Definition
Annual Recurring Revenue is a business metric used primarily by subscription and recurring-revenue companies to estimate the annualised value of revenue that is expected to recur from existing customer contracts or subscriptions.
ARR is typically derived from recurring revenue rather than one-time or non-recurring income. It can help companies and investors understand the current scale of a recurring-revenue business and track changes resulting from new customers, expansions, downgrades, and cancellations.
ARR is a management and operating metric, not a standardised accounting measure. Its calculation can therefore differ between companies. A company should define clearly what it includes in ARR, particularly when contracts contain one-time fees, usage-based charges, discounts, or other non-recurring components.
How is ARR calculated?
A simple calculation for a subscription business is:
ARR = Monthly Recurring Revenue × 12
For example, if a company has $100,000 in MRR:
$100,000 × 12 = $1.2 million ARR
Another approach is to annualise the recurring value of active customer contracts.
The appropriate calculation depends on the company's revenue model and ARR definition.
What is included in ARR?
ARR generally includes revenue that is expected to recur.
Depending on the business model, this can include:
Annual subscriptions
Monthly subscriptions annualised
Recurring software licences
Recurring platform fees
Contractual recurring service revenue
The company should establish a consistent methodology for determining what qualifies as recurring.
What is usually excluded from ARR?
ARR generally excludes revenue that is not expected to recur.
Examples can include:
One-time setup fees
Implementation fees
Professional services
Consulting fees
One-off purchases
Non-recurring projects
Certain usage-based charges, depending on the company's methodology
There is no universal rule covering every business model. Usage-based businesses in particular may need a more specific definition.
ARR vs. revenue
ARR and revenue are not the same measure.
Revenue is an accounting measure representing revenue recognised during a specific reporting period according to the applicable accounting framework.
ARR is an operating metric that estimates the annualised recurring revenue associated with the company's current customer base.
For example, a SaaS company could have:
$1.5 million ARR
$1.2 million recognised revenue
Those figures can legitimately differ because ARR is an annualised forward-looking metric, while recognised revenue reflects accounting treatment during a particular period.
ARR vs. MRR
ARR and MRR measure the same broad concept at different annual and monthly scales.
MRR, or Monthly Recurring Revenue, measures recurring revenue on a monthly basis.
ARR annualises recurring revenue.
A simplified relationship is:
ARR = MRR × 12
For example:
Metric | Amount |
|---|---|
MRR | $50,000 |
ARR | $600,000 |
However, companies should use consistent definitions when calculating both metrics.
Why does ARR matter?
ARR can help a recurring-revenue company track its commercial progress.
It can be used to monitor:
Revenue scale
Customer growth
Expansion
Downgrades
Cancellations
Recurring revenue growth
Fundraising milestones
Investors may also use ARR alongside other metrics to assess the scale and growth of a subscription business.
ARR alone, however, does not show whether revenue is profitable, sustainable, or efficiently acquired.
What increases ARR?
ARR can increase through:
New customers
A company acquires new recurring customers.
Expansion
Existing customers increase their recurring spend.
Price increases
The company increases recurring pricing, assuming customers remain on the service.
Product or seat expansion
Customers purchase additional seats, products, or recurring services.
These changes can be analysed through metrics such as new ARR, expansion ARR, contraction ARR, and churned ARR.
What decreases ARR?
ARR can decrease through:
Customer cancellations
Downgrades
Pricing reductions
Contract losses
Reductions in recurring usage, where included in the company's ARR methodology
This makes ARR useful for understanding how the recurring customer base is changing over time.
What is ARR growth?
ARR growth measures the change in ARR between two points in time.
A basic calculation is:
ARR growth = (Current ARR − Previous ARR) ÷ Previous ARR × 100
For example, if ARR increases from $2 million to $2.5 million:
($2.5M − $2M) ÷ $2M × 100 = 25%
ARR growth should be considered alongside retention, customer acquisition, margins, and cash consumption.
Does ARR mean guaranteed future revenue?
No.
ARR is an annualised estimate based on recurring customer relationships or contracts. It does not guarantee that the same amount of revenue will actually be recognised over the following twelve months.
Customers can cancel, downgrade, fail to renew, or change their usage.
The distinction is particularly important for contracts that are cancellable, usage-based, or otherwise subject to material changes.
ARR in fundraising
ARR is particularly relevant when investors evaluate subscription and recurring-revenue businesses.
Depending on the company's stage, investors may consider:
ARR
ARR growth
Net revenue retention
Gross retention
Churn
Customer acquisition cost
Gross margin
Sales efficiency
Cash burn
Runway
The significance of ARR depends on the company's business model. It is less informative for businesses whose revenue is primarily transactional or non-recurring.
Example
A software company has 200 customers.
Each customer pays an average of $500 per month for its recurring subscription.
Its MRR is:
200 × $500 = $100,000
Its ARR, using the simple annualisation method, is:
$100,000 × 12 = $1.2 million
If 20 customers cancel and the remaining customers do not change their subscriptions, the company's ARR decreases.
If existing customers add additional seats or products, ARR can increase even without acquiring new customers.
Common misconception
ARR is the same as the revenue a company will earn next year.
No.
ARR is an annualised measure of the recurring revenue base at a particular point in time. It is not a forecast of recognised revenue.
Future revenue can differ because of cancellations, expansions, downgrades, new customers, contract changes, seasonality, accounting treatment, and other factors.
