What is annual recurring revenue (ARR)

ARR, or annual recurring revenue, is the total revenue you expect to earn from active customer contracts over the next 12 months.

It includes annual contracts, as well as the annualized value of monthly, quarterly, or semi-annual agreements.

For SaaS companies, ARR is a key metric for tracking growth, identifying the right time to reinvest in the business, and measuring product/market fit over time.

It’s also a favorite among investors. ARR offers a high-level view of revenue predictability—making it a valuable benchmark when evaluating a company’s potential for long-term success.

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Recurring revenue is the foundation of predictable growth. It signals momentum—and strong product/market fit—when you’re bringing in customers organically, closing new bookings, and renewing existing contracts. These steady streams of revenue help build confidence in your business model and create a solid path for long-term success.

But recurring revenue means so much more than that: When it comes to SaaS valuation, investors benchmark companies around recurring revenue growth.

Here’s why your annual recurring revenue (ARR) is a critical SaaS business metric to track and how you can get the most out of it across the business.

How to calculate ARR

To calculate ARR, divide each customer’s total contract value (for recurring revenue) by the number of years in their full contract. This gives you the annual contract value. Then, sum the results to get your total revenue (in terms of ARR). The formula is:

• Total revenue of yearly subscriptions + total expansion revenue – total contraction revenue. 

For multi-year contracts, you should divide the revenue they generate by the number of years in the contract to get the average revenue per year.

The ARR formula is similar to the monthly recurring revenue (MRR) formula, except that ARR looks at yearly values instead of monthly.

While the general formula for ARR seems simple, this is one of the most complicated metrics in a SaaS business. Parsing out the nuances of your ARR logic requires a deep understanding of contract terms, pricing structure, and what should/shouldn’t roll into the calculation.

What you need to consider when calculating ARR

The focus of ARR is on yearly subscriptions, but you should break it out into its various components, including:

• ARR added from new customers
• ARR added from renewals
• ARR added from upgrades and add-ons
• ARR lost from downgrades
• ARR lost from churn

This produces the following ARR formula, which offers deeper insight into how customer segments factor into your recurring revenue stream:

When calculating ARR, accuracy matters. Be sure to exclude free trials, one-time fees (like setup charges), and one-off upgrades or installation payments—especially for customers on monthly billing. These aren’t recurring, and including them can inflate your numbers.

For monthly customers, include those amounts in your MRR instead.

In many cases, ARR and annualized MRR will align. But depending on your billing structure, ARR may come in lower—especially if you have shorter contract terms or experience higher monthly churn.

Understanding the nuances helps ensure your ARR reflects true recurring revenue.

Why is ARR important?

ARR is one of your most powerful indicators of long-term revenue predictability. It reflects the recurring revenue you can expect from your current customer base over a 12-month period—and offers a macro-level view of your business’s financial performance over time.

Unlike MRR, which can fluctuate with monthly promotions or one-off events, ARR helps highlight what’s truly recurring. Those month-to-month spikes may look promising, but if they’re not repeatable, they can’t support consistent year-over-year growth.

That said, ARR is still a snapshot—a point-in-time metric for a specific year. To get the full value from ARR, you need to track it over time and dig into the “why” behind the trends. Here’s how ARR helps you tell a broader financial story:

• Explain your company’s financial health. ARR gives a high-level view of recurring revenue efficiency and reflects how well your business is sustaining top-line growth.
• Attract investor interest. ARR is often the go-to metric for investors evaluating SaaS companies. Recurring revenue streams suggest stability and predictability, especially when backed by annual contracts. But to maintain that interest, the business needs to show progress toward profitability and responsible financial management.
• Support headcount planning and retention. As ARR grows, so does your runway. That creates room to invest in scaling—through new hires, compensation adjustments, and development opportunities for existing team members.
• Gauge customer satisfaction. Renewals, upgrades, and add-ons show that customers see continued value in your product. In contrast, churn or downgrades may point to product gaps, misaligned pricing, or shifting market needs.
• Forecast future growth. ARR plays a key role in revenue projections—especially when preparing for funding rounds. A rolling ARR model (or “ARR snowball”) can support strategic forecasting by blending MRR trends and ARR cohorts for a more nuanced, bottom-up view of your growth potential.

Download the expert-built ARR snowball model for top-line planning

Key takeaways

• Annual Recurring Revenue (ARR) is a vital metric for SaaS companies, reflecting predictable revenue from subscriptions over a year. It is a key indicator of financial health, growth potential, and business sustainability.
• ARR provides a high-level view of a company’s financial efficiency, making it a critical factor for attracting investors and retaining talent through its impact on headcount planning and compensation strategies.
• Calculating ARR involves summing up total yearly subscriptions, expansion revenue, and subtracting contraction revenue. It requires careful attention to contract terms and pricing structures to ensure accuracy.
• While ARR offers a macro-level view of financial performance, it should be complemented with metrics like MRR (Monthly Recurring Revenue) and GAAP revenue for a holistic financial analysis.
• Enhancing ARR involves reducing churn, targeting ideal customer profiles, diversifying revenue streams, and updating pricing strategies to align with market value and customer needs.

ARR vs. other metrics

At the simplest level, ARR and MRR differ by scope—annual versus monthly recurring revenue. But the distinction goes deeper than timing. Both are valuable for tracking predictability, but they serve different strategic purposes.

ARR offers a big-picture view. It helps you understand long-term revenue trends, which is why it’s often the go-to metric for investors. ARR supports strategic decisions around growth, headcount planning, and runway extension—and gives insight into how well your recurring revenue can sustain the business over time.

MRR zooms in. It’s useful for tracking short-term momentum—month to month or quarter to quarter. MRR is especially helpful for teams looking to tie revenue performance back to operational levers, like sales cycles, marketing campaigns, or customer experience initiatives.

When it comes to GAAP reporting, both ARR and MRR operate outside the formal accounting framework. They’re forward-looking metrics based on subscription commitments, not necessarily actual payments. GAAP revenue, on the other hand, reflects earned revenue—what’s been delivered and recognized, regardless of when it was billed.

For example, ARR might include a signed contract for $120,000 over 12 months, but GAAP requires that revenue to be recognized incrementally, as the service is provided.

So while ARR and MRR aren’t GAAP-compliant, ARR can serve as a directional signal for future recognized revenue—just with the caveat that it includes committed, not necessarily realized, revenue.

<<Get your numbers right with the SaaS metrics cheat sheet.>>

The limitations of ARR as a financial metric

ARR is arguably the most important financial metric for SaaS companies — but that doesn’t mean you can look at it in a vacuum.

Like most SaaS metrics, ARR only becomes meaningful when viewed in context. On its own, it can paint an incomplete picture. Here are a few common limitations to keep in mind:

• It doesn’t show efficiency. Relying solely on ARR to assess financial health can lead to a “growth-at-all-costs” mindset. Pair it with operational metrics—like burn multiple or CAC payback—to get a more accurate view of sustainable growth.
• It doesn’t highlight retention. ARR includes renewals and upsells, but it doesn’t tell you how well you’re retaining customers. Add net revenue retention (NRR) and churn data to get a clearer sense of customer loyalty and long-term value.
• It isn’t a GAAP-defined metric. ARR is a useful internal metric, especially for private SaaS companies. But for mature organizations—especially those preparing for IPO—ARR won’t meet financial reporting standards under GAAP, and will need to be supported by more formal revenue recognition practices.
• It doesn’t reflect revenue timing. Even with a solid grasp of ARR, your revenue picture is incomplete without accurate revenue recognition. For example, GAAP requires you to recognize earned but unbilled revenue, even before payment is received. That’s why visibility into billing and collections is so important for financial clarity.

4 ways you can improve your ARR

Improving ARR means looking deeply into retention and operational efficiency strategies. By collaborating with the sales, marketing, and customer success team, you gain a sense of the “why” behind the numbers.

Conducting a customer cohort analysis for these long-term customers gets into the “why” and illuminates patterns in customer satisfaction (both in regards to renewals and churn) that spur the following improvements into actionable insight.

1. Reduce churn

Churn tied to ARR can have a deeper impact—especially when customers commit for 12 months or more. While finance can’t prevent churn directly, it plays a key role in uncovering why it happens by partnering with sales and customer success.

If churn stems from product limitations, customer success can work with product teams to prioritize key updates. On the sales side, improving product-market fit starts with truly understanding customer needs at the time of signing—and making sure each customer is aligned with the right solution from day one.

Collaboration here is key to long-term retention.

2. Market toward ideal customer profiles (ICPs)

As sales evaluates ICPs for product/market fit, the marketing team also needs to evaluate the type of customers they attract to build the pipeline. Churn ARR provides insight into what channels bring in unsuccessful customers, while expansion ARR showcases opportunities to attract similar customers.

3. Differentiate revenue streams

If your company offers different platforms, tiers of functionalities, and additional products, it’s easier for sales to offer upgrades and add-ons for interested customers. Of course, these upgrades and add-ons can’t be on a monthly basis — for them to factor in ARR, the customer must commit to them for the duration of the annual contract.

4. Update your business model and pricing strategy

Subscription pricing can offer predictability—but does your price reflect the value you deliver and what the market expects? Revisiting your SaaS pricing strategy is a smart way to stay aligned with your value proposition and competitive landscape.

For example, Fivetran shifted from a flat subscription model to a usage-based approach with tiered pricing. By charging based on “rows” synced, the model better reflects how customers actually use the product—and its long-term value.

Strategic price changes can also shorten your CAC payback period, helping you reach profitability faster.

See your ARR in seconds with strategic finance software

Your customer relationship management system (CRM) can house your customer data, but it won’t automatically categorize your revenue streams as recurring or non-recurring, and it certainly won’t help you track the changes in your ARR and MRR or help you understand the how and why behind those changes.

Your enterprise resource planning (ERP) system stores your generally accepted accounting principles (GAAP) revenue calculation. But since ARR is a non-GAAP term, it’s not easy to track in an ERP.

The point is: There’s no canonical system to track your ARR. These metrics are most likely tucked away in a spreadsheet that’s tracked by one or two people at your company, and they’re almost always stale, rearview-mirror calculations that offer little in the way of workable insight.

Strategic Finance platforms that integrate with your source systems can automatically calculate your ARR based on contract dates. They often also compare your GAAP revenue against your ARR so you can quickly understand the difference between them. And they track changes in your ARR to show how it grows and contracts in real-time. Learn how strategic finance software can help CFOs and finance teams by checking out HiBob.

Annual recurring revenue FAQs

What is the difference between total revenue and ARR?

The total dollar amount coming into a business is revenue, while a company’s ARR is the amount of revenue generated by annual subscriptions. While revenue is a GAAP accounting metric, ARR has to be modeled out according to a revenue recognition schedule to meet GAAP requirements. ARR is an important metric to evaluate the health of your business based on the predictable revenue of long-term subscriptions.

What is the difference between ARR and MRR?

Although ARR and MRR both describe recurring subscription revenue, annual revenue from subscriptions is the better metric to evaluate your company’s big-picture growth goals and sustainability. MRR, on the other hand, can better describe the short-term impact on revenue by marketing campaigns or efforts to increase operational efficiency.

What is the difference between ARR and annual profit?

Annual profit refers to the total amount of profit generated over the course of a year, while ARR refers to the amount of revenue generated from subscription contracts over the course of a year. The difference between the two is that annual profit is a profit-based metric while ARR is revenue-based (see our article on how revenue is different from profit for more), and ARR solely includes income generated from subscription contracts, while annual profit includes all company income.

What is a good ARR growth rate?

A “good” ARR growth rate will vary significantly based on a company’s growth stage and current ARR. Earlier-stage companies are expected to have a higher ARR growth rate than later-stage companies. According to a Capchase analysis of 439 SaaS companies between 2020 and 2021, a company with less than $15 million in revenue needs 100 percent + YoY ARR growth to be in the top quartile of companies globally. Median ARR growth for companies of that size was 40-60 percent.