Annual Recurring Revenue (ARR): Calculation and Examples

Revenue that a company expects to generate on a normalized annual basis

Written by CFI Team

Reviewed by Jeff Schmidt

Read Time 5 minutes

What is Annual Recurring Revenue (ARR)?

Annual Recurring Revenue (ARR) is the total predictable subscription-based revenue a company expects to earn each calendar year. ARR is a key metric for companies that operate on a subscription or contract model, such as SaaS businesses.

Unlike one-time payments or short-term deals, ARR reflects ongoing contracts and subscriptions that renew on an annual basis, providing a clear picture of sustainable revenue.

Annual Recurring Revenue

Key Highlights

ARR measures the total value of recurring subscription revenue that a company generates over a 12-month period.
Calculate a basic ARR by multiplying Monthly Recurring Revenue (MRR) by 12 or use the comprehensive formula: ARR = Sum of Annual Subscription Revenue + Expansion Revenue – Contraction ARR – Churned ARR.
ARR differs from total annual revenue by including only predictable, recurring subscription revenue.

How to Calculate Annual Recurring Revenue

ARR represents the recurring revenue a subscription business generates on an annual basis. Conceptually, ARR can be thought of as the annualized monthly recurring revenue (MRR) of subscription-based companies.

Method 1: The Basic ARR Formula

The basic for calculating annual recurring revenue is:

Annual Recurring Revenue (ARR) = Monthly Recurring Revenue (MRR) × 12

Example:

Imagine a SaaS company sells five-year subscriptions to 50 customers with monthly payments of $100 per customer. You calculate the ARR using the basic formula:

ARR = Monthly Recurring Revenue (MRR) × 12

ARR = (50 x $100) × 12

ARR = $60,000

This basic formula is useful when you need a quick snapshot of a company’s annual recurring revenue. For a more detailed view, use the comprehensive ARR formula in Method 2.

Method 2: The Comprehensive ARR Formula

The comprehensive formula for Annual Recurring Revenue (ARR) formula is:

ARR = (New ARR) + (Expansion ARR) – (Contraction ARR) – (Churned ARR)

Where:

New ARR is revenue from newly acquired customers.
Expansion ARR is additional revenue from existing customer upgrades, upsells, or increased usage.
Contraction ARR is reduced revenue from subscription downgrades or seat reductions.
Churned ARR is revenue lost from canceled subscriptions.

Example:

A subscription software company starts the year with $400,000 in ARR. During the year, the company:

Signs 20 new customers with $5,000 annual contracts, adding $100,000 in new ARR.
Generates $50,000 in expansion ARR from customers upgrading to higher-tier plans.
Experiences $20,000 in contraction ARR when some clients downgrade their subscriptions.
Loses $30,000 in churned ARR as a few customers cancel altogether.

Using the comprehensive formula:

ARR = Current ARR + New ARR + Expansion ARR – Contraction ARR – Churned ARR

ARR = $400,000 + $100,000 + $50,000 – $20,000 – $30,000

ARR = $500,000

At the end of the year, the company has $500,000 in ARR reflecting a year-over-year growth rate of 25%.

Why ARR Formulas Can Vary

There isn’t a single universal formula for Annual Recurring Revenue (ARR). Companies adapt the calculation based on their contract structures, billing cycles, and reporting needs. What counts as “recurring” revenue can look different depending on the business model.

Key factors that make ARR vary:

Billing terms: Some businesses bill monthly, others annually, and some lock in multi-year deals. Each must normalize those into a yearly figure differently.
Revenue inclusions: Many companies exclude one-time fees like implementation costs, while others may include consistent annual maintenance or add-ons.
Customer changes: ARR can shift if customers upgrade, downgrade, or churn. Some companies update ARR to reflect these changes immediately, while others track only current active contracts.
Audience: For internal reporting, ARR is often calculated conservatively. For investors, it may include signed deals that haven’t started billing yet to show growth momentum.

The most important part isn’t which exact formula is used — it’s consistency. A business should clearly define how it calculates ARR and use that method the same way across all reports and presentations.

ARR vs. Monthly Recurring Revenue (MRR)

The main difference between ARR and Monthly Recurring Revenue (MRR) is the measurement period. ARR gives a long-term view of recurring revenue, while MRR highlights short-term revenue expectations.

Whether a company reports Annual Recurring Revenue (ARR) or Monthly Recurring Revenue (MRR) often depends on the company’s size, contract structure, and reporting needs.

Here’s why:

Companies with longer contracts (annual or multi-year) usually report ARR. SaaS businesses that sell to enterprises often sign annual or multi-year deals, so ARR gives a clearer picture of stable, predictable revenue. Investors also tend to prefer ARR because it reflects long-term commitments.
Companies with shorter contracts (monthly subscriptions) often use MRR. Startups or businesses selling to individuals or small businesses may rely on monthly plans. In this case, MRR is more useful because it highlights short-term trends, customer churn, and rapid growth or contraction.
Internal vs. external reporting: Finance teams may track both. MRR is helpful for spotting changes quickly, while ARR communicates long-term stability and is more compelling for board reports or investor updates.

Example:

A streaming service with millions of $10 monthly subscribers would track MRR to manage churn and short-term growth.
A SaaS company selling $120,000 annual contracts to enterprise clients would track ARR to measure revenue retention and growth across years.

What Is Annual Recurring Revenue Used For?

ARR serves four primary strategic purposes: growth measurement, business model validation, revenue forecasting, and investor communication.

1. Growth Measurement and Benchmarking

The predictability of annual recurring revenue (ARR) makes it a reliable metric for tracking a company’s revenue growth.

Companies use ARR to measure year-over-year progress and compare performance against their own historical results.
Investors and analysts use ARR as a benchmark to compare companies of similar size or within the same sector.

Because ARR reflects only recurring revenue, it highlights the sustainability of growth more effectively than total revenue.

2. Business Model Validation

Unlike total revenue, which considers all of a company’s cash inflows, ARR evaluates only the revenue obtained from subscriptions. Thus, ARR enables a company to identify whether its subscription model is successful or not.

3. Revenue Forecasting and Planning

Similar to MRR, ARR is commonly used for revenue forecasting. The metric is commonly referred to as a baseline, and it can be easily incorporated into more complex calculations to project the company’s future revenues.

4. Analysts and Investors

Investors and analysts rely on ARR for valuation multiples and company comparisons. Consistent ARR growth demonstrates business model strength and market traction.

Recap: Annual Recurring Revenue (ARR)

Annual recurring revenue (ARR) measures predictable subscription revenue on a yearly basis. ARR is calculated by multiplying monthly recurring revenue (MRR) by 12 and adjusting for expansions, churn, and downgrades. It helps companies track growth, validate their business model, and forecast future revenue.

FAQs: Annual Recurring Revenue (ARR)

What is the formula for ARR?

The formula for annual recurring revenue (ARR) is:

ARR = Monthly Recurring Revenue (MRR) × 12

To make the calculation accurate, companies adjust this number by adding revenue from new subscription revenue and customer upgrades and subtracting revenue lost from downgrades or churned subscriptions.

Does ARR include one-time fees?

No. ARR excludes setup costs, consulting fees, and other one-off sales since they are not recurring.

What’s the difference between ARR and MRR?

ARR shows recurring subscription revenue on a yearly basis, while MRR shows it monthly.

Why is ARR important for SaaS companies?

ARR provides a clear view of sustainable revenue, helping management plan for growth and investors evaluate long-term stability.

How do investors use ARR?

Investors use ARR to compare SaaS companies, evaluate growth rates, and assess business model strength.

Additional Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)® certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful: