Annual recurring revenue measures the subscription base, not total revenue or profit

Annual recurring revenue, or ARR, is the annualized value of recurring subscription or contracted revenue. For subscription businesses, it isolates the recurring revenue base rather than total revenue or profit, and it is only useful when the company defines what counts as recurring and applies that policy consistently.

What belongs in ARR

ARR normalizes eligible recurring revenue to a one-year figure. Subscription fees are ordinarily included. Ongoing support, maintenance and add-ons may also be included when they recur under the customer agreement and the company’s stated policy.

One-time setup, implementation, installation, professional-services and perpetual-license fees are generally excluded. Companies should also disclose their treatment of discounts, add-ons and signed contracts that have not started billing.

How to calculate ARR

If monthly recurring revenue, or MRR, has been calculated using the same eligibility rules, the common calculation is:

ARR = MRR × 12

A company with $5,000 of MRR has $60,000 of ARR on that annualized basis. Another method is to annualize each customer’s eligible recurring commitment and add the results. A $100 monthly subscription contributes $1,200 annually; a $3,000 quarterly subscription contributes $12,000; and a $1,200 annual subscription contributes $1,200.

For a multi-year contract, divide total contract value by the term in years. A $6,000 contract lasting four years represents $1,500 of ARR per year.

Terminology is not uniform. Many SaaS operators use “ARR” for MRR multiplied by 12, also called annualized run rate. Some use annual recurring revenue more strictly for annual and multi-year contracted subscriptions. An ARR disclosure should state which convention it uses.

Track changes with an ARR bridge

A headline ARR total shows scale. The bridge shows what changed: begin with ARR, add recurring revenue from new customers and expansions by existing customers, then subtract contractions and churn.

Ending ARR = Beginning ARR + New ARR + Expansion ARR − Contraction ARR − Churned ARR

• New ARR is annualized recurring revenue from newly acquired customers.
• Expansion ARR is additional recurring revenue from existing customers, including upgrades or increased usage.
• Contraction ARR is recurring revenue lost through downgrades or seat reductions.
• Churned ARR is recurring revenue lost through cancellations.

In one example, a business begins with $400,000 in ARR, adds $100,000 from new customers and $50,000 from expansions, and loses $20,000 to contractions and $30,000 to churn. Ending ARR is $500,000.

ARR versus revenue, MRR and profit

• ARR is an annualized measure of eligible recurring revenue.
• Total revenue includes all income sources, including non-recurring services, setup fees and one-time license sales.
• MRR is the monthly measure of recurring revenue. When revenue is measured consistently, multiplying MRR by 12 produces ARR.
• Annualized run rate applies a recent recurring revenue pace to a year. Results can differ if churn changes or new sales do not continue at the same pace.
• Profit is income remaining after expenses and costs. ARR does not measure profitability.

What to disclose with an ARR figure

A useful ARR policy identifies eligible revenue lines, annualizes each billing cadence, specifies the treatment of add-ons and discounts, separates new, expansion, contraction and churn, and states whether the figure is contracted ARR or an annualized run rate. Consistent treatment between periods makes the metric more useful for planning and investor discussions.

Frequently asked questions

What revenue should be included and excluded from ARR?

Recurring subscription and contracted fees are generally included. Ongoing maintenance, support and add-ons may be included when they recur under the company’s policy. One-time setup, implementation, professional-services, installation and perpetual-license fees are generally excluded.

How do you calculate ARR from MRR and multi-year contracts?

If MRR is measured consistently, multiply it by 12. For an individual multi-year contract, divide total contract value by the number of years in the term. A $6,000 contract over four years contributes $1,500 of ARR per year.

What is the difference between ARR and total revenue?

ARR isolates eligible recurring subscription or contracted income on an annualized basis. Total revenue includes that income and non-recurring sources such as setup fees, professional services and one-time license sales. ARR also does not measure profit.

How should a company report new, expansion, contraction and churned ARR?

Use a bridge from beginning to ending ARR. Add new-customer ARR and expansion ARR, then subtract contraction ARR from downgrades or seat reductions and churned ARR from cancellations.

Sources

• Annual Recurring Revenue (ARR) - Calculation and Examples — corporatefinanceinstitute.com
• Annual Recurring Revenue: What It Is and How to Calculate — www.salesforce.com
• What Is Annual Recurring Revenue (ARR)? — stripe.com
• ARR: Annual Recurring Revenue vs Annualized Run Rate — chartmogul.com
• Annual Recurring Revenue (ARR): Growth Metrics for SaaS — www.maxio.com
• Annual Recurring Revenue (ARR): Calculations and Examples — breakingintowallstreet.com