adjust your statistics to a 12-month period to calculate ARR.

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Best practices for Annual Recurring Revenue

ARR will give you interesting insights about your company’s growth and direction under your current strategy. You’ll therefore have hints about those business areas that could be adapted or changed to make your company more profitable.

Here’s an example of ARR in action: imagine you run a wine subscription business. In the month of February, you gained 50 new monthly subscribers, but lost 5. A monthly subscription is worth €100. Therefore, your MRR is €4500, and ARR €54,000.

Use ARR as a basis of knowledge to forecast future revenue, and to determine if and how you need to increase revenue. ARR can also allow you to gauge the state of your talent–and if your ARR is strong enough, you can use this metric to attract more talent to your business too.

Customer acquisition, customer happiness, customer retention–these are the ways to maintain and increase your ARR. Customer acquisition doesn’t require much explanation. But customer retention and satisfaction are extremely important, especially as it’s far less expensive to retain customers than obtain them.

Churn comes at a cost: make sure your current customers are happy with your products and services, and you’ll save a lot of time (and money) from trying to attract new ones. With this in mind, if your ARR isn’t where it needs to be, it’s time to invest more time and resources into customer growth and satisfaction.

If you’re looking to increase ARR, Plecto can help you achieve your goal. Give our dashboards a look, and see how they can spur on your teams’ output and company’s success.

Other KPIs similar to ARR include:

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