The ARR (Annual Recurring Revenue) is an indicator of the future annual revenue of a SaaS (Software-as-a-Service) company. SaaS is a business model based on subscriptions. The ARR makes it possible to measure the recurring revenue over the medium or long term. In this context, what is the benefit of using the ARR and how is it calculated?
ARR: definition
The Annual Recurring Revenue, abbreviated as ARR, is a technical indicator based on the number of annual subscriptions taken out with a company. It is measured in order to predict the company’s income over the year. It is an indicator that can be calculated with these conditions:
- non-recurring income, expenses and charges of the company are excluded from the calculation
- subscription offers are sold on the basis of a duration of at least one year. A SaaS company whose business model is based on three to six month subscriptions (or on non-binding offers) should instead rely on its monthly recurring revenue index (MRR).
How to calculate your ARR?
The formula for calculating ARR is simple: it is the multiplication of the number of customers by the cost of the annual subscription. In practice however, a company must deal with variation factors: cancellations of subscriptions, additional sales’ targets, etc. These factors are called KPIs - Key Performance Indicators. Silvr provides you with information about various types of KPIs to follow for SaaS companies that help to retain its customer base.
The variation of ARR occurs when a customer expands their current plan opting for more subscriber seats and a higher price. Conversely, a shortfall can occur when customers take advantage of a discounted introductory offer or reduce their subscription package.
Thus the overall formula for calculating the ARR from the MRR is:
(Monthly subscription revenue + new customer revenue + other recurring revenue) - (Loss due to plan change - Loss due to unsubscribes) = MRR
Then MRR x 12 = ARR
What are the benefits of calculating ARR for a SaaS company?
The calculation of ARR has essential advantages when drawing up a market study or a financialization plan.
First of all, it is a real tool for decision-making which makes it possible to make realistic projections in the relatively near future. The ARR offers a real estimate of the value of a customer base, which considerably influences strategic and operational choices. Furthermore, a negative variation of the ARR is an alert to which it is possible to react quickly in order to avoid critical situations.
The ARR also constitutes a basis from which it is possible to set realistic and achievable objectives, which fits perfectly into a SMART approach (specific, measurable, achievable, realistic and temporally defined objectives). Silvr also offers, within the framework of its financing contracts, consulting services based on the analysis of the ARR.
For SaaS whose type of business model is based on increasing the number of subscriptions (or their value), the ARR is an indicator of the growth of the company. Please note that this is not a profitability indicator since it does not take into account the cost of customer acquisition, which is often very high in SaaS companies. It is also a good basis for ensuring sufficient cash to cover the company’s annual costs, to obtain a global vision of its activity and to propose processes centered on its users.
ARR also functions as a key indicator in the customer relationship cycle of a SaaS company. The calculation demonstrates how crucial it is that subscribers sign up for a premium subscription as soon as possible.
Using your ARR to obtain a loan: is it possible?
The ARR is an excellent metric to convince investors of the businesses’ stability by highlighting its income. Indeed, the calculation of the ARR is an element that precedes the conclusion of a loan contract, which young SaaS companies sometimes have difficulty obtaining.
Our teams carry out a numerical analysis of several types of KPIs, including SaaS metrics . Among these indicators, we also study the Net Promoter Score (NPS) in order to estimate the proportion of customers likely to recommend the products to friends or colleagues, which has a positive influence on the borrowing capacity of our beneficiaries. We use our analysts to estimate the Lifetime Value (LTV), a value that allows us to better categorize our customer profiles to adapt our offers to each type of user.
Silvr uses the Revenue Based Financing method. Our teams calculate the possible evolution scenarios of a company by estimating the recurrence and the potential amount of its income. In this context, the ARR makes it possible to calculate a viable and realistic cost base. If the measure is positive and engaging, the ARR can be very useful for validating your financial credit.
Silvr uses the ARR calculation in its analysis to offer flexible financing to digital companies. Since the ARR reliably measures the fluctuations of the MRR, it is very useful for arranging financing repayments with variable and personalized amounts. In this sense, the ARR is a finance metric that reflects the functioning of young digital SaaS companies and meets the needs of startups.
