Last editedMay 20233 min read
For business owners, there is a wide range of different financial and performance metrics that you need to get your head around. One of these that is particularly relevant for companies that accept recurring or subscription payments is annual recurring revenue, also known as ARR. But what is ARR, exactly? And where can you learn how to calculate ARR?
In simple terms, annual recurring revenue is a term that is used for subscription-based businesses to show the amount of revenue that is committed and recurs on an annual basis. Basically, it’s how much revenue a company expects to receive from its customers, based on the number of subscriptions and the price of these subscriptions.
Keep reading to find out more about ARR and how to calculate ARR.
What is ARR?
As previously mentioned, annual recurring revenue is a measure of the amount of money that a subscription-based business expects to receive from its customers on an annual basis. It’s not to be confused with the accounting rate of return, which is also referred to as ARR. The figure is related to monthly recurring revenue, since it is a 12-month accumulation of this figure.
Why is annual recurring revenue important?
Now that you know the annual recurring revenue definition, you might be wondering about its importance and what it actually means for a business. It’s one of the most important metrics for understanding your company’s current financial standing and whether you’re meeting your growth goals, making the implementation of recurring revenue models essential for companies that utilize a recurring or subscription-based pricing strategy.
ARR is a tangible way to see whether you are progressing and if the changes you make to your company have a direct impact on your revenue. In addition, once you have been calculating annual recurring revenue for several years, you will be able to easily forecast future revenue and make more informed business decisions.
As well as telling you whether you’re meeting your goals, it also helps you to set realistic and achievable goals for your business. With a better idea of which actions have a greater effect, you will be able to choose goals that are ambitious yet within reach.
How to calculate annual recurring revenue
If your company uses a subscription-based business model, it’s important to understand how to calculate annual recurring revenue. In order to do this, you need to know a few important figures:
The total monetary value of annual subscriptions in dollars.
The amount of additional ongoing revenue, which includes training, support and installation, in dollars.
The total dollar amount of churn, which refers to the amount of money that is lost through subscription cancellations. If you need a refresher course on the difference between customer retention and churn, be sure to check out our handy guide to the subject.
To calculate net annual recurring revenue, you should add annual subscriptions to additional ongoing revenue, before subtracting churn. The annual recurring revenue formula is therefore as follows:
ARR = Annual Subscriptions + Additional Ongoing Revenue – Churn
How can you improve annual recurring revenue?
If you know how to calculate annual recurring revenue, the next logical step is to think about how you could improve this figure. There’s no singular solution for all businesses, so it’s a case of trying out different strategies to see which has the best effect for your company. Some of the approaches you can adopt include:
Aiming to attract more customers through investing in your sales and marketing campaigns. Consider how you can best reach and appeal to your target customer base to drive your annual subscriptions.
Increase your average revenue per user by reconsidering your pricing plans. If you increase the subscription amount, you increase the amount of revenue you get from each user. The danger here is that you can lose out to cheaper competitors if your prices are too high.
Improve retention by providing high-quality services and customer care. This reduces the churn rate and serves to keep your annual retention rate as high as possible.
Use GoCardless to collect recurring bank-to-bank payments. GoCardless enables you to collect 97.3% of payments at the first instance, while you can also use our Success+ tool to automatically collect on payments that fail. Combining the strength of bank debit with the agility and security of open banking, GoCardless gives you the best chance of reducing payment failure and collecting on your recurring payments when they’re due, helping to improve your annual recurring revenue figure and providing your business with an optimized payments process.
We can help
GoCardless is a global payments solution that helps you automate payment collection, cutting down on the amount of financial admin your team needs to deal with. Find out how GoCardless can help you with one-off or recurring payments.