What is ARR and Why Does it Matter for SaaS Companies?
Have you heard of ARR? Are you wondering if it is really a metric your SaaS company needs to measure? ARR, or annually recurring revenue, is a key metric for most SaaS companies. Consistently tracking revenue can show if your company is headed in the right or wrong direction.
SaaS companies run on a subscription model. The base of subscribers that builds up over time offers a dependable projection of how much money will come in each year. Having a firm grasp on funds coming in and going out is essential. This information allows you to recognize a need for change in your services or how you offer them.
In this blog, we will explore everything you need to know about ARR, so you can start using this metric to improve your business.
What is ARR?
What does ARR mean? The definition of ARR is a metric that measures a company’s recurring revenue from yearly subscriptions. What does ARR mean for a SaaS company? Most SaaS companies run their business with a yearly or monthly subscription model, which means tracking revenue from subscribers reveals important financial trends within a company. SaaS companies need to know how many subscribers they have, what the value of the contracts are, and if there are opportunities to upgrade the services they provide.
Annually recurring revenue is a critical metric to track if you run a SaaS company because this shows how much cash is consistently flowing into your bank account. Revenue measures all money coming in, which consists of subscriptions, as well as one-off services. When a SaaS company can show investors a healthy number of subscribers, they will be more likely to invest due to the consistency of revenue being generated.
A company can have a record month in revenue but could still be in trouble due to low subscriber rates. SaaS companies live and die by subscribers, which means their marketing methods to gain more leads and grow their customer bases are different from traditional business models.
ARR: A Momentum Metric
The ARR metric is a momentum metric because it shows where your company currently stands and where it is going based on the number of yearly subscribers. It indicates a team’s ability to complete projects, launch campaigns and, basically, get stuff done. A SaaS company could have great one-time services that drive revenue, but they must constantly look for new business to stay alive.
A company with a strong foundation of subscribers shows it is headed for growth and stability. When you have recurring revenue on a monthly or yearly basis, this allows you and your investors to see if the company is consistently growing.
ARR vs. MRR: What’s the Difference?
We now know ARR shows yearly recurring revenue, so what is the difference between ARR and MRR?
What is MRR? MRR stands for monthly recurring revenue, which is another great metric to track your SaaS company’s financial health. While MRR shows you how much money is coming in from subscribers each month, ARR tracks subscriber-based revenue on a yearly basis. Both metrics reveal vital information about a SaaS company’s financial performance. MRR offers a more focused, month-to-month picture, and ARR offers a broader perspective.
When a company can track monthly revenue, it can recognize trends and act quickly. For example, a company could look at its MRR, see potential causes of churn, and pivot to make a change. If you are not familiar with the concept of churn, we recently created a complete guide to understanding churn.
Measuring Revenue: Annual vs. Monthly vs. Both
The main difference between MRR and ARR is that MRR calculates the sum of the subscription revenue on a monthly basis, and ARR calculates this on an annual basis. ARR gives a big-picture look at the company’s business, where MRR gives a more focused view. MRR shows what is happening right now and provides immediately actionable insights for short-term gains. ARR reveals overarching and seasonal trends and actionable insights for long-term goals.
SaaS marketing experts agree that MRR is essential to track. However, both ARR and MRR are important metrics for any SaaS company to measure because their services are subscription-based.
Generally, newer SaaS companies will be more focused on MRR because they need to pinpoint their weaknesses. Tracking MRR makes them aware of any concerning data and allows them to make changes when needed instead of waiting for a catastrophe.
ARR could be more beneficial to an already established company, as they have more years of data to compare and analyze. ARR and MRR can be used by both new and established SaaS companies to give insights into company performance, possible price or service changes, and reports for investors.
Why ARR Matters for SaaS Companies
Being able to track your ARR is critical for the success of any subscription-based company. ARR as a business metric shows a company if they are bringing in new subscribers or driving them away. Whether a SaaS company finds positives or negatives in their ARR results, the report is positive because the business can follow up on the trends with educated steps to improve.
ARR reports can show key SaaS valuation multiples to improve your business. They reveal several insights that offer new opportunities to improve current subscribers’ experiences and bring in new ones like:
- Growth figures
- Realistic goals to set
- Company overview
When ARR is consistently and accurately tracked, it helps determine your business’s ultimate success.
Provides Growth Figures
An ARR report provides a SaaS company with a view of how their recurring revenue is trending over time. This report shows how changes have affected a company over the years and lay the groundwork for the most profitable way forward.
ARR gives basic insights that help a company understand what causes the yearly trends like customer churn, price/service changes, and goal achievement. If a SaaS company does not have an ARR report, it will be challenging for them to understand the impact of their choices and how to achieve or continue success.
Realistic Goal Setting
Tracking and measuring ARR allows a company to set realistic goals. If a company does not have goals based on accurate data, the results could be catastrophic. When a SaaS company has accurate year-over-year data, they can see past successes, how to continue that success going forward, and how to use that data to set realistic goals.
A Big Picture View
By tracking and measuring the ARR you get an overview of your company’s financial health. This metric allows a company to see potential areas of opportunity in which they can take action to gain new subscribers. This report shows how many subscribers a company has gained or lost.
This data can be correlated with pricing or service changes to recognize trends. If your company has accurate yearly numbers, they can be used as a roadmap to make realistic goals that can be acted on.
How is ARR Calculated?
ARR is clearly an important metric to guide SaaS companies toward strategic and effective marketing solutions, as well as monitor their current financial stability. Now, we will discuss how to calculate ARR. Together, we’ll explore the ARR equation and how to use it to your advantage. The ARR formula will require you to have numbers on your company’s:
- Expansion revenue
- Annual customer revenue
When you have accurate numbers, it should be easy to find out your company’s ARR.
When calculating ARR, you should not use one-time fees or services because this report aims to show recurring revenue, not one-time revenue gains. If your company has an accurate MRR report, the ARR report should not be difficult to generate. Another important metric to understand before calculating ARR is churn.
It is vital to have accurate numbers when calculating the ARR metric. If the calculations are off, your ARR roadmap will lead your company in the wrong direction. Inaccurate data could mislead stakeholders and investors, which brings another set of dangerous issues in and of itself. Remember, you will only need the recurring revenue or subscriptions, not one-off services.
- Churn: The rate at which customers are canceling their subscriptions to a service.
- Expansion Revenue: Revenue that is made in addition to the customer’s initial contract or subscription. The expansion revenue could be add-ons, cross-sells, or upsells to their original subscription.
- Annual Customer Revenue: This metric is the revenue calculated from the yearly subscription cost. This number varies based on the specific customer and what their subscription looks like, so be sure to add these carefully.
Annual Customer Revenue ($) + Gains From Expansion Revenue ($) – Loss Due to Churn ($) = ARR
For example, Company XYZ made $1,000,000 in customer subscriptions in 2020 and also made $500,000 in subscription add-ons, but lost $250,000 due to churn/customers canceling their subscriptions.
Annual Customer Revenue ($1,000,000) + Gains From Expansion Revenue ($500,000) – Loss Due to Churn ($250,000) = ARR ($1,250,000)
Understanding and Improving Your ARR
Tracking ARR shows your SaaS company its current and future financial health, which is essential. However, you’ll gain more from tracking ARR when your entire company understands what it means. The whole company needs to have a firm grasp on ARR because each department has a huge effect on its ultimate outcome.
The sales department needs to know about ARR so it can provide feedback on why customers are subscribing and/or leaving and if changes need to be made. Finance needs to be aware of ARR to know that the company is headed in the right financial direction. Even the developers need to be aware of ARR to ensure service features are working for customers, not creating churn.
If your company understands the current and future health of its services, everyone gains a clearer perspective on what actions should be taken to reach company goals. Below we will go over a few tips on how to improve ARR.
- Improve marketing – One way to increase your ARR is to gain more subscribers. Among other useful marketing initiatives, you can try changing up or adding to your marketing strategies to draw new customers’ attention.
- Offer trial subscriptions for FREE – At first glance, it may seem counterintuitive to give away your services when trying to make money. In reality, if you have a solid SaaS product, this could develop future paid subscribers. This is just one example of how SaaS marketing tactics are different from marketing for more traditional services.
- Build new features – If your company is losing subscriptions, maybe it’s because your service does not have all the features they are looking for. Send surveys or talk with your customers about how your service could better serve their needs.
- Develop a new pricing model – Another way to gain subscribers or keep from losing them is to have various pricing options. This way, you can keep customers who would have canceled your service due to their budget, gain new customers at a possibly lower entry price, and upsell current customers to a higher level of service.
Start Growing Your ARR Today with Augurian
ARR is vital to your SaaS company’s success because it reveals important financial trends and industry trends that you can use to generate further success. With an accurate ARR, the most effective growth indicators shine through, providing clear paths forward for efforts to invest in and efforts to cut out. For more helpful insights on SaaS marketing, subscribe to our SaaS Scoop newsletter.
Tracking annual recurring revenue provides your SaaS company with the insight needed to grow and continue to build on your success. If tracking and improving growth metrics are an important part of your strategy, partner with our SaaS marketing agency. Using our intelligent approach to digital marketing and our expertise, Augurian helps SaaS companies like yours drive growth and achieve measurable results. Speak with an Augur today to grow your business.