Annual recurring revenue (ARR) is a measure of a company’s subscription-based revenue that is expected to be collected over the next 12 months. It is a key metric for SaaS (Software as a Service) companies, as it provides a way to track and forecast revenue growth.
There are a few reasons why ARR is the SaaS standard. First, it is a relatively easy metric to calculate. It simply requires a company to add up the total amount of revenue that it expects to collect from its subscriptions over the next 12 months.
Second, ARR is a forward-looking metric. This means that it provides a way for companies to track their revenue growth over time. This is important for SaaS companies, as they typically have long sales cycles and it can take several months or even years for a new customer to sign up for a subscription and start paying.
Plus, ARR is a scalable metric that can be used to track the revenue growth of companies of all sizes, including early-stage startups through large enterprises.
Lastly, ARR is a comparable metric, meaning it can be used to compare the performance of different SaaS companies. Investors and analysts care about this because it allows them to compare the performance of different companies which informs their investment decisions.
To calculate ARR, determine the total contract value (TCV) of your software revenue. This number should exclude one-time fees associated with the initial onboarding of that product, ie: hardware costs. Next, divide TCV by the total months of the contract. Then, multiply that number (the MRR) by 12 to get the annual recurring revenue for that product or service.