Annual Recurring Revenue (ARR) is an important metric that businesses need to look into. They usually use this measurement when they want to check and estimate how much money they’ll make in a year. For both a company and an investor, this standard is critical to see the business’s overall health. This metric will always be seen in a company's annual portfolio.
ARR can also help a company see if they are on the right path or not. This is because annual recurring revenue can be assessed based on the customer's subscription. This can also help management make informed decisions if they want to make changes to the price and product development. Knowing how this method can help businesses is essential.
What does ARR mean?
ARR stands for Annual Recurring Revenue. It is a financial metric that measures the predictable yearly income a company earns from its subscription-based services. This is specifically vital for the business model in digital services, and earns a monthly or annual income. As the income is steady and expected, this type of metric helps companies see their long-term progress and plan for the future.
It offers numerous benefits for businesses. It can give stable and accurate data on a company's profit. Businesses can compare their earnings year on year to make long-term plans. Moreover, it can also be used to measure how much customer loyalty the business has, since it tracks how much money comes from people who keep paying regularly.
Annual recurring revenue helps investors as it is a vital metric that can showcase potential earnings growth in the business. It can also provide investors with clear information about a company's financial condition, whether it is stable or not. Many subscription-based companies use ARR as a key measure of success.
ARR business formula
Precise ARR calculation is important. You need to calculate it correctly. Firstly, you need to add the amount of yearly subscription earnings your company got from the business. Subtract the amount lost from churned customers. Despite its simple calculation, sometimes many startups still miscalculate it. They may include data that should not be included in the equation, and they will get an inaccurate result. Here is its formula:
-
ARR Formula = (Sum of subscription revenue for the year + recurring revenue from add-ons and upgrades) - revenue lost from cancellations and downgrades that year.
On this formula, you need to include recurring subscriptions, upgraded accounts, downgraded accounts, and lost revenue from cancellation. However, please keep in mind that you should not include discounts, set-up fees, account adjustments, and any other non-recurring charges in the formula.
ARR to revenue conversion
Converting ARR to revenue is mainly simple. However, it is only applicable for businesses that rely entirely on recurring revenue, like pure Software as a Service business models. This is because they only have subscription offerings for generating sales. In most real-world cases, the company usually has non-recurring revenue, making the formula like this:
-
Total Revenue = ARR + Non-Recurring Revenue
However, please keep in mind that this metric is looking forward and is a great measurement to predict. Meanwhile, revenue is the overall earnings the real money company receives. Annual recurring is great for forecasting, but revenue must be in financial reporting that reflects what the company actually earned that year.
Benefits of understanding annual recurring revenue
Understanding annual recurring revenue (ARR) offers many benefits for your business. One of them is tracking the health of subscription-based businesses over time. It can also give you thorough information about a company's current financial condition. By learning this, you will know how to generate yearly growth goals.
Understanding annual recurring revenue can also help evaluate whether your business is suitable or not in terms of product-market fit. Therefore, you can plan better for future product development. Not only that, but here are more benefits you can get:
Figure out tangible growth
ARR is also known as a momentum metric. This is because it can give you a clear measurement of how your annual recurring revenue compounds over time. You can use it to make better business plans and the most efficient way for your company’s future growth. It can act as a compass for you to track your company's success.
Forecast future revenue
Annual recurring revenue can also forecast a subscription-based business's future earnings. This is because you can reference earnings cancellations, potential changes, and goals. By knowing this complex calculation, you can build a better overview of what your company will do to generate more profit. Without this measurement, you will not understand the customer impact based on the choices you make for the business.
Set realistic goals
A strong understanding of ARR will enable you to set realistic goals. This is because it can provide you with valuable data for decision-making in the future. You can see an opportunity in your current business model. Then, you can decide what action you will take for the greatest effect.
Show business’s overall health
Only including the real money that your business gets will show you the real overall health condition of your business. Tracking it correctly is crucial as it is the only way you can have general information regarding your revenue stream. By knowing this, you can create the most accurate view of your business's success and health.
Ways to optimise ARR
ARR is the only way you can generate more money and momentum in subscription-based businesses. This is because the more recurring revenue you get, the more you can see your business growing. You can expand your plan to attract more customers for long-term business. Here we are going to share ways to optimise it:
-
Increase net customer purchase: Make sure you bring a valuable potential customer who is most likely to buy your subscription.
-
Increase expansion: You can use your current customer to upgrade their subscription, which will bring in more money.
-
Gain retention: Make sure your product matches with your customers so that they will purchase it again, month by month.
-
Reduce customer acquisition cost: Lowering this cost while ensuring you can generate sales for customers will most probably bring more money to your business.
Final consideration
Annual Recurring Revenue (ARR) is the key metric for those who run the business with a subscription model. Using this data is crucial as it will help you to check your overall business health condition. This can also help you to take action for growth momentum. Learning this standard will help your business in the long run.
If you want to learn more about business, you can enrol in the course with the College of Contract Management. As a reliable provider in this industry, the College has many courses that will help you run your business efficiently. With that in mind, you can ensure your company's growth is in your hands. So, why wait? Enrol now and join us today!
