Annual Recurring Revenue: Definition, Calculation and Different Types of ARR

Why is ARR such an important metric for SaaS companies?

1. A leading indicator you can use to track momentum 

In the SaaS world, ARR is a core metric that boards and investors use to evaluate a company’s prospects for success. SaaS companies can use the metric to set forward growth targets and sales quotas. The ARR is also useful for capacity planning for which your existing ARR can be used to calculate a new, forward-looking ARR target.

In fact, ARR provides the basis for several KPI-based SaaS planning processes and projections and plays a key role in the valuation of SaaS companies. Investors track ARR trends to determine valuation multiples (the ratio of a company’s ARR and its valuation), during funding rounds. As a momentum or leading SaaS metric, SaaS ARR intuitively gives stakeholders an idea of which way the company is headed.

2. Gives you a quick way to track gross sales 

ARR is a quick way to measure top-line growth. Calculating your ARR gives you a snapshot of where your business currently stands in terms of gross sales. It’s also a key component of the formula for forecasting ARR to estimate your year-end revenue, which can help you proactively  identify problems that need fixing. For instance, if your actual ARR lags your projections, you can dive deeper into your go-to-market (GTM) team’s performance to investigate any issues. 

3. Provides insights into different areas of business

There are six different types of ARR that are crucial for SaaS decision making because they offer insights into several aspects of your business including sales, customer success and satisfaction, and a customer’s lifetime value (LTV). 

Some of the different types of ARR seem very similar, offering slightly different ways of looking at performance. However, they’re all interrelated and by combining them in different ways, you can gain a much deeper understanding of your SaaS business finances. 

The 6 types of ARR you must know and why

Here are the different types of ARR you must know and why they matter.  

1. New ARR – This is ARR generated from new subscriptions, which helps you assess how well you’re on track with your new business development. It is the total ARR from new customers. As such, it is sometimes also referred to as “New Logo ARR” or “New Business ARR”. 

2. Expansion ARR – This is ARR gained from subscription upgrades via upsells and cross-sells, which tells you the impact those efforts specifically are having on your revenue. Calculating and then drilling down into what is driving your expansion ARR can help you improve it and other metrics as well. For example, the additional revenue from expansion ARR increases the lifetime value (LTV) of your customers and your net retention rate (NRR). And, because selling more services to existing customers doesn't add to your customer acquisition cost (CAC), it also improves your LTV:CAC ratio—a key indicator of your sales efficiency.

3. Renewal ARR – This is ARR generated from renewed subscriptions. For SaaS companies, the subscription model provides the basis for business growth. Renewal ARR (also known as Retention ARR) is a predictor of customer satisfaction. It’s also an indicator of future growth because it represents your ability to deliver long-term value to your customers, which helps to generate more revenue without adding to your CAC. 

4. Churned ARR – This type of ARR measures the revenue lost from customers canceling their subscription or choosing not to renew (the logo is lost). Churned ARR can indicate a number of things. Churn can be an indicator of customer satisfaction. For example, an increasing number could mean your customers aren’t happy with some aspect of your product, something you might be able to address. Or, it could be that the customer has simply found a cheaper alternative. 

5. Contraction ARR – This type of ARR represents any type of reduction in what the customer was previously paying, which could include plan downgrades, one/more canceled licenses or seats, or usage-based reductions. (Contraction ARR should not be confused with “Contracted” ARR, which reflects contractually guaranteed annual recurring revenues.)  

6. Resurrected ARR – ARR gained from subscribers who canceled subscriptions but signed back up during the time period. Resurrected ARR (also known as Reactivation ARR) can indicate a couple different things. Reaching out to your resurrected customers to find out why they came back is a good idea because it can reveal insights into what it might take to win back previous customers.

How do you calculate your company’s total ARR (with an example)

You can calculate ARR by summing the following individual metrics:

• Revenue earned from new subscriptions (New ARR)
• Revenue earned from subscription upgrades (Expansion ARR)
• Revenue earned from existing subscription renewals (Renewal ARR)
• Subtract revenue lost from canceled subscriptions (Churned ARR)
• Subtract revenue lost from downgraded subscriptions (Contraction ARR)

Here is the formula to calculate ARR for your SaaS business.

Here’s an example ARR calculation

Let’s see an example of how you can calculate your company’s ARR. In this example, our company has the following:

New ARR = $5M
‍Expansion ARR = $2M
‍Retention ARR = $3M
‍Churned ARR = $1M
Contraction ARR = $1M

Alternatively, you can calculate ARR by multiplying your monthly recurring revenue (MRR) by 12. MRR is the revenue you earned from subscriptions over the course of a calendar month. Note, that any annual contract payment included in your ARR will need to be divided by 12 and spread out over the entire year to get an accurate MRR with this method.    

Here’s an example of how you can calculate ARR using MRR. In this example, our SaaS company has an MRR of $700,000:

What is a good SaaS ARR growth rate?

There is no single “good” ARR growth rate. However, depending on the size and maturity of your company, you can benchmark your growth by looking at ARR benchmarks for other SaaS companies. 

There are a number of studies that have attempted to determine ideal SaaS growth rates. One study conducted by venture capital company OpenView in 2021 revealed the following ARR benchmarks, based on company stage:

• Angel/seed stage: $2 million
• Series A: $6 million
• Series B: $15 million
• Series C: $35 million
• Series D and later: $50 million
• After IPO: $1,029 million

Based on these results, this much is clear: The larger or more mature the company, the lower its growth rate. This is because companies with smaller revenues tend to grow faster and as such have a higher growth rate while larger companies generally have lower growth rates. 

Another 2021 study conducted by Bessemer Venture Partners broke ARR benchmarks down by growth rate and stages. The study highlighted the following growth rates, grouped by company ARR:

A 2020 study conducted by SaaS Capital listed the following growth rate percentiles, grouped by ARR:

ARR versus revenue

Revenue is the sum of all the cash generated from sales in your business while ARR accounts for just subscriptions. Revenue is a generally accepted accounting principles (GAAP) term, which applies to money coming into your business from services that have, for the most part, already been rendered. In contrast, ARR is not. A SaaS company can earn revenues through the following channels:

1. Revenue from subscriptions
2. Revenue from consulting fees
3. One-time payments such as installation and onboarding fees

GAAP revenue is the sum of these three items while ARR is just the first. As a result, ARR is always lower than total revenues.

The following table illustrates the major differences between ARR and revenue:

How Drivetrain simplifies ARR analysis and tracking

If you have a relatively simple pricing model for your SaaS, such as a price based on the number of licenses sold, then tracking your ARR may be relatively straightforward. However, tracking ARR becomes much more challenging with the more complex pricing models increasingly prevalent in the SaaS industry today. Such models use a combination of pricing factors for which the data resides on different platforms and is difficult to consolidate. 

Many FP&A teams also rely on spreadsheets and business intelligence (BI) tools to create models and projections but this approach has its drawbacks. Spreadsheets are inflexible and not built for modern SaaS FP&A needs. BI tools offer a historical view of your business based on past data but cannot answer the “what-if” types of questions needed to support planning and analysis. 

Drivetrain offers a purpose-built solution for simplifying the FP&A process with an easy, intuitive interface that can help you:

• Automate data sourcing and build reports and dashboards in an Excel-based interface.
• Drill-down from summary to transaction data to quickly identify drivers that impact revenue goals and answer follow-up questions.
• Automate calculation and consolidation of financial and SaaS metrics, cash flow and sales projections.

ARR is an important SaaS metric that plays a critical role in financial projections. Drivetrain makes ARR tracking and analysis simple, giving you powerful insights into your business that you can leverage for faster growth.