Metrics & Finance DefinedTerm

ARR (Annual Recurring Revenue)

Also known as: ARR, Annualized Run Rate, Annual Recurring Revenue

Predictable revenue a company expects to receive annually from subscriptions or recurring contracts.

Updated: 2026-01-04

Definition

ARR (Annual Recurring Revenue) is a fundamental metric for subscription-based companies (SaaS, membership, recurring contracts) that measures the annualized value of active recurring revenue at a given point in time. It represents the predictable revenue the company can expect to receive in the next 12 months, assuming no growth or churn.

The basic ARR formula is:

ARR = Sum of all active annual recurring contracts + (MRR × 12)

Where MRR is Monthly Recurring Revenue. For example, if a SaaS company has 100 customers paying 100 euros/month, ARR is: (100 × 100) × 12 = 120,000 euros.

ARR is crucial because:

  • Predictability: Provides visibility into future revenue, essential for planning and valuation
  • Comparability: Normalizes revenue on annual basis, enabling comparisons
  • Growth tracking: Decomposes growth into components (new, expansion, churn)
  • Investor metric: VCs and public markets value SaaS on ARR multiples

ARR emerged in the 2000s with the rise of SaaS models. Salesforce (2000) and NetSuite (1998) were among the first to use it. Today it’s standard for SaaS: Snowflake, Databricks, ServiceNow publicly report ARR.

Unlike traditional revenue (GAAP), which follows accrual accounting, ARR is a forward-looking operational metric. It doesn’t replace GAAP revenue but complements it, offering insights into recurring business health.

How it Works

ARR calculation requires attention to detail for accuracy and comparability.

What to Include in ARR

Include:

  • Recurring subscription fees (monthly, annual, multi-year)
  • Recurring add-ons (additional users, premium features)
  • Multi-year contracts normalized annually (3-year 300K contract → 100K ARR)

Exclude:

  • One-time fees (setup, implementation, training)
  • Non-recurring professional services
  • Variable usage-based revenue (except if predictable via minimum commits)
  • Free trials (count only when converting to paying)

Example: Customer pays 10,000 euros setup (one-time) + 5,000 euros/year subscription. ARR = 5,000 euros (not 15,000).

Detailed Formula and Components

ARR = ARR₀ + New ARR + Expansion ARR - Churned ARR - Contraction ARR

Where:

  • ARR₀: ARR at start of period
  • New ARR: Revenue from newly acquired customers
  • Expansion ARR: Upsell/cross-sell to existing customers
  • Churned ARR: Revenue lost from cancelled customers
  • Contraction ARR: Downgrades/reduction from existing customers

This decomposition (ARR waterfall) is essential for diagnosing growth.

Example quarterly ARR waterfall:

  • ARR start Q1: 1,000,000 euros
  • New ARR: +150,000 euros (30 new customers @ 5K each)
  • Expansion ARR: +50,000 euros (upsell to enterprise tier)
  • Churned ARR: -80,000 euros (16 lost customers @ 5K)
  • Contraction ARR: -20,000 euros (4 customers downgrade)
  • ARR end Q1: 1,100,000 euros (+10% QoQ)

ARR vs MRR

MRR (Monthly Recurring Revenue) is the monthly equivalent. Relationship:

ARR = MRR × 12 (only if all contracts are monthly)

In reality, a mix of monthly and annual contracts complicates calculation. Correct approach:

ARR = (Annual contracts) + (Monthly contracts × 12)

When to use ARR vs MRR:

  • MRR: Early-stage startups, rapid movement, monthly granularity
  • ARR: Scale-ups and enterprise, annual planning, investor reporting

A company with 100K MRR has 1.2M ARR. But if 50K is from annual contracts and 50K from monthly, need to distinguish for accurate churn analysis (annual vs monthly churn is different).

Derived Metrics

Net New ARR: Net ARR growth in a period. Formula: New + Expansion - Churned - Contraction.

ARR Growth Rate: (ARR_end - ARR_start) / ARR_start × 100. SaaS benchmarks:

  • Early stage (under 10M ARR): Target 100-300% YoY
  • Growth stage (10-100M ARR): Target 50-100% YoY
  • Scale stage (over 100M ARR): Target 30-50% YoY

Net Revenue Retention (NRR): (ARR from cohort - churn - contraction + expansion) / Initial cohort ARR. NRR over 100% indicates expansion exceeds churn (holy grail for SaaS). Best-in-class: 120-150%.

Use Cases

Valuation and Fundraising

VCs value SaaS on ARR multiples. Simplified valuation formula:

Valuation = ARR × Multiple

Multiples vary by stage, growth rate, profitability:

  • Early stage (pre-PMF): 5-10x ARR
  • Growth stage (hypergrowth): 15-30x ARR
  • Public SaaS (mature): 5-15x ARR (median ~8x in 2024)

A company with 5M ARR growing 150% YoY and 120% NRR can target 20-25x multiple → 100-125M valuation.

For fundraising, projecting future ARR is critical. Typical pitch deck shows historical ARR + 24-month projection with assumptions (CAC, churn, ACV).

Planning and Budgeting

Forward-looking ARR guides hiring and spend decisions. Formula:

Burn Multiple = Net Burn / Net New ARR

Measures efficiency: How much cash burned to generate 1 euro of ARR. Best-in-class: Under 1.5x. Over 3x indicates inefficiency.

A company with 500K ARR and 100K monthly burn (1.2M annual). If ARR growth is 300K/year, burn multiple = 1.2M / 300K = 4x. High. Need to optimize CAC or reduce burn.

Cohort Analysis and Retention

Segmenting ARR by cohort (acquisition month/year) reveals retention trends.

Cohort analysis example:

  • Cohort Jan 2024: 100 customers, initial ARR 500K
  • After 12 months: 85 customers remaining, ARR 550K (expansion compensated churn)
  • Cohort NRR: 550K / 500K = 110%

If NRR is negative (under 100%), indicates churn exceeds expansion. Action: Improve product, customer success, or pricing.

Pricing and Packaging Optimization

Tracking ARR by pricing tier identifies opportunities.

Scenario: SaaS with 3 tiers (Starter 50 euros/month, Pro 200 euros/month, Enterprise 1000 euros/month).

ARR distribution:

  • Starter: 400K ARR (200 customers) - 33% ARR
  • Pro: 600K ARR (250 customers) - 50% ARR
  • Enterprise: 200K ARR (17 customers) - 17% ARR

Insight: Starter and Pro dominate. Opportunity: Expand Enterprise (higher ACV, lower relative CAC), or introduce intermediate tier to capture Starter upgrades.

M&A and Due Diligence

In SaaS acquisitions, ARR is key valuation metric. Due diligence verifies:

  • ARR quality: % from annual vs monthly contracts (annual more stable)
  • Churn rate: Logo churn and dollar churn (net revenue retention)
  • Concentration risk: % ARR from top 10 customers (over 50% is risk)
  • Expansion potential: Historical upsell/cross-sell

An acquirer pays premium for “high-quality” ARR: Long-term contracts, low churn, diversified.

Practical Considerations

ARR vs GAAP Revenue

ARR is not an accounting-recognized metric (not GAAP). Differences:

GAAP Revenue: Follows accrual principle. Annual contract of 12K paid upfront is recognized at 1K/month (deferred revenue).

ARR: Counts entire annual contract immediately (12K ARR when signed).

This creates discrepancies. A company can have growing ARR but flat GAAP revenue (if contracts are new and revenue is deferred). For investors, ARR is leading indicator; GAAP revenue is lagging.

Best practice: Report both. Public SaaS like Snowflake present ARR in shareholder letters, GAAP revenue in financials.

Usage-Based Revenue and Hybrid ARR

Consumption-based models (AWS, Snowflake) complicate ARR. Approaches:

Committed ARR: Only contractual minimum commits (e.g., customer commits 100K/year). Excludes overage.

Trailing ARR: Annualize last 12 months of usage. Formula: (Last 12 months revenue). Forward-looking but assumes constant usage.

Hybrid: Separate subscription ARR (fixed) from consumption revenue (variable). Report separately.

Snowflake uses “Product Revenue” (includes consumption) as ARR proxy. Databricks reports “Annual Contract Value” (committed + expected usage).

Multi-Year Contracts and Normalization

Multi-year contracts must be normalized. Example: 3-year contract for 300K total.

Approach 1 (Total Contract Value annualized): 300K / 3 = 100K ARR.

Approach 2 (Year 1 only): If contract has escalation (year 1: 80K, year 2: 100K, year 3: 120K), ARR = 80K (conservative).

Best practice: Use approach 1 (average annualized) for simplicity, disclose assumptions.

ARR by Segment and Geography

Segmenting ARR reveals dynamics:

  • By customer segment: SMB, Mid-Market, Enterprise
  • By geography: EMEA, Americas, APAC
  • By product: If multi-product (e.g., Slack + Salesforce)

A company discovers 70% ARR from SMB, but SMB churn is 25% vs 5% Enterprise. Strategy: Shift focus to Enterprise for long-term ARR stability.

Common Misconceptions

”ARR is the Same as Bookings”

No. Bookings is total value of signed contracts (includes one-time + multi-year). ARR is annualized recurring value.

Example: 3-year 300K contract + 50K setup.

  • Bookings: 350K
  • ARR: 100K (300K / 3, excluding 50K one-time)

Bookings are leading indicator (sales pipeline), ARR is current state of recurring business.

”ARR Growth is the Only Important Metric”

ARR can grow while burning unsustainable cash. Need to balance with efficiency metrics:

Rule of 40: ARR growth rate % + profit margin % ≥ 40. Example: 60% growth + (-20)% margin = 40 (acceptable).

A company with 100% ARR growth but 10x burn multiple is unsustainable. Need path to profitability.

”High ARR Means Healthy Business”

ARR is backward-looking snapshot. Need forward analysis:

  • Churn trend: If churn accelerates, future ARR is at risk
  • Customer concentration: If 50% ARR from 3 customers, high risk
  • Expansion rate: If NRR under 100%, ARR unsustainable without continuous new acquisition

A company with 10M ARR but 40% annual churn must acquire 4M+ ARR/year just to maintain flat ARR. Unsustainable.

Sources

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