Annual Recurring Revenue is a metric used as a factor to value companies. In venture capital, for instance, this number is used as one of the key metrics to determine how much money should be invested in any given company. There are two ways ARR can be calculated: (1) by multiplying the average annual customer contract value by the average annual contract count, or (2) by dividing the total revenue of a company in one year by its recurring revenue.
What Does ARR Mean?
The most direct way to determine what ARR means is to use an example. If a company has 50 customers with an average customer contract value of $1,000, then their ARR is $50,000. If this company has recurring revenue of $20,000 in the same period, then it’s all fairly simple to calculate.
Basically, Annual Recurring Revenue (ARR) is what a company earns in recurring revenues every year. This means that if the metric value for an annual recurring revenue is given, then it can be calculated by multiplying the average customer contract value (ACV) per customer with the number of customers or average customer count.
How to Calculate Annual Recurring Revenue (ARR)?
To fully understand how to calculate ARR, it is important to first know about ACV and average customer count. [This part can be skipped if ACV and average customer count are known.] Average Customer Contract Value or ACV simply means the average amount a customer pays for a subscription. ACV is used to calculate annual recurring revenue by multiplying it with the average number of customers that a company has. So, if a company’s ACV per customer is $20 and they have 100 customers, their ARR will be $2 million.
In general practice, Annual Recurring Revenue (ARR) is calculated by multiplying the average annual customer contract value (ACV) with the average number of customers or average customer count.
This is how it’s generally done:
- First, find out what your ACV per account is. The formula here would be Subscription Value / Number of Accounts =ACV Per Account.
- Multiply your ACV per account with the Average number of customers or average customer count. Using the example from above, it would be $20 x 100 = $2 million.
- Finally, simply add any additional revenue streams to your product if required because sometimes an enterprise SaaS will have more than one revenue stream.
The first way to calculate Annual Recurring Revenue is by multiplying ACV per customer with the average number of customers or customer count. The second method is by dividing total revenue in one year with recurring revenue. To summarize, ARR can be calculated by either of these two methods: (1) multiplying ACV per account with the average customer count (2) by dividing total revenue for one year with recurring revenue.
How to Use Annual Recurring Revenue?
When a company has a predictable and constant stream of income, then it is important to show investors that a company has a stable foundation. This makes ARR an essential indicator in business valuation and will play a major role in how a company is valued. Therefore, it is important to be aware of ARR when pitching a company’s valuation.
In terms of the financial health of the company, knowing this number can give investors an idea of how profitable a business is and where they should allocate further investments. In short, Annual Recurring Revenue is a crucial number to know when pitching the valuation of a company.
What is an Investor’s Perspective on ARR?
ARR is similar to gross profit in that it shows how much money a business can make after all expenses are paid. While annual recurring revenue may include costs like upfront costs for establishing new contracts, other expense items should be deducted from the gross revenue to come up with a net income.
In short, ARR is a more accurate way to measure the financial health of a business compared to other methods typically used by investors. It allows investors to see what percentage recurring revenues generate as total profits for a year and how much money the company is making after paying for all of its expenses.
How is ARR Different from MRR?
It’s important to note that there are two types of revenue that are commonly referred to as “revenue”: the first being MRR, which stands for Monthly Recurring Revenue. This can be calculated by multiplying Annual Recurring Revenue (ARR) with 12 (the number of months in a year). The other type of revenue is ARR which stands for Annual Recurring Revenue. The difference between the two types of revenue is that MRR only includes monthly recurring revenues while ARR also includes annual recurring revenues.
What are some Example Uses of Annual Recurring Revenue?
One way to determine the value of a company is by using the multiple of annual recurring revenue. This is because companies with stable cash flow are more valuable compared to ones that have higher risk due to variable income, which may or may not be recouped in certain periods of time.