Annual Recurring Revenue (ARR)

Last updated: Sep 25, 2025

What is Annual Recurring Revenue

Annual Recurring Revenue (ARR) is a key financial metric representing the value of a business's repeatable, predictable subscription income normalized over a 12-month period. It quantifies the expected yearly revenue a subscription business, particularly those with contracts of a year or longer, can count on from its current customer base. The metric is calculated by annualizing all active, contractually committed subscriptions, excluding one-time fees, professional services, or variable usage charges. ARR is crucial for long-term forecasting, capital allocation, and business valuation, as it highlights the stability and scale of the subscription revenue stream.

Annual Recurring Revenue Formula

ƒ Sum(Recurring Revenue irrespective of billing interval expressed as an annual value)

How to calculate Annual Recurring Revenue

If a customer subscribes to a service with a 1-year renewal agreement for $12,000, then Annual Recurring Revenue would be; ARR = $12,000 If a customer subscribes to a service for $10,000 (with no contract), then Annual Recurring Revenue would be; ARR = $0 If a customer subscribes to a service with a monthly renewal agreement for $1,000 per month, then Annual Recurring Revenue would be; ARR = $1,000 * 12 = $12,000

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How to visualize Annual Recurring Revenue?

To visualize your Annual Recurring Revenue, you can use a summary chart to display the value and optionally compare it to a previous time period.

Annual Recurring Revenue visualization example

Annual Recurring Revenue

$133k

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6.24

vs previous period

Summary Chart

Here's an example of how to visualize your current Annual Recurring Revenue data in comparison to a previous time period or date range.
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Annual Recurring Revenue

Chart

Measuring Annual Recurring Revenue

More about Annual Recurring Revenue

Annual Recurring Revenue (ARR) is the North Star metric for many Software-as-a-Service (SaaS) and other subscription businesses that rely on term-based contracts, usually with a minimum term of one year. It provides a standardized, high-level view of a company’s financial health and growth trajectory over the long term. Since ARR focuses exclusively on contracted, recurring fees, it offers a more reliable indicator of future performance than simply looking at total revenue, which can be inflated by non-recurring transactions.

The Strategic Value of ARR

ARR is fundamentally a strategic tool used by executive leadership, boards of directors, and investors for long-range planning and valuation.

  • Long-Term Forecasting and Budgeting: The stability of ARR allows finance teams to create highly accurate 12-month, 3-year, and 5-year financial models. This predictability is essential for making capital-intensive decisions, such as securing new office space, significantly expanding the engineering team, or making strategic acquisitions.

  • Business Valuation and Investment: For venture capitalists and strategic buyers, ARR is the primary determinant of a SaaS company’s valuation. Companies are often valued using an ARR multiple (Valuation ÷ ARR), where high-growth, high-retention businesses command significantly higher multiples. Longer term contracts, where churn is demonstrably lower, signal future financial stability and are highly attractive to investors. A strong ARR trend indicates both product-market fit and a scalable business model.

  • Strategic Segmentation: ARR can be segmented by various factors, such as product line, average contract value (ACV), customer industry, or sales channel. This detailed segmentation helps leadership pinpoint the most profitable and fastest-growing areas of the business, informing sales and marketing strategy. For instance, if ARR is growing quickly in the Enterprise segment but stagnating in the Small Business segment, resources can be strategically reallocated.

ARR vs. MRR: The Key Distinction

While ARR and Monthly Recurring Revenue (MRR) are closely related, each metric serves a different operational purpose.

ARR is best for strategic planning, long-term forecasting, investor communication, and companies with annual or multi-year contracts. It's mostly used where the target market is B2B SaaS, Enterprise software, and preferred if most customer contracts are for 12 months or longer.

MRR is more common for operational management, short-term health checks, tracking the impact of monthly marketing/pricing changes, and companies with monthly contracts. Unlike ARR, target markets here are more likely to be B2C, SMB SaaS, consumption-based models, where customer contracts might be less than 12 months. 

The primary difference is their utility: ARR offers the big-picture view, smoothing out the smaller monthly fluctuations in the recurring revenue stream, making it the superior metric for year-over-year growth comparison.

Components of Net New ARR

To understand the health and momentum of the business, leaders track the change in ARR from one period to the next, which is known as Net New ARR or ARR Growth. It captures all revenue movements within the customer base.

  1. New ARR (or Gross New ARR): This is the annualized recurring revenue from brand-new customers acquired during the period. It reflects the effectiveness of the sales and marketing efforts.

  2. Expansion ARR: Additional recurring revenue gained from existing customers through actions like upgrading to a higher-tier plan, purchasing new add-ons, or increasing the volume of a usage-based subscription. High Expansion ARR is a crucial indicator of customer satisfaction and Net Revenue Retention (NRR) above 100%.

  3. Contraction ARR: Lost recurring revenue from existing customers due to downgrades to a cheaper plan or the removal of paid add-ons. This often signals a shift in customer needs or budget constraints.

  4. Churn ARR: The total recurring revenue lost from customers who cancel their subscriptions entirely and do not renew their contracts. This is the most direct measure of customer dissatisfaction or failure to deliver promised value.

  5. Reactivation ARR (or Restart ARR): Revenue from customers who previously churned but have returned and re-subscribed to the service.

Tracking these components separately allows management to identify whether growth is being driven by landing new customers (New ARR) or by increasing the value of existing customers (Expansion ARR). As companies mature, the proportion of growth driven by Expansion ARR tends to increase.

Best Practices and Exclusions

To ensure ARR is an accurate and trustworthy metric for a business and its investors, specific calculation standards must be maintained.

  • Exclusion of Non-Recurring Revenue: This is the most critical rule. ARR must exclude all one-time fees, such as setup fees, implementation charges, professional services consulting, custom development, and hardware sales.

  • Normalization of Contract Terms: For multi-year contracts, the total contract value (excluding one-time fees) must be divided by the number of years to arrive at the correct annual contribution. For example, a three-year, $150,000 contract contributes $50,000 to ARR each year, not $150,000 in the first year.

  • Inclusion of Recurring Add-ons: Any fixed, recurring fees that the customer is contractually obligated to pay annually, such as ongoing maintenance or technical support fees, should be included. However, variable, usage-based fees (like overage charges or consumption credits) should generally be excluded, as they lack the predictability required of an ARR metric.

  • Focus on Committed Contracts: ARR should only reflect revenue from customers who have a contractually committed term. Revenue should be calculated as if the customer will complete the full term of their agreement.

The failure to adhere to these standards, particularly the inclusion of non-recurring revenue, is the most common error and can severely distort the perceived health and valuation of a subscription business.

Annual Recurring Revenue Frequently Asked Questions

Why do investors prioritize ARR over GAAP Revenue when evaluating a SaaS company?

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Investors heavily favour ARR because it provides a clear, unvarnished measure of a business’s predictable growth potential, which is the most valuable asset in the subscription economy. GAAP (Generally Accepted Accounting Principles) revenue, while mandatory for regulatory purposes, often includes unpredictable elements and can be significantly affected by when cash is received. For instance, a $12,000 annual contract might be billed and recognized as $12,000 of cash flow in January, but GAAP revenue might be recognized incrementally throughout the year as the service is delivered (deferred revenue). More critically, GAAP revenue includes non-recurring, one-time fees (like setup or consulting charges). By contrast, ARR meticulously strips away these one-time fees and normalizes all contracts to a 12-month figure. This focus on the reliable, continuous revenue stream allows investors to confidently apply a valuation multiple (e.g., 10x ARR) to determine the company’s worth and forecast future cash flows, making it the definitive metric for M&A and fundraising.

How can a high Expansion ARR (or NRR over 100%) be a stronger growth signal than New ARR?

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A high Expansion ARR—the revenue gained from existing customers upgrading or buying more services—is often a stronger and more sustainable signal of business health than revenue from new customer acquisition (New ARR). Expansion ARR demonstrates a profound level of product-market fit and customer success; it proves that the company not only delivered initial value but continued to grow that value over time. Furthermore, acquiring new customers is expensive, requiring significant spending on sales and marketing (Customer Acquisition Cost or CAC). Expansion revenue, however, is generated from customers already paying for the product, making it significantly more profitable, as the cost of generating this revenue is far lower than acquiring a new logo. For high-growth SaaS companies, relying on expansion revenue to drive a greater share of Net New ARR means the business can scale more profitably, as demonstrated by the fact that top-performing companies often achieve a Net Revenue Retention (NRR) of over 120%.