Annual Recurring Revenue for a SaaS Business
Apr 03, 2020 ● 3 min read
One of the primary reasons why were are all in Software as a Service (SaaS) industry is the monthly or yearly recurring revenue. Recurring revenue simply implies that the growth of your business can compound.
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What is Annual Recurring Revenue (ARR)?
Simply put, annual recurring revenue refers to the total amount of income earned for a product or service that requires subscription usually calculated on a 12-month time frame. This calculation always involves money earned before costs, which is alternatively referred to as revenue.
For instance, it’s not uncommon to see metrics used in predicting the future of revenue for a gymnasium based on its current membership levels. On the other hand, it is also used by businesses to measure the yearly revenue for subscription-based products or services.
If you desire to invest in a particular business and you would want to foresee how much revenue you would make at the end of the year, then you need to know your ARR.
The value of subscription-based businesses solely depends on the growth of their annual recurring revenue. This is because your annual recurring revenue determines how you make decisions that relate to hiring more people and expanding your business.
How to Calculate Annual Recurring Revenue (ARR)
Let’s assume that you are providing Software-based subscription services, and it costs about $40 per month.
The simple thing about the annual recurring revenue is to take the monthly payment of $40 and multiply by 12, which is one year. Then, you’ll simply get your annual recurring revenue. So, your annual recurring revenue per one customer is $480.
Here is another example:
Let’s assume you created and launched an online course that’s worth up to $5,000, and you offer an installment payment plan of $416 monthly.
This will put your monthly recurring revenue at $416 per each customer while the annual recurring revenue is $5,000 per customer.
Calculating ARR is simple. Here is the simple equation:
ARR= (Cost of Product or service) * (# of customers) * (12 months).
Why Should You Care About ARR/MRR?
Tracking both your annual recurring revenue and monthly recurring revenue provides you with the opportunity to plan for the short and long term.
Typically, businesses and companies with more than $10M annual recurring revenue think more about their recurring revenue and even most of their metrics in an annual recurring revenue fashion. Those smaller businesses with less than $10M ARR typically shifts their focus on MRR.
Why Should You Understand Your ARR/MRR?
When it comes to segregation between the successful and unsuccessful elite in the SaaS industry, understanding the ARR/MRR is one of the driving factors. The main areas you need to shift more of your attention include compass metrics, finance, and products/sales.
Below are a few reasons why you should understand your ARR/MRR.
Products and Sales Team
Every month, you should consider incentivizing your product team to formulate features and experiences to defend your MRR against MRR churn. Of course, the majority of your product teams may have incentives to help them focus on the net new MRR. Ensure that your sales and marketing team also focuses on net new.
Post-Product-Market Fit Compass Metric
After utilizing the procedures for user testing and activity to determine the accurate product-market fit, MRR or ARR then begins the operation of serving as the primary compass to facilitate and monitor the growth within a SaaS organization.
This is crucial as MRR is the purest and most effective way to measure and monitor your revenue in the SaaS business, thus indicating the level of increase or decrease in your momentum over time.
Critical Financial Metric
Typically, MRR is considered the most crucial financial metrics when it comes to giving the most accurate financial projection for your SaaS Company. It gives the most reliable and appropriate account of the recurring components of your subscription model. And yes, it also gives that same component for the yearly basis with the use of ARR.
All these measures we’ve explained helps to understand our business on a deeper level. But nothing will grow your business more than hustling and making more sales. You need to focus more on these two things, and everything else will take care of itself.